How Dividend-Paying Stocks Are Like Tenants
Real estate investors ask, “How much income can this building produce?” In our opinion, stock market investors should too.
In real estate, people tend to invest for rental income today and the possibility for more an increased price tomorrow. But in the stock market, I’ve found that many investors focus on price and ignore the long-term potential of dividends. They’re taught to buy low and sell high—and they forget about the income opportunity between those two points. They may believe the price will go higher, or that maybe the company is on the cutting edge of some technology or breakthrough. So they wait, and hope to sell the stock for a profit later on. Some call this a “buy and hope” strategy.
Using my real estate analogy this would be like buying a 20-unit apartment building and then keeping it empty of tenants, hoping you could sell it for more than you paid maybe 10 years from now, without receiving any rental income during those 10 years. Would that make sense?
If you were looking to buy an apartment building, you’d ask, “How much rent or income can this building produce?” In real estate this is called the “capitalization rate”, or the rate of return on a property based on the income it is expected to generate. In the stock market, it’s called current yield—how much annual income the stock produces relative to its current price.
Now the next important question for a landlord might be, “Who will be living in my building?” You want to check into your tenants’ credit history, their past and present earnings, how much debt they have, and so on. Quality tenants tend to pay rent on time and will generally continue to do so even when the rent rises.
In my opinion, investors in dividend paying companies should do this too. You may be so focused on buying low and selling high that you don’t do a thorough investigation into the quality of the stock. We seek quality companies that have a track record of paying their dividend on time with a tendency to increase that dividend over time.
Instead, investors tend to open their statement, check the bottom of page 1, and ask, “What’s the value of my account?” Or they check the stock price every day on their cell phones thinking the price should be going up. We believe this behavior may be too narrow and can lead to destructive behavior. As an investor in dividend stocks, the next time you receive your statement have a look at page 2 for the income received amount to answer “Has my account produced any income, aside from a change in my principal value?”
For comparison, imagine your real estate agent calling you every day to tell you if the value of your building has gone up or down. It probably wouldn’t take you long to ask them to stop calling. The most valuable part of owning the asset are the steady rent checks.
Like rent, any income generated by dividends may arrive on a schedule. Though not guaranteed, this income typically continues while the stock prices bounce up and down. We believe that dividend income can help investors build wealth in a more stable and calculable manner than relying on the underlying stock price.
For dividend paying companies total return is part income and part price accumulation. But the income provides flexibility. You can spend income or you can reinvest it. Though dividends may seem small, they tend to add up over time.
Conceivably, not only could you receive income from a stock—much like rent—but if you buy more shares, you could be getting even more income from the company if it raises its dividend. If you are a landlord, this is akin to taking money you’d earned from rental income and buying more units. Now you would likely increase your total rental income.
With dividend-paying stocks you may benefit from compounding over time without the same considerations of rental ownership.
If you’re interested in learning more about our Dividend Investing Strategy or want to see how it might work for your portfolio, give us a call. Thanks for watching, I’m LPL Financial Advisor Pat Alfano.