1. Your Questions About Stocks That Pay Dividends
Sandra asks…
Why do some investors invest primarily in stocks that pay notable
dividends, but others minimal or no dividend
I am trying to review and determine that implications, positive and negative, of investing in
dividend paying stock versus stocks paying minimal or no dividends
Steve Winston answers:
Some people invest in dividend paying stocks because they are looking for current regular
income. A good example might be someone that's retired and needs the dividend income for
living expenses.
Stocks that pay little or no dividends are using all of their profits to reinvest in the business. If it's
a good company, that means the company will likely grow faster than it would if it was using a
lot of its profits to pay dividends and the price of the stock will go up more. The people that buy
that type of stock are those that do not need current income but are looking for an investment
that will grow in value.
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2. Donna asks…
If dividends are certain, why don't everyone invest in stocks that
pay dividends? What are the risks?
For instance, IVR pays healthy dividends every quarter. What is stopping the big guns
investing heavily in IVR? I am just learning this game, please help me understand.
Steve Winston answers:
Stocks like IVR are a problem for amateur investing because they aren't traditional corporations
producing a product or a service and then paying out a dividend from earnings. Hence
comments like "Companies that pay high dividends have flat revenue growth" just don't make
sense in this context.
IVR is a mortgage REIT (mREIT). REIT's have to pay out at least 90% of their revenue as
dividends or they lose their status as REIT's and get taxed at the corporate level (which would
destroy them as other REIT's don't pay this tax). Thus, an mREIT can't reinvest dividends into
the business and grow the business unlike traditional companies.
The business of mREIT's is to borrow money and buy mortgage backed-securities. The huge
dividends that you see are the result of the difference between the REIT's borrowing expenses
and the yield on the MBS. There is no trick to this - MBS rely on people's abilities to pay their
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3. mortgages and that's suspect right now so yields are high and borrowing costs are really cheap.
The downside is that the mREIT is making a big bet on mortgages. As the mortgage market
looks more and more shaky because economic conditions deteriorate, the MBS in their portfolio
lose value which is why the stock value has slid so much this year. There is no free lunch. MBS
pay high coupons because their credit quality or cash flows are suspect. As there are problems
with the securities the value of the stock goes down. Thus you can get a 25% dividend
(because as a REIT they have to pay it) and get a 30% decline in the value of the stock which
means the dividend didn't help you that much.
There are some questions about IVR in particular that make it offer a very high dividend. If you
like mREIT's I recommend the guaranteed ones like AGNC and NLY that seem to be aa little
more solid than IVR.
I also think that if you are simply looking at one number about a stock such as dividend yield
and thinking you should buy the stock, that you are not yet ready to buy any stocks. Every stock
has a story and you need to start by understanding the company's fundamental business model
and then deciding if that's something you want to invest in. Before you invest in mREIT's you
need to decide if leveraged investing in mortgage backed securities is something you want to
do.
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