In Today’s reprint of Thomas’ Rebel Income newsletter ($1,164 annual subscription), he discusses the often overlooked but incredibly important role dividends play in your overall returns.
As you’ll see, over the last 25 years, $1 invested in 1990 has grown to almost $10 today including dividends. Whereas that same $1 without dividends has only grown to $6. That’s a 40% difference in overall wealth creation.
In the Rebel Income picks, Thomas always looks to sell put options on fundamentally solid companies that pay strong dividends, since dividends are the single best indicator of true company strength.
Furthermore, a healthy dividend makes it much easier to hold onto stocks, which have been assigned, even if the stock price drops a fair amount below the strike price of the original put option.
And finally, your overall long-term returns will be much higher once the stock price recovers, and the stock is either sold or called away because of a subsequent covered call trade recommended by Thomas on stocks which have been assigned.
This three-prong approach is really what sets the Rebel Income system apart from just about any other income generation system. You have the opportunity to get paid 3 or more times on the same stock.
First from the initial put sell, second from collected dividends, third from covered calls, and finally any capital appreciation on the stock itself.
I believe this is why Thomas has generated near 30% returns over the last two years turning every $100K into $171K as compared to only $112K investing in the S&P 500.
Week 5: The Misunderstood Role of Stock Dividends
If you’re a student of the stock market, you look for as much information as you can find about different investing methods and systems. Books, newsletters, videos, seminars, classes – you may not use them all, but even if you learn something you don’t end up using, it’s all useful, because it expands the scope of your knowledge, your perspective about the market’s many different possibilities, and your understanding of what fits you best.
One of the things I’ve found interesting over my more than two decades of studying and investing in the stock market is the role dividends can—and in my opinion, should—play in a successful investing system. Directional trading strategies, which usually emphasize relatively short-term trades based on price swings from low to high points that might last anywhere from a few weeks to a few months, tend to ignore dividends altogether, since in many cases you might not actually hold a stock long enough to be counted for a dividend distribution. The same is true of directional investing strategies that focus on equity options, since buying and selling call or put options on a stock will rarely translate to actual ownership of that stock.
Kinds of Stocks that Pay Dividends
Long-term investing concepts usually differentiate between stocks based on the underlying company’s size and scope of business, how much their business has grown in the past and what analyst’s forecast of future growth is likely to be. Large, established and easily recognized companies, like General Electric Co. (GE), Caterpillar Inc. (CAT), and Microsoft Corp (MSFT) among others are referred to as blue-chip stocks; these stocks are usually included in the major market indices including the Dow Jones Industrial Average and the S&P 500. Medium-sized businesses who have been successful at building their businesses but have not yet reached the status or size of a blue-chip stocks are usually called mid-caps, and smaller, up-and-coming companies are called small caps. Depending on how aggressive or conservative you want to be as a stock investor, these different categories present various levels of opportunity as well as risk. Small-cap stocks, who usually have the largest scope of opportunity to grow, generally provide the largest overall growth potential, with mid-caps coming in next, and blue-chips last, since these stocks already have become the 600-lb. gorillas in their respective industries and sectors. In the same way, blue-chips are usually considered to be the safest overall long-term investments, while small-cap stocks are far more speculative since a minority of these up-and-comers ever actually fulfill their potential.
One of the other reasons that blue-chip stocks are considered to carry a higher level of safety comes from the fact that most of them pay a regular dividend to their shareholders. Why do some stocks pay dividends while others don’t? Because companies are naturally allowed to decide what they want to do with their profits. What they actually do with those profits can tell you a lot about the strength of the business and what management thinks about the future. Dividends are one of the simplest and most transparent means companies have to return a portion of their profits back to their shareholders. Smaller, less-established stocks often don’t pay a dividend simply because their profitability can be widely variable from one year to the next. Dividends have to be approved by the company’s board of directors, and they won’t be likely to commit to pay out a portion of their profits if they don’t believe they will be able to maintain a level of profitability that is higher than the dividend.
The most common line of thought suggests that a stock shouldn’t begin to pay a dividend until the business has reached a size and scope of business that makes a dividend easier to maintain. Microsoft Corp, for example, didn’t pay a dividend to its shareholder for almost 20 years after their initial public offering in 1986 despite their domination of the software industry and the mountains of dollars they held in cash. When they finally declared their first dividend in January 2003, MSFT held more than $43 billion in cash; their initial dividend payout was only $864 million of that amount, or about 1.8% of their total cash. To me, this is a good example of why identifying stocks that pay a dividend—even a small one—is so important; it says a lot about management’s confidence in their business as well as recognizing the important role shareholders play in their overall success.
Another interesting aspect of dividends is that while blue-chip stocks are the most likely places you’ll find attractive dividends, it also isn’t unusual to find mid-cap and in some cases, even small-cap stocks that have committed to a consistent dividend payout. I think there is a lot of power in finding these types of stocks, which are even more in the minority than their larger brethren; most of these companies prefer instead to reinvest their profits in their business to keep driving growth. Those that do decide to pay a dividend, in my opinion, are communicating a different level of confidence in themselves and future of their business than those that don’t. They are using the dividend payout to attract shareholders that can buy in to their long-term plan and prospects, which I think is a smart thing. That’s why you’ll see me write about stocks like SLCA, CBI, GME and others as I find them and they meet my other fundamental criteria.
The Real Impact of Dividends Over Time
The fact of the matter is that on an historical basis, dividends have always made up a significant piece of the overall returns the stock market has achieved for decades. As of now, the average dividend yield for all stocks that make up the S&P 500 is 2.02%; the average yield for the past 25 years isn’t too far from that same level, at 2.07%. Over the same period, the index itself has returned an average 11.29% return. If you take dividends out of the equation, that annual return lowers to only about 9.22%. What does that mean in real dollars? Including dividends, $1 invested in January 1990 would grow to almost $10 today; but without dividends, it only grows to a little less than $6. That’s a 40% difference over the last 25 years, and it’s a major reason I include dividends in the criteria I apply to my income generation system.
I get emails quite often from subscribers asking me when I’m going to get out of a stock I’ve been assigned from a put sale that has seen a major drop from the price I was assigned at. My general answer has always been that as long as I see the stock’s fundamentals holding, I will continue to wait for the stock’s price to recover back to my assignment price; my analysis of the company’s business strength still confirms my belief that the value of the stock should be higher than my assignment price. I also want to continue to hold the stock because when it does recover, I should be able to find opportunities to generate even more income with covered calls. Both of these statements are true; but another reason I don’t mind holding these stocks even for an extended period of time is because of the fact I can draw dividend payments from them. Those dividends are extra income I don’t have to do anything to get except to hold the stock before and through the announced ex-dividend date.
It’s true that in general, I don’t expect to hold a stock long enough to see an entire year’s worth of dividend payments on it; even so, the fact that I can enhance my ability to generate income—even if by just a few cents per share—by doing nothing more than emphasizing dividend-paying stocks in my screening process is more than worth the trouble. It is also one more layer of protection I can add to my system, since I can also lower my overall cost in a stock by the per share amount of the dividend.
Dividends vs. Stock Buybacks
Tech stocks, in particular have historically chosen a slightly different tack over paying dividends, which is to implement a large-scale stock buyback program. The result is that shareholders hold fewer shares than before, but also see an increase in the stock price; the increase in buying activity over time will also often create an extra wave of bullish enthusiasm for the stock that inflates the price even higher than the buyback alone would yield. I prefer to look for stocks that pay a regular dividend because it signifies a greater commitment to return value to shareholders on a consistent basis; stock buybacks are really about letting the company maintain flexibility and control over your shares, since the timing of buybacks, how large they are, and what they mean to you is at their complete discretion. With a dividend, you get to decide what to do with the money; you can spend it at your discretion, or you can invest in back in the stock or the market at large.
Another element that can also make a company more attractive from a fundamental standpoint is whether their dividend payout has grown over time, remained static, or decreased. Ideally, dividends should grow as profitability does, and more proactive companies do this either by increasing their regular dividend or by issuing a special dividend on an annual basis. If I’m trying to decide between two different fundamentally strong stocks, this can be a way to delineate between them. Be aware, though that the dividend itself is the main criteria for my income trading system, even if the company has not increased its payout. I also don’t place a lot of emphasis on the size of the dividend, again unless I’m trying to differentiate from multiple candidates.
Dividends provide a strong reason to hold stocks even when they might be in a downward trend. If the company’s fundamentals remain strong, the dividend adds an element of income above and beyond my ability to write covered calls. While there certainly are undervalued, fundamentally strong stocks out there that don’t pay dividends, the presence of a dividend says a lot about that company’s management, their management style, and the relationship they maintain with their shareholders. That’s why dividends are a big part of my system.
As you can see, dividends are critical to achieving long-term returns that far outpace other investing strategies which ignore this important source of income and overall return.
Thomas’ subscribers recently got paid 9 different times on Archer Daniels Midland (ADM), by selling puts, writing covered calls and collecting dividend income.
The total cumulative return on this one trade was 15.38% in only 7 months. In today’s zero yield world, those kinds of returns are nothing short of spectacular.
We understand that at $1,164 per year, Thomas’ Rebel Income newsletter is out of reach for many investors.
That’s why a little over a year ago we asked Thomas to launch a second newsletter called Retirement Revival as a way to introduce investors to income generation through selling puts, writing covered calls and buying high dividend paying undervalued companies.
Retirement Revival is a monthly rather than weekly publication. Each issue contains one put sell recommendation and one undervalued stock pick.
As of now there are 12 open stock positions with the average gain per trade of 9.56% with one stock up more than 38% in less than a year.
Eight of these stock picks are still in our recommended buy range with several paying dividends between 4% and 5%.
The average gain per put sell has been 2.54% in less than 30 days. Compounded and annualized that works out to be 35.12%.
Thomas is currently offering new Retirement Revival subscribers a 1-year subscription at an introductory rate that’s less than you’d pay for dinner for two at a modest restaurant.
To learn more, click here.