Anthony Speciale Stock Market Analyst

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The big myths about high dividend investing

Speaker 1 (00:01):

Hi everyone. It’s Tim, Melvin, back once again, to talk about, about a better way to wealth. Now, the day I want to talk about the myths of high dividend investing. You can’t even look on the internet or any of the financial newspapers without seeing ads for dividend investing and that, you know, just talking about how great dividends are now, let me be straight. I love dividend paying stocks. I always have. I always will. If you remember, when we talked about how there’s the 4% rule, the stocks that provided all of the wealth, one of the characteristics, the big winners had was they paid out a steady and growing dividend. I love dividends. However, all dividends are not created equal. In fact, a lot of dividends are not building value. They’re destroying the value of the company. That’s paying the dividend to you. And here’s why, what we call payout ratio is so critically important.

Speaker 1 (00:58):

Now pay our payout ratio is simply pairing the cash amount of the dividend to the amount of earnings per share that the company is earning. If the dividend payment is greater than earnings, there’s probably a problem here. It’s hard to pay out more than you earn. Now. One thing I like to do is I like to use the free cashflow numbers to make the comparison, instead of just earnings per share, it allows me to get a little deeper and it gets us around any accounting fraud or tricks. Well, let’s just call it a good accountant. Can make the earnings per share, be any number that he or his boss wants it to be. It’s a lot harder to do that with the free cashflow number. So again, if the dividends hired in the free cashflow number, they’re actually returning the value of the company to you.

Speaker 1 (01:48):

They’re destroying the underlying value of the business by paying that dividend. Now, now why would they do such a thing? Well, the biggest reason is if you cut that dividend retail investors are going to dump the stock, they’re going to dump the stock real fast. Retail hates a dividend cut. So to some institutional investors, but for some reason we retail folks, we seem to be the most guilty of all dumping stocks when when dividends got now, right? That does, by the way. And we’ll talk about this more in the future can create in a normal buying opportunity. If you get one of those higher yielding stocks that cuts its dividend, because it’s not covering it with free cash flow, that’s a sign of extreme honesty and fiscal prudence on the part of management. You’ve probably got really good management here. That’s being punished for doing the right thing.

Speaker 1 (02:47):

Okay. When you find those instances and they’ve cut the dividend back to levels where free cash flow per share actually covers it and leaves enough money to run the business. That’s good management doing the right thing. And we want to give consideration to buying the stock on that. Sell-Off but that’s just such set a topic for a whole nother day. What, where do we really see the most examples of these? Because there are certain segments of the model market where companies destroying value through dividends are more common. You’ll be shocked to know that they’re in areas that wall street loves to sell to individual investors. Because look, people love dividends. People in some cases need those dividends to support their retirement you know, to support their lifestyle, to send their kids to college. They’re counting on those dividends wall street finds dividends very easy to sell to individual investors.

Speaker 1 (03:47):

So where do we see these problems popping up? The most master limited partnerships, which are sold 100% based on dividend yield and the potential to grow that dividend to individual investors, real estate investment trusts, exact same story. They’re sold on the basis of yield. People love to buy them. They kind of stand in line to buy them so to speak. And then finally business development companies, which are fairly new development in area of the market, which I love. And we will be talking a lot more about in the future because there’s some wonderful wealth building opportunities there. However, there’s also a lot of companies in there that are not covering their dividend with free cashflow. They’re not bringing and the door to support that payment. So every penny they’re paying you out in the form of a dividend is reducing the net asset value of the company.

Speaker 1 (04:43):

It’s literally destroying the value of the business, that case it’s not a great dividend. So you really have to be careful about these folks. When you’re looking at a dividend situation, whether you found it on your own or a broker brought it to you. So folks, you really have to be careful when you’re looking at dividend stocks. It doesn’t matter if you found the stock on your own or a broker bought it to you. You really have to be careful with these higher dividend paying stocks, check the free cashflow, make sure it’s covering the dividend. Don’t just look at the most recent quarter, go back a couple years, make sure it’s consistently covering it. You know, you can like you can miss once in awhile, for instance, in the first quarter of 2020, nobody was earning their dividends. Phillip Morris wasn’t earning their dividends because everything had just kind of gone flowy, but yeah, they were covering it again by the next quarter. So go back, look at the last couple of years, make sure management’s doing the right thing and matching that dividend pal to the free cash flow. The company is producing. So you don’t buy what I call a destructive divot. Joey I’m 10 Melvin. Thanks for watching. Be sure to come back tomorrow because I’m going to provide you with the list of three of these destructive dividend stocks.