Understand the Case for Dividends

Source: www.capitalpixel.com

It's no secret that the Federal Reserve has been on a mission to push investors into higher-yielding, riskier assets.  By pledging to hold the federal funds rate - the rate at which banks lend reserves to each other - in a range of 0 - 0.25% ( the so-called "zero bound"), they affect rates on short-term, less risky assets across the board.

Naturally, investors have found their way to both longer-term riskier bonds as well as dividend stocks.

To examine the attraction of a dividend paying stock compared to a bond, let's consider common stock for Sandy Spring Bank (full disclosure:  I own this stock), which recently announced a dividend increase (ticker SASR), and the benchmark 10-year Treasury.

Here's the announcement for SASR:

Sandy Spring Bancorp, Inc., (SASR - News), the parent company of Sandy Spring Bank, announced that the board of directors has declared a quarterly common stock dividend of $0.12 per share payable May 16, 2012 to shareholders of record on May 9, 2012. This dividend represents a $0.02 per share increase over the dividend paid in the first quarter of 2012.
Source: Global Newswire

IMPORTANT DATES

Note the record date of 5/9/2012.  This is the date the stock has to be held.  Note the payable date of 5/16/2012.  These are the 2 dates shareholders need to know.  On 5/9, the stock will go ex dividend.

There are also simple rules that affect whether the dividend is qualified or not that income investors need to know to capture lower tax rates.  Essentially the dividend will qualify if it is a U.S. stock and is held for 2 months over the 4-month period beginning 2 months before the ex-dividend date.  If you are playing it close to the vest, just call a rep at your brokerage and ask.  The tax break is what pays you to take the risk!

Returning to SASR, the .12 quarterly dividend implies a yield of 2.69% ( .48/17.87).  At the previous dividend, the implied dividend yield was 2.24% (.40/17.87).  In contrast, the yield on the 10-year U.S. Treasury note is 1.93%.  The coupon yield is 2%.

In comparing the two, a primary consideration is that there is a good likelihood that the stock dividend will be increased over time whereas the payout on the bond will remain constant over 10 years. 

The risk, of course, is that SASR stock may move a lot lower over the next 10 years.  On the positive side, if it moves higher, it is pretty much gravy for the income investor.  In contrast, the 10-year Treasury price is known for certainty 10 years hence.  At maturity it will be par, i.e. $100 per $100 principal. 


If you are interested in using stocks to generate income, you may want to follow dividend bloggers like Dividend Growth Stocks or consider dividend ETFs like SDY or DVY.

Disclosure:  I and my clients hold stocks and ETFs mentioned above.  The intent of this post is educational.  Individuals should do their own research or consult a professional before investing.