Teach Your Kids About Stocks - Dividend Yields

In honor of Financial Literacy Month, we continue today with an exercise parents can do with their kids to learn about stocks.

Bonds pay interest and stocks pay dividends. Bond interest is usually a fixed percentage of the principal amount and has to be paid as scheduled - otherwise a company may be forced into bankruptcy. Dividends on the other hand may or may not be paid and they can be increased or reduced.

If we put on the hat of the CFO (Chief Financial Officer) of a company we realize that he or she has a choice on what to do with profits earned by the company. They can be reinvested in the company  or they can be paid out in dividends to the owners, that is the stockholders.

As investors we are interested in the dividend yield of stocks for a few different reasons. Dividends act as a cushion when the stock market drops and are therefore stocks that pay dividends are generally considered less risky than non-dividend paying stocks. Dividends provide an income stream to investors who are in retirement and living off of their investments. Many dividend stocks today actually yield more than bonds and have the likelihood of increasing their dividend over time. Simply stated, investors would rather have a stock like Johnson & Johnson (ticker = JNJ) that pays a dividend of $2.28/share to yield 3.50% than the 10 year U.S. Treasury note that yields 2%.

Not only does JNJ have the higher yield but it also has the potential to raise the dividend payout significantly over the next 10 years, Keep in mind, however, that JNJ is riskier than the U.S. Treasury note - what we are describing here is the basic risk/return trade-off.

After reading the posts of the last 2 days it should be easy for you to find the dividend and yield of any stock. Just go to the Yahoo Finance site described in those posts and you'll find, for example, the yield discussed here:

Source: Yahoo

CLICK IMAGE TO ENLARGE  Take the dividend (2.28) and divide by price(64.20) to check the yield calculation. If you follow the procedure to get historical prices that we looked at on Monday you can actually see the quarterly dividend payouts. It would be a good exercise for a young person to write-up the process of getting the actual dividend payouts for a stock (Coca Cola say) for the last 2 years.

Investors, as you might imagine, keep track of which stocks have increased their dividend over a long period of time. These are called "dividend aristocrats".

Today dividend investors are fortunate because there are a number of good blogs devoted to dividend investing. They do excellent research and give the dividend investor good ideas. Here are a couple I follow:

• Dividend Ninja
• The Dividend Pig
• Dividend Growth Investor

To me one of the best ways for the DIY investor to participate is with dividend exchange traded funds. They provide you with immediate diversification. Some I use are DVY, SDY, and SCH . Using the method described yesterday  find the 5 top holdings in these funds and compare their yields.

Disclosure: I own some of the stocks and exchange traded funds mentioned in this post. It is intended for educational purposes only. Individuals should do their own research or consult a professional before making investment transactions.

How to Analyze a Dividend Stock

You've read about the attractiveness of dividend paying stocks, especially in an environment of historically low interest rates. As a do-it-yourself investor you want to pick your own stocks. How do you analyze this sector?

Fortunately, you don't have to reinvent the wheel.  At your fingertips are some really great approaches. Here's one by "Dividend Growth Investor" as revealed in his analysis of  3M. These are some of the things he looks at:

• sector (important to ensure that diversification is kept at the forefront)

• is it a "dividend aristocrat" ? (member of the S&P 500 that has longevity and consistency in raising dividends
• major competitors (GE et. al.)
• annualized return over 10 years ( 8.6%...double investment in 8.4 years!)
• earnings per share growth rate for current year and 12 months ahead (graph of earnings per share)
• return on equity over 10 years (graph - shows return has consistently exceeded 27% over the decade)
• dividend payout over 10 years (graph )
• dividend payout ratio ( sustainability indicator)

There is much more in his analysis including important commentary on 3M's R&D spending, entry level target etc. All-in-all Dividend Growth Investor provides an excellent approach to analyzing dividend stocks. 

As always I recommend limiting investments in single names (stocks and bonds combined) to 5% or less of investable assets.

Disclosure: This post is intended solely for educational purposes. Individuals should do their own research or consult professional advice before investing.