Most professional traders take an aggressive stand when it comes to long-term investment strategies and point to the Enron bankruptcy, the recent case of General Motors and everyone’s favorite, the Nikkei index, conveniently overlooking Japanese Yen exchange rates for that period.
Contrary to popular belief, the best option for people investing in stocks in my opinion is the buy-and-hold strategy, especially considering stocks with good dividend returns.
Pushing the buttons and playing the stock market is extremely exciting, and it should make up 20% of your investment portfolio, because the risk involved in pushing those buttons is indeed high. The bulk of your investment should comprise stocks of market leading companies that promise high, stable dividend yields. When considering this strategy, you should bear in mind that year-on-year increases in inflation and company growth push up dividends. So if today’s dividend yield is 3-8%, that kind of return may look more attractive if you look back on past dividend trends, and it may well increase significantly over the next 3 to 4 years.
Then there’s tax optimization. Paper profit is tax-deductible, and within 8-12 years investments like that pay for themselves and bring in net profit from then on.
I have read Damodaran’s critical review of this strategy in his Investment Fables, where he analyzes all the stocks on the market to make his point. A collective approach like his always leads to results that are far from a standard dividend-oriented investment strategy. He does acknowledge that a strategy like that is a good option when interest rates are low, because dividend stocks are seen as an alternative to bonds and interest rates are low now.
In theory, a company either pays out dividends, or there is capital growth equal to the amount of undistributed profit, which affects the company’s market capitalization. In practice, although these figures are connected, the market isn’t very good at evaluating them. The stock price does often fall by the size of your dividend the day after the dividend date. The question is – does it stay there, and will it fall by the same amount again next year?
Another popular assumption is that companies that don’t pay out dividends spend their undistributed profit on good assets, which, in turn, improve their ability to generate profit in the future. A little knowledge of bookkeeping will tell you that assets are best bought with a bank loan – that’s if the interest rate is lower than profit tax.
I really think that a policy of paying out 50% of profits in dividends would somewhat cool off the economy and make the cycles less volatile. Instead, we first race to gain assets, production capacity, output and sales, and then start playing the game of ‘who gets rid of their drastically depreciating assets first’. But then you realize that the ones playing the game are usually the ones who are good at it, which is why the whole thing is never going to make any sense. Putting together your portfolio, the dividends you’ll be taking are definitely not the only thing you should be worried about. I started off by choosing the industries I wanted to invest in, then the businesses within those industries, narrowing my choices down by reputation, financial results, and dividend policy.