Why I Would Not Buy A Popular Dividend Paying Stock

I don’t think there’s much money to be made buying stocks that are popular.

If I learned anything, as a stock picker, it’s that buying popular stocks is a way to investment mediocrity, or worse.

What stocks are popular today?  Dividend paying stocks.

Would I avoid them?  Not indiscriminately, but overall, yes.

Historically, dividend paying stocks have performed well for two reasons:

1.  The earnings that are paid out to shareholders are undeniably real so these businesses tend to have staying power.

2.  The relatively low price to earnings ratios typically allow for powerful dividend reinvestments over time.

Back in the day, stocks that had long histories of increasing dividend payouts were considered stocks that your grandmother would buy.  If there were investment bloggers in the 70s, 80s, and 90s, they wouldn’t have been touting dividend paying stocks (with the exception of the nifty fifty crew of the 70s).  They would have been touting growth.

And what do you know?  Dividend paying stocks generally outperformed the market.  Why?  In a nutshell, they were a better value.

But are they a better value today?  I don’t think so.

To be fair, I don’t want to indiscriminately paint all dividend paying stalwarts with the same brush.  That would be foolish.  But I don’t believe that they’re as cheap as they used to be—nor as cheap as they should be.  They have become “smart investments” because they “have performed well historically.”

I think stock pickers need to discriminate more thoroughly.  I have to admit that I’ve been nervously watching the popularity of dividend paying stocks increase, online, for the past few years.  So when I wrote my book’s chapter on purchasing individual stocks, I didn’t suggest that investors should look for stocks that “have been paying higher and higher dividends every year.”  In fact, among the main stock picking tenets mentioned in my book, I don’t mention dividends once.

Let’s take a poke at Johnson & Johnson for a moment.  I’ll admit that I used to own this stock.  But I want to add that when I bought shares in JNJ, its average PE ratio (when calculating the average earnings over the previous three years) was a lot lower than the S&P 500’s PE ratio.  I bought shares when JNJ was far less popular than it is today.  And I believe that this is a great way to make money in the stock market.  Buy a great business that isn’t popular.

Johnson & Johnson was never considered a sexy stock, so its historical PE ratios have typically lagged the PE ratio for the average S&P 500 business.

But that’s not the case today.  The S&P 500 is currently trading at a PE ratio of 13X earnings, and JNJ is trading at a PE of 15.09.  Scouring through an old Valueline Investment Survey Report, and looking back at Johnson & Johnson’s historical PE levels from 1985 to 2002, the PE ratio of the S&P 500 proves to be consistently higher than JNJ’s. 

What’s the difference today?  Popularity. 

And I see the same thing occurring with many dividend paying stocks.  Their popularity has pushed their price to earnings levels to a point where future investment profits will be jeopardized.

Buying popular stocks has never been a great strategy.  If online bloggers are practically in unison, touting high, consistent dividend paying stocks, it’s probably going to result in mediocrity for those investors.  Their stock picks will lose to the indexes.  I’m quite sure of it.

Today, my entire portfolio is indexed.  But if I had to buy an individual stock today, it would likely be a non dividend payer—or at least, not a high-dividend payer.

I would jump at Berkshire Hathaway, trading at roughly $68 per share.  It doesn’t pay a dividend.

And I would jump at another stock—one that you might not have heard of:

John Wiley & Sons.

This company has been around since the 1800s.  They publish books, journals and electronic products.  They’re actually the publisher of my book, Millionaire Teacher.

You haven’t heard of them?  Good. 

Let’s talk about growth, shall we?

John Wiley & Sons has seen its earnings per share increase by 100% in the past seven years; 200% in the past 11 years; 710% in the last 15 years; and 5,900% in the last 22 years.

Eat your heart out Johnson & Johnson.

Yeah, a boring publisher with insider ownership exceeding 80%, with decade return on total capital averaging more than 15% annually, and with… gasp, a history of paying out increasing dividends (but with much lower yields than most companies on the Dow).

But, as Buffett always asks, has each retained dollar in earnings equated to at least a dollar of market value?  The answer to that is yes.

Have a look at this long term performance chart of John Wiley & Sons stock, compared to Johnson & Johnson’s stock:

Currently, its PE ratio is roughly in line with Johnson & Johnson’s PE ratio.

But there’s a difference.

Johnson & Johnson’s earnings aren’t growing at anywhere near the rate that Wiley’s earnings are growing.

The higher the growth rate, the higher the justified PE ratio.

It’s fair to say that Wiley’s growth is making JNJ look like an ox and cart mired in the mud—and it has been making JNJ look like a mud-stuck business (in comparison) for a very long time.

I used to think the publishing business was dead.  But after looking at Wiley’s fundamental growth, I realized how wrong I was.

When my book gets published, how much will it cost Wiley to sell an electronic version of my book? 

And as an author, how much do you think I’ll get paid per book?

I’ll make roughly $1 per hard copy of each book sold.  And I’ll make roughly 50 cents for an e-book that sells for $10.

Those sort of metrics look pretty good for Wiley, don’t you think?

So… as I see it, you can follow the crowd into stocks that have grown in popularity, thanks to their long history of increasing dividend payouts, and their popular presence on investment blogs.

Or you can search a little harder to recover stocks that your neighbours (and other financial bloggers) never have on their radar screens.

If you want to do well as an individual stock picker, I think it’s a highly necessary course of action to take the road less travelled.

Don’t follow the crowd. Groupthink doesn’t work very well.

 





Andrew Hallam

I’m a financial columnist for Canada’s national paper, The Globe and Mail, as well as for AssetBuilder, a financial service firm based in Texas. I’m also the author of Millionaire Teacher: The Nine Rules of Wealth You Should Have Learned in School (2nd Ed. Wiley 2017) and The Global Expatriate’s Guide To Investing: From Millionaire Teacher to Millionaire Expat (Wiley 2015). My mission is to educate, motivate and inspire people on basic retirement planning and best practices for investing, using evidence-based strategies. I’m happy to comment on your questions. However, please read the Terms of Use, Privacy Policy and the Comments Policy.

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26 Responses

  1. Mandy says:

    Hi Andrew,

    Thanks for sharing your insight. For a newbie like me who's just about to start my investing journey, dividend paying stocks seem to be a no-brainer. Do you think of the same with dividend paying stocks here in SG? Thanks.

  2. Hi Mandy,

    Overall, companies that pay regular (and increasing) dividends tend to be great business. I didn't mean to paint all dividend paying businesses with the same brush.

    But in North America, they are starting to get pretty popular, so I think investors need to be a bit more careful today.

    As for Singapore, I would buy an exchange traded total market ETF rather than trying to choose individual stocks. But having said that, dividend paying stocks aren't as expensive here (in Singapore) as they are in Canada. People in Singapore view dividend payers the way they used to be viewed in North America.

  3. Now that you've let the secret out and blogged about it the stock will quickly become overpriced 🙂 I'll just have to stick to my index funds.

  4. I love reading your posts when you share your wisdom!

    I am guilty of recently getting JNJ. Interestingly enough, I am not trying to beat the index though … I don't mind measuring my portfolio against an index but my focus is on generating income.

    How do you identify if dividend investing is popular? Bloggers may talk about it but that's just a small amount. Is it just by P/E or mostly due to the economy where investors are looking for save havens?

    I have always found it challenging to decide on a fix price value of a stock and simply waiting for that price. Especially when you start investing as defining the entry point can be challenging. I like to think that I can DCA (Dollar Cost Average) through DRIP or more capital.

    Thanks for the challenging thoughts!

    • I thought I read that you mentioned JNJ – can I quote you from your post )

      "We already have roughly $45,000 invested in JNJ, but I believe that, at roughly $63 per share, it’s offering itself at a very good price."

      🙂

      • Hey Passive:

        You're right. Two things, I guess:

        1. I was having a bit of fun, purposefully being a bit cheeky in this post, just to see what people would say.

        But

        2. I think that there may be some merit to the over-popularity of regular dividend payers, and I might be more inclined to buy Wiley or BRKB over JNJ right now, when comparing the merits and prices.

        Having said that, I sure don't have a crystal ball!

  5. Think Dividends says:

    Bang on Andrew! Lately, I've been focusing on the dividend growers in the 2% dividend yield range. I try to avoid the popular higher yielding stocks like BCE and TransAlta where the dividend crowd has fallen in love.

  6. I agree that you don't want to buy what's popular. It's usually over priced.

    I am not sure if dividend investing is popular as opposed to high yield stocks. Take CNR or CP for example, they are dividend stocks with growth but a low yield. It's still dividend investing 🙂

    This is a reason why I follow a lot of companies and I don't eliminate them from my list just because they don't match my criteria today since it may match it tomorrow.

    In any case, I always like the challenging and thoughtful post!

  7. I'm finding that certain types of dividend payers are expensive.

    I mostly focus on US markets, and what I've seen is, the markets were heated for most of this decade (both dividend payers and non-dividend payers being overvalued), and after the financial crisis, there has been a flight to safety. Safety can include bonds, but also includes some stable dividend-payer blue chips, relative to the wider market. People see low bond yields and realize they can get just as much if not more income from dividend payers, while also hoping for some protection from inflation and growth potential.

    In particular, I'm not finding many good utility bargains, a traditional stronghold for income investing. To get that sort of exposure, I've invested in publicly traded partnerships instead.

    I'm finding good values in certain areas, like specific publicly traded partnerships, some medical device manufacturers (there are worries about regulation in that industry, keeping valuations reasonable), pharmaceuticals (I've been picking up shares of NVS, and holding JNJ and ABT), certain insurance companies, and some others. I've been eyeing Microsoft lately, with its P/E ratio of 9 and solid prospects. The fear of the company losing some profitability as it shifts from client to more server computing ("cloud computing") seems to be weighing the valuation down, and at these levels, the company is madly repurchasing its own shares to provide decent returns.

    I consider JNJ to be a decent buy at the current time. I believe it is adequately valued relative to the market for decent risk-adjusted returns. It should rightly demand a bit of a premium for the type of business it is. But, I prefer to avoid investing based on assessing valuation compared to the wider market, and instead prefer to invest on a more absolute view of valuation- that is, based on expected growth, dividend payouts, and share repurchases, etc, which all basically comes down to sustainable EPS and dividend growth and the current dividend yield. If I calculate a decent return, I'll buy. If not, I won't.

    • Hey Dividend Monk,

      It's interesting that you are seeing some of the same things that I am.

      I have to say that I absolutely love your blog posts. If anyone is reading this, and they haven't checked out the absolutely suberb job that Matt does on his site (assessing great, dividend paying businesses) then you really should check it out!

  8. Humm, Andrew.

    You are aware I love dividend-payers like PIE, Monk and others, so it was interesting to read this post., also considering, you used to hold many dividend-paying stocks yourself! 🙂

    I have no desire to beat the index, my desire, like PIE, is to generate some passive income as part of my retirement plan. Watch my mailbox and bank account, for my money making money – which it is starting to!

    Can I interpret this post to mean, you are moving away from the idea that dividend-paying stocks are an excellent vehicle for this?

    Or, just being a bit cheeky?

    • I'm definitely being a bit cheeky Mark.

      But there's a bit of truth to my jest. I just bought Wiley shares for my investment club, after selling half of our JNJ holding.

      With the investment club, our goal is to try to beat the market. It's not probable, but to do it, we'll have to keep buying what's under-rated or unpopular. And I don't think big, popular dividend payers are going to cut it. They'll be great, but to beat the market, we need to buy something offering us better value.

      Having said all that, I don't invest any of my personal money in stocks. It's all in index funds, as you know. So I'm not totally willing to put my money where my mouth is!!

  9. Hey Value Indexer!

    I was thinking about you the other day. You once asked me if I ever under-weight bonds when the stock markets are cheap. And I said that I didn't: that I just kept an allocation of bonds equal to my age at all times. But then I looked at one of my account statements from June, 2010. I had just sold a wack of bonds when the markets hit their June low. I bought stocks with the proceeds, and I noticed that my account had only 30% bonds. I even wrote a blog about it, mentioning that I had an unusually low bond allocation (low for me, anyway).

    It worked out really well. But I guess I was using your strategy!

  10. It's fun to present a challenge Passive–and it's fun to be challenged as well! Thanks! I love your comments, and I love watching and cheerleading your growing passive income on your blog!

  11. Hey Think Dividends:

    Probably a very wise move!

  12. Fair comment Andrew, and I know:

    ("totally willing to put my money where my mouth is!!")

    That is what is GREAT about your investing approach and this blog. I read every article 🙂

    • Thanks Mark,

      Having the blog let's me keep an interesting record of what my thoughts are as well. It acts as a bit of a real life diary of sorts. I'm sure you probably agree that your blog has similar benefits for you.

  13. A thought provoking post, which certainly caught the eye of many 🙂

    I think there's a big difference between a dividend investor who is seeking long-term, 'buy and hold' positions in large cap stocks that have proven themselves both in terms of dividend increases and long-term share price appreciation, and an investor that is chasing yields, and strictly for the income.

    A bank stock like the Bank of Nova Scotia may be popular because it's been in business since the late 1800s and has a proven record of success -period. In my view, there's a big difference with a company like this and a dividend-play that is trendy, popular, and being mentioned on Mad Money because it's offered a juicy yield to investors for 3 years and counting.

    I don't think the entire personal finance blogosphere can generate enough hype to depress values in solid dividend-paying stocks. I'm not suggesting that you are implying this, but there are many different paths that can be followed at creating wealth. We will never see the dividend strategy go away. I know it's bold, but some of the best investors still need to get paid while they wait.

    I don't think there's anything wrong with tweaking your investment club's approach to one that's more tailored to value plays. Good for you! As large companies get larger, there's no question about it in that there's a real possibility that the investor may be losing out on significant growth rides; there's a cost in enjoying stability. But with that being said, there's a massive difference between investing in a company with a market cap of $2.6 Billion vs $176 Billion. There's an element of risk tolerance that comes into play here and it's where the water can get murky.

    The personal successes you have attained with your own investment strategy and low cost index funds had paved your path to financial freedom. The proof is in the pudding, there's no question about it.

    Yet, a sound dividend investment strategy can still be one that allows an investor to enjoy stable long-term appreciation, generate an income stream, and at the same time preserve the principal invested. In my view, these facts alone are enough to substantiate incorporating an approach such as this. It's worked for me and I stand by it!

    An excellent post. I really enjoy reading about your investment adventures. Keep up the great work 🙂

    • Hey Wealthy Canadian,

      You're absolutely right, on every front mentioned. I like, especially, this comment:

      "A bank stock like the Bank of Nova Scotia may be popular because it’s been in business since the late 1800s and has a proven record of success -period. In my view, there’s a big difference with a company like this and a dividend-play that is trendy, popular, and being mentioned on Mad Money because it’s offered a juicy yield to investors for 3 years and counting."

      When I started to invest, nobody talked much about dividends. But today, many people are going out on limbs for stocks paying unusually high dividends. Businesses paying really high dividends can be like companies offering high rates of returns on their bonds. These types of bonds, of course, are generally called "Junk bonds". The interest could always evaporate. And the businesses could too! They're paying a high rate of return to attract bond investors seeking high yields because they can't borrow money at lower rates (because they don't generally have great credit). I wonder about businesses doing something similar with their dividends. Short term, they want to keep their stock prices up, so they practically borrow money (with clever accounting) to offer a sweet dividend…with thorns.

      Bank of Nova Scotia (and the other businesses that I've noticed you like) don't play those kind of games.

  14. SPBrunner says:

    I agreed that you should not over pay for stocks. I am into dividend payings stock, and it certainly affects your long term income in dividends if you pay too much. I look at a number of things including P/E ratios and yield to decide if a stock is reasonably priced.

    Personally, if a stock l like is not reasonably priced, I do not wait around for the price to be better, I will look at other stocks. There is usually something around that is good and reasonably priced.

  15. Susan,

    I have read your blog, and the great online interviews done on your methodology. Readers would be wise to follow your lead.

  16. pjone says:

    What price would you look to buy john wiley at.? Thanks

    • PJone,

      I would pay the current market price for Wiley. If you average its earnings over the past 3 years, and divide that by its stock price, you get an owner earnings yield in excess of 5%. This is double the return on a 10 year bond (which is the benchmark we need to compare to) so this ensures–at the current price–that we are promised an adequate amount of return for our risk. If you buy it now, be really really patient. Don't freak out if the price falls. Buy more if the price falls, and celebrate. This business is very solid, and the insider ownership is incredibly high. Far fewer accounting games will be played, because of this.

  17. Neil G says:

    So for newer investors trying to catch up on all this, has your opinion from the original post changed much? Just finished reading your new fantastic book (Global Expatriate’s Guide to Investing)…and was surprised to see dividend stocks dismissed so easily. I suppose that’s the answer to my question, but I decided to research first (which led me to this post) and then now follow up to this old post to be sure.

    So!.. is it smart to have one of your balanced approaches of ETF/Indexes and dividend stocks? Is there any value in it?

    PS – how’s Wiley doing?

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