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HEATHER KNIGHT: When markets are feeling volatile, dividend stocks can be an attractive way to stay invested.
JIM ARMSTRONG: Let's be honest, Heather, dividend stocks aren't typically the most exciting thing investors can be thinking about, especially when you compare them to high-growth AI companies. But in today's market, what makes dividend-paying stocks potentially good investments right now?
HEATHER: Yeah, you're right, Jim, in a world where everybody's chasing that next AI superstar, it's kind of tough to think about dividend-paying stocks. But what I would say is that they do provide some benefits. So one of the things you can think about is potential for growth through reinvestment as well as stability. I would say, too, that when we think about how that's part of a diversified portfolio, potentially, that can be a complement and not a replacement of growth stocks. So I'd say a little bit together amongst other investments like fixed income, and so forth.
JIM: Now, before we get too deep into the conversation, I want to make sure everybody's on the same page. What is a dividend?
HEATHER: I would say, simply stated, a dividend is a company's way of saying thank you for being an owner. Those companies, when they have some earnings that come out, they might choose to share those in the form of dividends with their shareholders. And so they will typically send out a payment in the form of that dividend, either quarterly or however their schedule fits.
JIM: So the concept of dividend-paying stocks makes sense to me in theory. But as with a lot of investments, there's a great deal of nuance. So let's hit the pros and the cons. First, what are the potential advantages to owning dividend-paying stocks?
HEATHER: I think that there's a common misconception about dividend-paying stocks, in that it's only meant for retirees, and that's really not the case. There's actually a lot of different benefits when we think about those dividend-paying stocks. So I narrow it down to four areas. The first one I call slice of pie. The second one I call the shock absorber. The third one I call the snowball effect and then, finally, the quality badge. So I'll go through each one of those so that we know what those potential benefits are.
So the first one, slice of pie. That's simply that income that's coming in from the dividend. And I would say that it is what I would consider to be a supplement of income. And I don't use that word lightly because it certainly isn't a replacement for a true income strategy.
The next one, I would say, is shock absorber, and why I like to think about as shock absorber is that some of those individual stocks, they have high quality inside of them too. They might provide a barrier, potentially, for some of the other positions in your portfolio. So if there's volatile times that are going on, they tend to be a little bit more stable because they're mature companies on many occasions.
And then the next one is the snowball effect. And this one is my favorite, I would say, because just like a snowball, you have a potential for taking some of that income that's coming in and buying more shares. And when you think about a snowball rolling down the hill, it's continually adding to it. And so that's something that can happen as you think about reinvesting those particular dividends if you don't need it right away.
And then, finally, the quality badge. I mentioned a little bit before. But when we think about quality badge again, some of those individual companies, they've been around for a long time. They're a little bit more mature. So things like their cash flow might be a little bit more stable, or they might be able to manage their debt for a little bit differently. So those are some of the benefits that I think are out there when you think about your portfolio.
JIM: What you called snowball there, I have heard referred to as DRIP. What are the potential advantages of DRIP?
HEATHER: So DRIP stands for Dividend Reinvestment Plan. And so essentially, if you don't need that particular income right away when the stock pays a dividend to you, you can essentially choose to buy more of that same stock. Now, the more that you continue to do that, and looking forward, you can find that if I buy more stock today with that dividend payment, now the next one that actually comes out, I'm going to have more stock that will continue to buy more dividend as I can keep going. So that's part of that compounding effect, but also thinking back to the snowball.
JIM: And so there, you've covered a lot of the possible advantages. What are some of the potential disadvantages of having dividend-paying stocks?
HEATHER: Like with everything, there's always a flip side, right? So when you think about some of the disadvantages, I would say this, we talked earlier about the AI and right now, that's a big focus from a growth perspective. Sometimes these companies don't grow as fast as some of the newer ones. So you think about them paying out some of those dividends. They're probably paying more of their shareholders and so forth. So you're not going to see that massive growth.
The next thing, too, is that a company at any time is free to stop, start, cut, or even potentially increase, which would be nice, their dividends. So you can't always guarantee that income that's actually coming in.
JIM: So Heather, I think a lot of investors might look at a dividend-paying stock with a high yield and think, aha, I found it. I found the right investment. Why are some high yield dividend-paying stocks more potentially risky, though?
HEATHER: Yeah, so a lot of times, you take a look at those, and you say, wow, look, I see a 10% stock. And that gets pretty exciting. But there could be some problems with that, especially if we think about what its peers are doing. So for me, what I like to do is to take a look at the stock itself and maybe look at the sector or the industry and try to figure out what that baseline looks like. What are its peers paying out from a dividend standpoint? Because oftentimes, that 10% that looks attractive, there could be problems that are coming up with that particular stock itself. They might be having a situation where they might cut their dividends. Sometimes, when we think about that 3% number, that might be a stock that you might feel a little more comfortable with and might look a little bit better down the line.
JIM: I want to also ask about dividend yield. This is probably the point at which we want to bring in some gentle, gentle math. What is a dividend yield?
HEATHER: Yeah, so dividend yield is the annual dividend divided by the stock price. It's basically telling you how much you're getting essentially in a percentage perspective for a year. So for example, let's just say that you had a stock that was paying $2 a year. The price of the stock was $50. You'd get the 4% yield.
JIM: Once an investor has calculated that yield, though, I guess, how do they figure out whether or not they're looking at a potentially high-quality dividend-paying stock or one that could be a lot riskier?
HEATHER: Yeah, Jim, we get this question all the time. And what I would say is this, beyond yield, you'd want to take it back to that quality badge. So this is an opportunity to take a look and find what's going on with the company specifically. So are they consistently growing from an earnings perspective? Are they consistently increasing their dividends over an extended period of time? Do they have are they potentially managing debt in addition to that? And what does their balance sheet look like? So I'd say take a look at all of the fundamentals.
Now what's really neat is that places like Fidelity, we offer things that are called stock screeners. And so you have the ability to put in some of those non-negotiables and to be able to find a list of stocks that are going to beat your own criteria. And what's really nice about that is that you might find a stock that you didn't even know existed. So not something that you hear on Main Street every single day. So those are some of the things that I would actually take a look at.
If you want to be simple and safe, I would say you can take a look at a couple of different things. The first one is the Dividend Aristocrats, and those are stocks that have been rising and consistently paying for about 25 years. And then there's also the Dividend Kings, and those, Jim, have been consistently increasing and paying for 50 years. So that's an alternative solution as well.
JIM: I know a lot of investors have been relatively happy earning steady income from money market funds. But I wonder if, in your opinion, it's a better idea, potentially, to invest in dividend-paying stocks instead of money market funds.
HEATHER: I know we hear this a lot, but honestly, it starts off with goals. You really need to know what your goals are. When I think about a money market, that might be something I'm looking at from a short-term perspective. So do I need the money up front in the next few months or so? So that's more of a short-term investment that I might be looking at.
If I'm looking for the long run, and I'm looking to, as a part of my portfolio overall, I might consider taking a look at a dividend-paying stock because it might provide me that additional growth over a period of time. And even thinking back to the snowball effect, too, the compounding, essentially, from some of those payouts that are there.
JIM: So up until now, we have been talking exclusively about dividends associated with the stock of an individual company. We haven't yet talked about funds or ETFs. Why would someone buy a dividend fund or an ETF over an individual dividend-paying stock?
HEATHER: So I would say this you don't have to pick all your players at once. When you look at an ETF or a mutual fund, you might actually find some of them that have the objective of investing or tracking an index that actually has dividend-paying stocks. So that's really nice from the perspective of being able to have multiple positions all in one place, gives you a little bit of diversification potentially as well. What I would say, too, though, is that when we look at those individual funds, how it works is that the stocks pay out inside of the fund and they either pay out quarterly, or they might even pay out monthly, depending again, on the objective of the fund itself.
Now, the trade-off there is that you might want to be in a position where you're looking at a yield of the overall fund itself, rather than just the yield of one individual position.
JIM: You've covered a lot of ground, so thank you for that. If you had to leave investors with one key takeaway about dividend-paying stocks, what would that be?
HEATHER: I would say this, Jim, start with your goals. You really have to think about that first because if you're chasing the biggest slice of pie or trying to search for that yield, you might not be looking for something that's specific to your particular goal or your needs.
So think back to some of the things we talked about earlier. Whether you're looking for the slice of pie, the shock absorber, the snowball, or the quality badge, any of those can have a valuable place in a diversified portfolio.
JIM: Heather, thank you. If you are looking to learn more about a dividend income strategy, you can head to Fidelity.com/DividendIncome for more information. Thank you for watching Fidelity Viewpoints.