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  • Writer's pictureIshfaaq Peerally


If you look at the dividend yield of my portfolio, it is 1.75%, less than the 1.92% of the S&P 500 $SPX500 . That's because I never really was a fan of dividends. But with the current market situation, I'm, looking more and more at dividends.

My approach to dividends has been the same as that of Warren Buffett. When Warren Buffett $BRK.B buys a whole company, he doesn't expect the managers to pay him a dividend. Only if they cannot use the money anymore, then they can send it back to him as a dividend. He has the same approach to investing in stocks, the best thing that a company can do with its extra cash is to reinvest in the business, then buyback shares and only at the last resort, to pay a dividend. That's why Berkshire Hathaway doesn't pay dividends.

Why Warren Buffett doesn't like Dividends:

1. You have to pay income taxes on dividends, which is usually higher than capital gain taxes

2. It is better to invest in growth

In America, most of the big tech companies such as Amazon $AMZN or Google do not pay a dividend. They would rather invest in growth. In the UK, the FTSE 100 $UK100 has not been moving that much over the past 20 years but when we add dividends, we see a much better performance. In the UK, companies have much in dividends.

Now, things are different, the stock market is in a bubble and bonds have low yields. Does it make sense investing in dividend stocks as an alternative to bonds? Not really. Bonds have a low or even negative correlation with stocks. Dividend stocks are still stocks. If the stock price falls, the dividend yield goes up, but that doesn't mean that the company is paying you more in dividends.

Some companies will make the mistake of trying to keep the dividend yield high by taking debt to keep paying dividends. For example, MCDonald's is was taking debt to buyback shares and pay dividends. Then, one bad year happens and the company is forced to cut those dividends. This happened with Boeing . Crown Castle International now has a dividend payout ratio of over 200%.

The best way to look for dividend stocks is to look at the cash flow statement. It is better to look at the real numbers of how much a company is paying. For example, Apple $AAPL last year had about $60 billion in free cash flow, $15 billion was reinvested in Research and development. It doesn't make sense to invest more money. There's a limit to innovation. They bought back $75 billion worth of shares. Since Apple has an over $200 billion cash pile, they could do that. Only $15 billions was used to pay dividends. Apple will be able to pay a dividend even in a recession or even if the company doesn't make any sales for a few years.

Instead of just looking at dividend yield, it is very important to look at the company. To know if really they can pay dividends and if it is sustainable.

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