The Politics of Stocks, Part 4: Dividend Yield

Can political policy impact a company’s dividends? What impact can the tax code have? Join Chris Perras for the 03/08/2019 edition of Stock Talk as he discusses these and other questions on part 4 of “The Politics of Stocks”!

 

Chris Perras: This is Chris Perras, Chief Investment Officer at Oak Harvest Financial Group. Welcome to the March 8th edition of our weekly Stock Talk podcast, Keeping You Connected to Your Money. This week, I wanted to title it, “The Politics of Stocks, Part 4: Dividend Yield.” This is continuing with our five-part series on how political policies can affect stock market returns.

Last week, we covered price earnings ratio and valuations. This week, we focus on the third component of stock market total return, that would be dividend yield. This material can all be found at oakharvestfg.com, under the investment management tab, and then look for the ideas and insights subtab.

What is dividend yield? It’s the third component in investment return, and all it is is the dividend divided by the company’s current market share price. Remember, dividends are not contractually guaranteed by a company. They have zero legal obligation and a requirement that they’re paid every year. However, most management teams do everything within their power to pay them once a trend has been established.

The percentage distribution of a company’s earnings is decided on by a company’s board of directors, then it’s paid out to shareholders and its dividend. This transfers economic value almost always in the form of cash from the company directly to shareholders. At Oak Harvest Financial Group, we love cash. Cash is king. Alternatively, some companies usually in growth mode, think of Netflix, think of Facebook, usually use 100% of their free cash and profits internally to hire people or to go out and spend money on capital equipment to try to grow their companies.

How do political policies affect dividends? They affect them generally through three ways, and they’re all related to taxes. First, the current tax policy discourages companies from paying dividends to shareholders by incenting companies to go out and spend money on capital expenditures. They incent them by having accelerated depreciation schedules for that capital expenditures.

If you accelerate capital expenditures, you de-emphasize free cash flow available to pay dividends in any given year to shareholders. You don’t have as much flexibility to raise that dividend because you’re going to go out and buy a bunch of equipment or build a new plant. The tax code allows you to accelerate the depreciation of that plant.

Second way the tax code incents, or really disincentives companies to pay dividends is it incents companies to go out and borrow money to take on debt. The incentive is that interest payments paid by corporations are tax-deductible. The problem is that heavily indebted companies are riskier in the public markets. They have less flexibility during bad times because that extra cash is getting paid to the bank or the lender is going to pay interest, and debt payments don’t have the flexibility to pay dividends to shareholders.

The third way the tax code disincentives dividends is double-taxed. What I mean by this is, companies have to pay their own taxes first, go down their income statement. They pay their employees. They pay their bondholders. Whatever’s leftover, they have to pay the government taxes. Then finally, they can pay a shareholder a dividend. So they’re paying you with after-tax dollars.

As a shareholder, you receive a dividend. Unless it’s in a retirement account, you have to pay tax on that dividend in the year that you receive it, so you’re double taxed in a sense. When we create portfolios at Oak Harvest, we do have a bias towards single stocks that pay dividends. We like dividends. Our team takes into consideration the current state of dividend yield, a company’s ability to continue to pay that dividend, and whether it has a history of growing that dividend.

While cash dividends are a great investment tool, they are only one component of stock market total returns. Remember, you should always remain cautious on stretching for dividend yields. While an 8% to 12% dividend yield, it may look really enticing, we at Oak Harvest look at it almost always as a big red warning flag of impending bad news. Yields that high historically are not sustainable. It does not create a bargain investment in the stock market.

Quickly, on the current stock market, S&P 500 peaked two weeks ago, right near our 2810, 2825 level, and close to exactly in line with our thinking, which was up seven to nine weeks. It was actually eight weeks from the Christmas Eve lows. Also happened to be the last payday in February, which we spoke about in the past paydays being a big-time for passive money coming into the market. Also happened to be right when stock buybacks peaked for the first quarter at the end of February.

We’ve dropped about three and a quarter percent in the two weeks since then. We are not at all negative on the stock market here. We are once again actually buying stocks today for accounts that have given us some new money. We’re accelerating their stock purchases right now because there has been a spike in volatility up to about 18. Valuations have gotten attractive again in some areas. A lot of this short-term noise on TV, we expect to dissipate over the next four to six weeks as we do believe that the China deal will come to fruition at the end of March, early April.

We think there’s about 5% upside, that would be a max number we think into mid-April taxed on, but we are expecting more noise, basically through the second quarter, through the end of June, as people struggle with. Is the economy getting worse? Is it going to get better? What’s the outlook for the second half? We believe the outlook for the second half is going to be very good. We’re very optimistic about the second half being a resumption of the bull market that has been going on now for about 10 years.

Once again, in closing, if you find this content helpful, please feel free to forward it to any of your friends, and family. You can go find it on our website at oakharvestfg.com. Remember, your most valuable investment tool is discipline. You shared your retirement vision with us over a number of meetings, over a number of years, and we’re here for you. Occasionally, an investment environment will change. We’ll make calculated changes to your portfolio to the allocations. We’ll do it slowly. We’ll do it thoughtfully.

If you have any questions, please feel free to get on the phone. Give us a call. Send us an e-mail. Reach out, and we will be here for you. Many blessings. Chris Perras, Oak Harvest Financial Group.

Voice-over: Content contained within this Oak Harvest podcast is for informational purposes only, and is based upon information current as of the time of recording. It should not be considered an offer or solicitation to buy or sell securities, nor is it a tax or legal advice. Investments involve risk. Unless otherwise stated, particular investment returns are not guaranteed.