Topic: Value Stocks

5 things to know about value stocks that pay dividends

dividend investing vs value investing

Savvy value stock investors know that many consistently offer dividends with high yields, although capital gains may take longer to materialize.

Investors typically look to value stocks for their low trading prices compared to their financial fundamentals. As more and more investors recognize that these stocks are undervalued, their trading prices begin to rise.

When we look for value stocks to buy, we usually start by looking at a few basic ratios. For example:

  • Low price-to-earnings and price-to-book ratios—a sign of a cheap or undervalued investment.
  • Low price-to-book-value ratio—another sign that stock is cheap in relation to other stocks on the market.
  • High dividend yield—the yield is the stock’s annual dividend divided by the share price. A high dividend yield could indicate a cheap stock that is set to rise.

Savvy investors know that value stocks can test your patience by moving sluggishly for months, if not years. But they can make up for it by rising sharply when investors discover their true value.

Fewer investors know that value stocks can offer the highest dividend yields, along with steady growth

When value stocks pay dividends, you can see returns earlier and more often. Here are five other tips investors in dividend-paying value stocks should follow.

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Tip #1 for value stocks that pay dividends: Pay attention to these three dates

The declaration date: Several weeks in advance of a dividend payment, a company’s board of directors sets the amount and timing of the proposed payment. The date of that announcement is known as the declaration date.

The payable date: The payable date is the date set by the board on which the dividend will actually be paid out to shareholders.

The record date: Only shareholders who hold the shares before the payable date will receive the dividend payment. That date is known as the record date, and is set any number of weeks before the payable date.

Tip #2 for value stocks that pay dividends: Remember the dividend tax credit

Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

This means that dividend income will be taxed at a lower rate than the same amount of interest income. Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. At the same time, investors in the highest tax bracket pay tax on capital gains at a rate of about 25%.

Tip #3 for value stocks that pay dividends: Look for value stocks that have a history of paying dividends

One of the best ways of picking a quality Canadian dividend stock is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce.

Tip #4 for value stocks that pay dividends: Seek out hidden assets

When researching value dividend stocks, also take a close look at the balance sheet. Can you spot any hidden assets?

For instance, when a company buys real estate, the purchase price goes on its balance sheet as the historical value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. Yet the purchase price remains unchanged on the balance sheet.

You have to look closely to spot this hidden value. At times, the hidden assets in a company’s real estate may even come to exceed the market value of the dividend stock.

Tip #5 for value stocks that pay dividends: Sometimes “good value” may be due to hidden problems

While we do find that value stocks can offer the highest dividend yield, if a dividend-paying value stock seems like an exceptional bargain based on its dividend, earnings or asset values, it may suffer from hidden risks. The stock can plunge when those problems begin to take their toll.

Academic studies suggest that on average, value investing produces better results than growth investing. But these studies mostly look back on what would have happened in a particular historical period, if you followed a particular set of rules. Most distinguish between growth and income investing by looking at average p/e’s (per-share price-to-earnings ratios). They assume high p/e’s are a benchmark for growth stocks and low p/e’s for value stocks. As any serious value or growth investor can tell you, it’s more complicated than that.

If you balance and diversify your portfolio as we recommend, it should include both growth and dividend-paying value stocks.

Many investors focus on dividends, although a high dividend yield can be problematic. Do you have one sure way to assure that a dividend-paying investment is worth buying?

Have you bought a dividend stock that you ended up regretting? What went wrong?


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