Updated on 04.11.10

Review: The Little Book of Big Dividends

Trent Hamm

Every Sunday, The Simple Dollar reviews a personal finance book or other book of interest.

little book big dividendsI’ve always found the idea of investing in stocks for dividends to be an intriguing one. In a very simplistic way, that means you buy stocks in individual companies that are very stable and have paid strong dividends for a long time. Usually, you care little about the ups and downs of the value of the stock because your primary focus is in the dividend checks you receive as a stockholder.

Yes, The Little Book of Big Dividends is a new entry in the now quite long “Little Books” series from Wiley, each of which focuses intensely on a specific investing topic, writing about it in simple terms which everyone can understand. This entry is written by Charles B. Carlson, the editor of the DRIP Investor and long-time advocate of dividend investing.

Since I’ve had an interest in dividend investing for a long time, I looked forward to reading this book with a healthy dose of excitement. Does it live up to the potential or does it just stretch what I wrote in the first paragraph out for two hundred pages? Let’s dig in.

One | The Check Is in the Mail
The book opens with a clear explanation of what dividends are (small pieces of profits of a company given out to shareholders) as well as some common traits that companies that offer dividends have in common. Typically, they’re large, stable, and have a predicted future of stability. That, of course, means that they’re not growth companies (usually). It also discusses the most common way to compare dividends offered by a company, which is yield (annual dividends divided by the price of the stock).

Two | Super Size Me, without the Heartburn
Of course, investing is not without risk, and dividend investing is no different. Quite often, yield is a great proxy for risk – if you see a company with an enormous yield, there’s probably some serious risk involved. Healthy companies balance a dividend with investment in themselves, so if they’re dumping out tons of money to shareholders, there may be something fishy going on that’s not good for long term health. The best way to mitigate this risk is to avoid small companies paying any sort of exceptional dividend.

Three | If Einstein Was a Dividend Investor
In other words, a big part of dividend investing is looking at the total return potential, not just the dividend potantial. A company paying great dividends now that dies in three years is still a bad investment. How can you make sure that a given dividend-paying company is actually legitimate and worthwhile? The first place to look is in their financial numbers. Do they actually have a lot of money in the bank? Can they actually afford to pay out those dividends?

Four | The World Is Your Oyster
Here, Carlson makes the astute point that it’s worthwhile to look internationally for stocks that pay good dividends, because quite often the large companies in other nations are very steady dividend payers, just like those in the US. In fact, doing this can help diversify a portfolio of dividend-rich investments, making sure that you’re not too heavily invested in a certain sector.

Five | It Pays to Be Direct
Rather than investing through a broker, the best way to invest in a good dividend-paying stock is directly with the company. A few options are discussed here, but the most compelling one is known as a DRIP. Basically, it’s a program offered by some companies that allows people to buy stock directly from those companies with no fees. The dividends earned in those plans are directly reinvested into more stock in that company until you’re ready to sell it. It’s convenient, low cost, and very easy to manage.

Six | Postcards from the Hedge
One catch in all of this: if a company is paying exactly the same amount as their dividend for years and years, the investment gets worse. Why? Inflation. As years go by, a dollar is worth less and less, so if the same amount is paid out each year as a dividend, the company is actually continually reducing their dividend. Ideally, you want stocks that pay a dividend that keeps pace with inflation.

Seven | Lifeguard on Duty
Some people eventually reach a point where they live off of their dividends. If you plan to do this, keep a few things in mind. First, diversify. You don’t want to be completely left out in the dark if your company fails. Second, try to make sure that the dividend payment dates from the various investments you have are spread out, as it will make money management easier. Finally, avoid selling unless you have to, as selling reduces your dividend income level in future years.

Eight | Juice Your Portfolio without Striking Out
There are other options for investment that pay dividends besides stocks. MLPs are partnerships that invest in various assets. REITs are real estate trusts. These (and a few others) allow you to invest in things besides corporations and still earn dividends. These can be very useful in adding some diversity to your investment portfolio without sacrificing the steady income of dividends.

Nine | When DRIPs Become Floods
The neat thing about dividend reinvestment is that it can turn your dividend investing into a flood of money over time. Let’s say you buy some stock and agree to reinvest the dividends in more stock whenever it’s paid. You also agree to buy more stock regularly out of your pocket. It’s a good company, so the dividend payment goes up over time. Right there, you have three avenues for growth, and they can all build on each other.

Ten | If You Build It, Dividends Will Come
Just like any other investment, it’s well worth your while to develop a diversified portfolio when you’re buying dividend-bearing stocks. You should also buy bonds (which pay out regularly as well) as another component of your portfolio, and you certainly should diversify the stocks you own. The more stable it becomes, the longer it will support you safely and successfully.

Is The Little Book of Big Dividends Worth Reading?
If you’re unfamiliar with dividend investing, The Little Book of Big Dividends is really a good read. It’s tight, informative, and easy to understand.

Of course, on the other hand, if you know the basics of how dividends work and know what a DRIP is, you might not get too much out of this one. It doesn’t break any really new ground.

As for me, this book was very much worthwhile. It gave me the kick in the pants I needed to look into dividend investing. My wife and I are strongly considering trying out two different DRIPs and this book gave me the impetus to dig a little deeper.

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  1. Kirk Bond says:

    I love dividends! So does our government and one concern going forward is that increases in dividend taxation rates in the near future make these stocks potentially less valuable as time goes on to many investors. This has the possibility of decreasing the sale price of the stock. Caution is in order unless Congress realizes the detriment such policies have on stock prices.

  2. George says:

    There are many paths to income investing with publicly traded securities and one should explore them all since they have different capabilities and tax consequences: stock dividends, master limited partnerships (MLPs), royalty trusts, real estate investment trusts (REITs), business development corporations (BDCs), bond funds, and individual bonds. Most books only cover stock dividends and ignore the rest of the publicly traded possibilities, to the greater detriment of our financial knowledge.

    Also, few if any, books cover evaluating whether a stock that pays a 3% dividend and increases that dividend by 3% annually is a better choice than a stock that pays an 8% dividend which never is increased… which should you choose and under what circumstances?

    These are the things that investors should know rather than the generic advice “buy shares in a DRIP and cost average your way to riches”.

  3. IASSOS says:

    Suppose you buy a stock that pays a 6 percent dividend. Now suppose that stock goes up 30 percent. Do you sell? After all, you can immediately gain 5 years equivalent dividends!

  4. This book looks like it would be a very good read. I especially like the decription “tight and informative”. This kinda tells me it gets right to the point.

    I am fairly knowledgeable on the subject, but it sounds like it would be useful to me as well.

  5. deRuiter says:

    I forgot! Buying DRIPS direct through a company OFTEN involves a fee each time, which is not the case with a discount brokerage. The company fee eats into your profit each month or each quarter the dividend is reinvested. Plus the ability to sell immediately vs the cumbersome dealing with the company to sell does not allow you to maximize profit by timing your sale of the stock. I don’t care if you’re a “buy and hold” person. When stocks get to a dizzying height, sell and take your profit. Stocks are cyclical, they go up, they go down, buy low, sell high. I’m not suggesting day trading, merely stating the obvious.

  6. Daniel says:

    I definitely would emphasize the advice to not get blinded by yield. And don’t let the idea of patiently collecting dividends distract you from the basics of carefully reading a company’s financial statements and thinking about a company’s future prospects before you buy the stock.

    There’s a famous old saw in the investing world: “More money has been lost by investors reaching for yield than at the point of a gun.”

    It’s pointless to get excited about a stock with a seemingly high yield if that industry is about to go through a downcycle and the company cuts the dividend. One thing we learned from the banking crisis, for example, is that those seemingly rich bank dividends can disappear AND the stock can plummet.

    That being said, there is nothing cooler than collecting a bunch of dividend checks from a portfolio of stocks. It’s a great way to earn passive income.

    Casual Kitchen

  7. Beth says:

    “some common traits that companies that offer dividends have in common”–I wish all ‘professional’ bloggers would pair off and trade proofing services.

  8. GayleRN says:

    “Let’s dig in”

    I am pretty sure every book review Trent has ever done contains this phrase. Maybe he uses a template. It has become a game to me to find it. He never fails me.

  9. DiscoApu says:

    Look at DVY, you will see what chasing yield gets you. Also using a DRIP eliminates your free lunch(diversification) Most of the comments above are spot on. George also forgot to mention CEFs, Prefs, and munis. If you absolutely wanted dividend yield, look at funds/etfs that dont overweight in one sector.

    Finally, be very careful with international stocks, they have different tax rules then the US. For example, for german companies you have the tax removed from the dividend before you receive the payment. Then you get taxed again by the US for the remainder of the div. Each country is different.

  10. Lexi says:

    Trent it seems I could really use a vocabulary lesson. I know that most of your readers probably don’t, so could you (or any readers) suggest a good source for investing terms?

    For example, I didn’t know what a growth company was (I did a search and found a definition, which led to more questions)and although I haven’t done an exhaustive search just yet, the sites that I have found have more terms that I’m not familiar with, which leads me on quite a long road for answers.

    Any suggestions are greatly appreciated, thank you!

  11. Nicole says:

    Yes, I know that there’s a trade-off between dividends and stock prices, and it’s good to drip so long as you rebalance.

    But today is April 15th. Yesterday and today I got all the dividends from individual stocks (from back when I was a naive young investor and my only ETF was QQQ — I don’t drip them because I don’t want to unbalance things) that put out… I just have to say I LOVE dividends. Love love love getting money that I didn’t have to do anything to get except save money and put it somewhere. It makes you think… if I can get ~$700/quarter (when times are relatively good) from the not so huge amount I have invested currently, how long would it take me to get enough that I could live on it without working?

    Yay profit sharing! Yay dividends!

    Thank you. There’s not many people I can share that with without people getting annoyed. I hope you all understand. :)

  12. Mike says:

    I love individual dividend paying stocks! I frequently read the Dividend Growth Investor Blog. If you want to learn more about dividend stocks this is a great start. I hope to achieve my financial independence by growing my dividends ehough to cover my frugal lifestyle. Here is the web address if you are interested: http://www.dividendgrowthinvestor.com/
    Full Disclosure: Long dividend paying stocks and no tie in to the blog (I just really like it).

  13. Wade1066 says:

    Nicole’s comment made me hard. Yes, dividends are very exciting because it’s money and you don’t do anything extra… the work was already done.

    Yay for Nicole!

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