Not All Dividends Are Equal: Dividend Kings, Aristocrats, and Red Flags

0:00Not all dividends are created equal. A high dividend can mean that you're looking at a healthy shareholder friendly business, or it can be a warning sign that the market thinks that this payout is not going to last and this company possibly could be headed toward bankruptcy. Today, Andrew and I are going to break down the two main types of dividends and what they actually mean and how you can use them to avoid getting tricked by the you. You're tuned in. You're tuned in to the Investing for Beginners podcast. The show for the long-term investor. We cut through the noise to focus on what works.

0:38Compounding, discipline, and the conviction to buy wonderful businesses and stick with them. Your path to financial freedom. Start now. Welcome back to the Investing for Beginners podcast. My name is Stephen Morris and he is Andrew Sather. One of the things I love most about what Andrew and I do in the company and in the stock market is that I learn something new every day, all the time. And especially, I've only been doing this for a few years, so I am way behind the curve when it comes to Andrew. And so today we're going to be talking about something I literally just learned about, and that are two main types of dividends, which are the dividend kings.

1:25and the dividend aristocrats and so basically what that means correct me if i'm wrong andrew so it's it's dividend or kings first right or is there no it's aristocrats before kings yeah because you're in which do you think well i was researching it yeah when i was researching And it's like, OK, so the king is above all the aristocrats. So and I'm in a monarchy. OK, so the aristocrats are 25 years plus and the kings are 50 years plus. So basically what that means is that this company has paid a dividend for 25 straight plus years consecutively without missing one in order to be a dividend king.

2:17uh so uh i think it was dick's sporting goods we were talking about andrew that had to stop their dividends during the pandemic i can't remember yeah uh we recently i don't remember what the company was we were talking about a company and i don't know if they were a dividend aristocrat or king but the reason i bring that up is them having to stop their dividend during the pandemic for whatever reason would have removed them from the list disney it was disney okay yeah yep so that that would have removed disney from whatever tier they were on because this has to be a consecutive uh uh year so uh that's what we're talking about today and andrew like it seems so i don't know like as i was researching and learning about it it's like man this is so corny, but it's actually, I mean, it's corny.

3:17I think to me, just because of the aristocrats and Kings, like it sounds corny, but it's actually a super useful tool to use. How do you, how is it useful to you as an investor? I'm, I'm looking at it right now. Cause it's been a while. And I'm, I'm like, man, after we get off this call, I need to add like five different stocks to my watch list because these are great businesses. Like you don't accidentally pay a dividend 25 years in a row. So a lot of these businesses are doing something right. You do have to be careful because for every business that looks like it's growing a lot and could continue to grow, There could be an equally dangerous business where maybe they're just treading water or maybe they're on the decline phase of their life.

4:10So it's not just this fix, end all, be all. And if you just so highly believe in these dividend aristocrats or Keynes, companies have set up ETFs so you can buy to match these different ones. But I think it's a great place to pick and find ideas because, like I said, they didn't get here on accident. Yeah, that's such a great point, Andrew. And I think it speaks a lot to a business when we start talking about their intentionality. Like you said, they don't accidentally pay a dividend for 25 straight years. That is very intentional. What other things can a long dividend streak tell you about that company?

4:58That they've been profitable for a long time. You can always take out debt or you can always raise capital to pay a dividend. And companies do do that sometimes. But if you want to do it for a very long term, you're going to have to do that from internally generated cash flow. So you've got to be profitable. and it's easy to be profitable. I don't know if that's a good thing to say or factually accurate, but profitability is common. But being profitable through multiple business cycles is not as common. And if you're in a boom or bust industry, you probably will have to pause the dividend if your industry is going through a really tough time.

5:49So some of the businesses on here are in more resilient industries, those that don't lose as much money during a downturn. And some of these businesses are just really good at navigating tough times and keeping enough profitability where it doesn't cripple the business. And I don't know. I saw some really interesting companies on the list. So the dividend aristocrats, Coca-Cola is on here. Probably not a surprise. I think they're a keen also. Pepsi's on here. Walmart is on here. General Dynamics and Caterpillar are on here. You're two of your favorite names. Johnson & Johnson, obviously. McDonald's, Target.

6:37Sherwin-Williams, that's a company I've been watching for a very long time. Of course, Chevron and Exxon. So you have these great businesses and, and, you know, I, I, I look at like a Chevron or an Exxon. The re you know, why have they been able to pay a dividend for so long? You look at their business model and they're completely vertically integrated. They've, they do the production, they do the refining and they do whatever that last piece is. and then so that helps them stay solid during during different time periods and so you will see companies like that companies that are maybe have more diversified revenue streams or just for whatever reason they have this long lasting this to them and again it's no guarantee that they will continue into the future but it's a decent signal that hey maybe this has a better chance of continuing than Allbirds or somebody like that.

7:37Allbirds, our new favorite stock to just trash. No, you talk about them being able to survive through downturns, different markets. So you mentioned Sherman Williams, and I don't know anything about Sherman Williams. I've never looked at their their stock at all but i do know the housing market is not great right now and that's kind of exactly what you're talking about whatever sherman williams is doing to ensure because you know sherman williams what do they do they make paint for houses now do they make other stuff i have no clue but i i know that's what they're most known for so it's a lot i guess in my head it's logical that they would be suffering right now um but they've found a way to stay relevant even though the housing market isn't doing great right now um so and i but again like i don't know since the housing market isn't doing great that means people are keeping their houses so maybe they're upkeeping better and sherman williams has a plan for that uh i have no clue but i i thought that when of all the companies you listed it's like yeah of course they're they're on there but then sherman williams like when you got to that one it kind of stuck to me that now's not a great time to to be in the home uh space that's a really good point so that brings up the next kind of idea behind what enables somebody to pay a dividend for so long, somebody being a company.

9:17Capital efficiency can play a big role in this. But we like to talk about like ROIC or return on equity. These metrics that show that a company is very capital efficient. When a company doesn't need as much capital to make their profits, then they have a lot more ability to pay dividends. And so when you look at Sherwin Williams. I haven't looked at them lately. Maybe I can pull them up, but high return on invested capital means they're very efficient. They can grow and not need to tie up a bunch of money to grow. And those are the types that can pay dividends for a long time. And that's why Warren Buffett likes to find very capital light businesses.

10:04That's how he calls them, is because they just invest a little bit reinvested in the business the rest can just come back to shareholders and that can be a dividend that can be buybacks um and so that's another it's like the chicken and the egg you know is it because they're capital light that they pay dividends for a long time or because some of these paid dividend for a long time does that make them capital light um they're not necessarily one doesn't cause the other, but it's another decent signal that a lot of the businesses on this list could be very capital light. And that's what enables them to do what they've done.

10:48And it's interesting. And I think that leads into my next question nicely is, and again, I have not researched Sherman Williams at all. I know nothing about them. but when we're talking about them paying their dividends so they've been around forever i don't know when they're founded but i know they're around in 50s 60s so to me that's forever before i was born um long before i was born actually that was my dad was born in 1950 so uh they've been around the hot minute. How do we know that this isn't the signal that they're there on the end cycle of the business getting towards the end of that life cycle?

11:42Yeah, great question. That is the big risk with buying dividend aristocrats or dividend kings is they could be on that tail end of their life and just kind of paying dividends just to attract shareholders because the growth picture is not very attractive on its own. So you just use the same metrics we use whenever we analyze any business. You want to look for historical growth. Are they able to grow that top line? Are they keeping healthy? Not too much debt, not too much interest payments, things like that. And then back to the ROIC, our return on equity question, do they generate a good return on the invested capital?

12:27And I think another one to consider, how does that compare to their direct competitors? So if we look at Chevron versus Exxon, both probably decently returning, decently our return on equity during most years, if they're doing that way better than some of the smaller oil and gas companies, which I know they do, that can give some staying power. So you want to just analyze it like you would any other business. And then you can add on metrics like dividend payout ratio. how much of their earnings are they paying out in a dividend? Because sometimes that can show when the dividend payments becoming unsustainable.

13:17And so sometimes you can use that to get ahead of a company about to cut their dividend. Right. That's interesting. Are there any other key red flags you can think of when it comes to a company and the dividends they are paying that kind of show you that it's unsafe? Yeah, that's a good question. So another one in REIT land, which is short for real estate investment trust, is companies might sometimes issue shares to pay a dividend. So it's like the concept of like, what do they call it? Robbing Peter the PayPal. Is that the phrase? um so they're basically they're they're making your slice of the pie smaller and then giving you some of that pie back again so it's like you feel like you're getting this payment but really they just took from you and then gave it back to you um so you so you've got to be careful about that that um companies aren't doing that too much it's okay they do like REITs that's that's kind of the game that's the game they play but you want to make sure they're not doing that too much where you're getting diluted into nothing yeah that's interesting you so like you just put the most god-awful visual in my head you're like they they take your piece of pie away from you and then give you a piece of it back it's like great so you just gave me a pre-chewed up piece of pie thanks um that's just horrible but like you said like don't let that turn you off of reeds though because Andrew is right that is a very common practice in a REIT but I also just focus on the fact like that is what they do that's part of the way they make money um so it's a little bit different in REIT land um we we I don't know Andrew maybe we can dive into that in another episode later on about like how REITs actually make their money but uh but for a company like Sherman Williams um like andrew said if they're doing that repeatedly all they're doing is just over diluting and eventually they're going to dilute your shares into worth nothing and that's not obviously sustainable or good um we talked about this uh a couple episodes ago i don't remember how long ago but i feel like it's a good uh i feel like it's a good topic just to kind of keep hammering home because i feel like it's something we miss often or maybe even miss a label often and that is when and why can a high yield uh be a giant red flag for us yeah and it comes down to how the yield is calculated so a lot of times when we're looking at a stock we're looking at the business you can separate the business from the stock and just look solely at the business but when you're looking at a dividend yield the stock price is inherently tied into that and so if the yield gets super super high that could mean that a lot of people are selling the stock and that could that could be kind of like where there's smoke there's fire people yeah i mean the market's pretty emotional and irrational at times but like it's also pretty decently smart too like uh there's not going to be there's not going to be huge sell-offs unless there's a decent reason why we all have to make judgments on how bad is is the development but um yeah so so you see a big sell-off you'll see that yield shoot higher you want to figure out why and is it because something happened in the business that now puts the dividend at risk puts the business at risk all of those things love it absolutely so when it comes to to your practices and buying stocks uh dividend stocks is there they're a checklist like i know i know you like you have a checklist for for a stock needing to measure up to certain things before you even consider buying it um do you have one specifically for like uh or maybe not a separate checklist but like a separate section for dividends of like the dividend has to meet this criteria if it doesn't then it's a no-go sort of um we i could go through my process on sherwin-williams on air and if it's bad we could just edit and then the audience love it let's do it okay so so i pulled up sherwin-williams uh pe of 31 so that's pretty expensive growth rate is whatever uh one metric that i think is good to look at is dividend per share growth i can't remember what the company was it might have been ibm and um some other company i heard recently uh maybe even apple i think apple grew their dividend by a penny and they've done that like two years in a row so it's like just because you're on the list doesn't mean you're doing it in the right way uh so we want to look at is the growth rate of the dividend actually meaningful or are they just doing it to check the box um for dividend growth rate it looks pretty good uh over three years five years and ten years dividend growth rates been very good for Sherwin-Williams.

18:53So a couple other things, like I said, financial health, debt to equity is a three, that's kind of high. And the EBIT to interest is an eight. So that's pretty decent. Let me pull up my charts, which nobody can see, But I like to look at how are they either diluting the company or are they doing share buybacks? So what I do in fiscal is I look at shares outstanding. How is that trending? For Sherwin-Williams, it's kind of coming down slowly over time. And then you can see I also put like a dividend yield. So their yields are like 1%. So I figure, okay, if it yields at 1 % and it looks like the buybacks, you're getting about a percent or two.

19:42So if I want to earn 9 % a year, or I'm sorry, if I want to earn 11 % a year, I'll get 1 % from the dividend. Let's call it 1 % for the buybacks. So I want Sherwin-Williams to grow like 9%. And that would be my first, uh, maybe hurdle hurdle rate is, is the term they use, but basically that's where the bar is set. Um, you can compare this to a company like Pulte group, which is a home builder that I've owned them for a long time. They're buying back like 5 % of shares per year. And you're getting, I can't remember like 2%. So in that case, I'm already getting 7 % growth. Um, from Pulte Group just from dividends and buybacks.

20:29Now I only need an extra 4 % from the company to hit my 11 % hurdle rate. So that assumes everything kind of stays the same and the price doesn't move, which obviously we know that's not the case. But that's one of the bars that I'm looking for. And the only reason I'm buying a stock that doesn't meet that bar is if their PE is so cheap that it will compensate for the fact that I'm getting lower growth. Am I getting too off the rails on that? Or does that all kind of make sense for now? No, that makes perfect sense. Just when it comes to like the, your exception, the PE growth, that makes total sense, but it also seems fairly risky slash possibly unlikely that that's going to pay off.

21:24in the long run. Yeah. Okay. Which is fair. Like that is fair. I think one of the mistakes that too many value investors get into, myself included, is we think the stock is cheap and eventually the market's going to figure it out and eventually the market will take it to a higher PE. Not realizing that some stocks are just always a lower PE. They're always going to be cheap. Pulte Group's a good example of that. Homebuilders are always cheap because everybody knows that those swings are pretty wild. That is like if you're at a theme park, the number one or number two roller coaster is like a home builder.

22:06So people know that that profit, whatever profits they're showing now are probably not going to sustain over the very long term. And that's why it's cheap. So to your point, like if I was to look at Pulte's low PE and just think, ah, you know, this PE will be a 35 one day and I'm basing my whole decision on that, it's probably not going to work out. So you do have to be careful with the PE part 100%. And I think that's where the quality of the business comes in. And so you want to make sure. I don't know. I haven't had super great success recently buying the dip on stocks. I've talked about Adobe.

22:44I've talked about Starbucks. Alphabet was a pretty good one. But it's tough to buy stocks on a dip. But that's kind of like what you're doing is like betting that this PE is lower and that they'll go back to their historic highs. But it is a very treacherous idea. So you do want to try to focus on the business as much as you can. Perfect. And is there anything else that you, other than having to make that hurdle, is there any other check or balance that the company has to make with its dividends before you're you're sold or not yeah i mean um going back to the the debt thing so i have like charts that show where is the debt not only where is it on the absolute basis but what where is it trending over time is that debt climbing up over time or is it staying pretty stable in the case of Sherwin-Williams, everything here looks pretty stable.

23:45Even their coverage ratio, which is saying how much are they profiting versus their interest payments, that's pretty stable too. So they get a check like okay on that bullet point. So yeah, that would be a very important one to look at all the time. Perfect. I think, I don't know, it's interesting. Sherman Williams, we might need to do a bird's eye view of Sherman Williams soon. Because I'm super interested. Because like I said, Sherman Williams has been around for a minute. You mentioned competitors. I can only think of one and that's Bear. Which I think that's a Home Depot only. I think that might be owned by Home Depot.

24:34Oh, really? I think so. I don't know. That's the only other home paint that I can think of. Yeah. Other than Sherman Williams. So, I mean, obviously you got the Lowe's brand, Home Depot brand, whatever they are. Right. But, yeah, interesting. Yeah, the one thing that concerns me, which I would have to run on the spreadsheet, is like their return on invested capital seems lower. So it's like only a 15. So I don't know. I would have to see like, is the dividend at risk? And I don't have any checks for payout ratio, but I could pull up their payout ratio real quick. I do have a buddy who works in home building and he's super bullish on Sherwin-Williams, but uh let's see yeah pay ratio has been pretty steady so i think it would be fun to look at them and yeah what if we what if we did a stock one time and that was the valley spotlight pick and everybody got to hear it on air how thrilling so i'm on so is sherman williams sold in lowes or Home Depot or they got to be right well Sherman Williams has their own stores right but yeah I would think they would have to be sold because I've honestly never been in a Sherman Williams store I don't think I don't know that's interesting we need wow I got lots of questions we need to find out so we know the next bird's eye view episode we're going to do because i'm too curious now i'm about to drive over there's a sherman williams store about two miles from my house so i'm about to drive over there and just start asking their store manager a bunch of questions i love it awesome so when we're talking about these dividend kings dividend aristocrats or I'm sorry, dividend aristocrats or dividend kings, say it in the proper order.

26:56I think the most important thing for me, at least in this regard, and again, I'm just learning about this this week. So I think the biggest thing that stood out to me from all of this is it's a great pool to go play in. it's you know it's it's the the the little two foot section of the pool like you get in you get acclimated to the water you splash around for a little bit and then you're ready to go swim in the deep end um it's a great place to swim around so if you're brand new and you're looking like trying to find your first stock idea great place to start start looking like andrew said is not a safe or not not a end-all be-all like some of these companies may not be good companies to invest in but there are definitely some that are you know coca-cola being one of them um sherman williams maybe another uh but there are definitely good companies that you can find there they're good uh a good safe place to get your feet wet um and then from there uh using for me using my rabbit hole method of just okay who supplies sherman williams with x let's go see what they're like or you know let's go see if that's a good company and then you're expanding your circle of competence your your uh you have a diversified portfolio um that way and i mean it's just it's it's a good method i really like it and i kind of wish i knew about it in the beginning but it's okay i'm happy learning about it now uh is there any other key takeaway that i've missed andrew for for someone that's beginning i i like the way that you describe it like being a great place to get your feet wet um i look over the list and maybe this is a mistake on my part but i don't have any of these stocks in my portfolio i used to have like i had hormel that that went pretty well until it didn't.

29:06Walmart, I guess, was a miss because I think Walmart's been awesome. And that's been on the value list for a long time. And I just missed that one. So yeah, I think your chances are in this list, you're going to get a boring company that probably doesn't beat the S &P 500. But that's based on just where the market's been over the last 10, 15 years. Maybe we see a comeback. Maybe the next trend for the next generation is like old and stodgy and safe is now the new cool. And the market like flocks to that. We laugh, but Vitaly Katzenelson, he has this great book I've been reading lately called Active Value Investing.

29:54And he says, if you have a sideways market he calls a range bound market old and stodgy becomes cool again so if we do see i'm hoping we don't i hope this market just keeps raging on but if we do see one of those range bound markets um this this could be the the place and by the way you heard it here first so come back and give us credit for if if we convince you to get into these stocks love it yeah and i think that's such a valuable uh thought as well you know we've already talked about how you have no idea what what trends are going to happen so i mean your portfolio not only does it need to be diversified from a million other things you know being diversified from from the market chasing after trends as well maybe something you should look at so awesome i learned a lot andrew thank you for breaking all that down for me um thank you for bringing it up because i don't think i ever would have picked this up otherwise um and i and i learned a lot like they're like these are just the two main things we wanted to talk about there are many different other types of dividends out there which i i also didn't know so um it's been a great learning journey for me this week i appreciate it let us know what you think do you own any kings or any aristocrats i promise i'll say in the proper order one day but it's not going to be today um but let us know in the comments if you own any or what you think of them or do you have a dividend checklist that you follow similar to andrews or maybe completely different i don't know let us know we appreciate it we love your feedback and thank you so much for joining us today we will see you next time but in the meantime Never, ever, ever forget.

31:46Invest with a margin of safety. Emphasis on the safety. Peace.

31:55You've been listening to the Investing for Beginners podcast. All show notes can be found on our website at einvestingforbeginners.com. To master the basics of stocks in seven days, Sign up for our free email series at einvestingforbeginners.com slash newsletter. Until next time, have a wonderful day. The information contained is for general information and educational purposes only. It is not intended as a substitute for legal, commercial, and or financial advice from a licensed professional. The hosts may own positions in the securities discussed. Review our full disclaimer at einvestingforbeginners.com.

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