Dividend Stocks and to DRIP or not to DRIP

Investors have been reminded in the last month that the market is always prone to volatility. In times like these, investors might very well find themselves drawn to safer, more stalwart companies. And while tech is known for high growth-high risk companies, there are at least a few dependable dividend payers in the sector.

In this episode of Industry Focus: Tech, Motley Fool analyst Dylan Lewis and Motley Fool Million Dollar Portfolio analyst Jason Moser name two of their favorites -- Verizon Communications (VZ -0.84%) and Apple (AAPL 0.98%) -- and explain why these companies are a great way for investors to get low-risk exposure to the tech sector.

Plus, they explain dividend reinvestment plans (DRIPs) and when it does and doesn't make sense to use the tool.

A full transcript follows the video.

This podcast was recorded on Nov. 11, 2016.

Dylan Lewis: This episode of Industry Focus is brought to you by Rocket Mortgage by Quicken Loans. Rocket Mortgage brings the mortgage process into the 21st century with a fast, easy, and completely online process. Check out Rocket Mortgage today at QuickenLoans.com/Fool.

Welcome to Industry Focus, the podcast the dives into a different sector of the stock market every day. It's Friday, Nov. 11. Shout-out and thank you to all our veterans out there. Today we're going to be talking about dividend investing in tech, name a company or two that we like, and talk about whether to DRIP or not DRIP. I'm your host, Dylan Lewis, and I'm joined in the studio by Motley Fool premium analyst Jason Moser. Jason, how's it going?

Jason Moser: Hey, all right, how are you?

Lewis: Doing all right.

Moser: Excellent.

Lewis: The background for this show, earlier in the week, we saw there was some potential for volatility in the market. (laughs) 

Moser: Just a smidge.

Lewis: Naturally, when there's something that people are worried about, I think people tend to turn to dividend stocks, or they tend to look at some of these more stable and stalwart companies. I felt like we haven't done one of these shows in awhile, it made sense to dust off the book and see what's going on.

Moser: Absolutely.

Lewis: First, I'm going to talk about a company that I've liked for a very long time. I've been a Verizon bull for quite a while now. I'll say this is a company that is not really going to wow you with share price appreciation. They've been within a pretty tight band over the last couple years. You look at their P/E, they're at a multiple of like 14 times now, which kind of reinforces the idea that they are not a high-growth company. But, investors have gotten a nice 4% to 5% yield via dividends. In a lot of ways, I think this company models what I look for in a dividend payer, and something that I can set and forget.

Moser: They're almost like an air company. We need air to breathe, and basically, you either need Verizon or AT&T to live. That's your connection, whether it's cable or wireless or whatever. Verizon seems to have a pretty good hold on that market, no question.

Lewis: Yeah. It's become an essential part of our life, which is great if you're looking for a company that's not going anywhere.

Moser: Sure.

Lewis: To go back to that framework I talked about, the three things that I generally tend to look at -- and you can agree or disagree here, Jason -- is a company that operates in an industry with high barriers to entry, or just has a really strong hold that isn't going to be going away; has available growth avenues, so they can continue to be growing the top line, continue to pay out; and then, maintains a sustainable payout ratio, which is something that allows for growth in the dividend, and also makes sure that what you're currently being paid, you will continue to be paid.

Moser: I think those are all great. I love the high barriers to entry. That's something that we probably don't talk about enough as investors, because I think a lot of times, people don't really think about how tough is it to actually get in there and compete with someone. But when you look at a market like that ... Barriers to entry can come in many forms. They can be economic barriers, they can be regulatory barriers, they can be technology barriers. It seems like with Verizon, they probably have a little bit of all three of those. It's going to cost a lot of money to build out that kind of an infrastructure. You're going to have to get permission to actually do it. And then, really, you're going to go in there and build this awesome infrastructure and then convince me to switch from Verizon to your service provider because you think you're better? You have to have, at least, a track record there. So, to that point, that's the one for me where if you find a business with those kinds of barriers to entry, where they can really fire on all three, you've got something that's probably going to stand for a long time to come.

Lewis: Yeah. The infrastructure-intensive nature of that business creates a really difficult environment to enter. You look at other very recognizable names in the space -- Sprint, T-Mobile -- they have trouble stealing market share. And that's a well-recognized name. People know them. And the way they have to do it is with heavy discounts, really intense promotions. And that's not necessarily something that is sustainable.

Moser: Right. And that could play out, eventually, into that sustainable payout ratio, like you were mentioning. So it's always a good thing to watch there, because that payout ratio tells you, essentially, what they're paying out vs. what they're bringing in. If they're not bringing much in, they're going to have to be very careful about what they promise to pay out.

Lewis: And on a trailing-12-month basis, their payout ratio is around 65%. It's a little bit higher than it was for 2015, which was about 50%, but still well below the 80% figure it hit in 2014. So, not a concerning level, certainly a little bit higher than it has been in the past. But some of that is due to some of the strike issues that they had early in the year. They forecasted that 2016 was going to look a lot like 2015 for them financially. So, as they've grown that dividend, it stands to reason that the payout ratio is going to be a little bit higher. 

There are some concerns to be aware of with this business. Postpaid additions, which is a big thing to watch with them, was up just $440,000 as net additions in the last quarter, which was a little bit below what they have done the previous year, around $1 million. It was also below what analysts were expecting. I do think you'll see that rise; a lot of people are expecting that to get back on track with the holiday season coming up and new iPhones on shelves. So, if you're looking for a risk with this business, that's one to be mindful of. But, certainly a company that I've liked for a very long time, and one that I think dividend investors should keep on their list as a potential watch list.

Moser: Yeah, I think you really struck in on something important there. It's not something you're buying thinking that the stock price is going to double over five or even ten years. You're not even buying it for that purpose. You're buying it for that reliable quarterly income. This is a company that, probably, in a financial crisis, is still going to be OK.

Lewis: And my favorite stat about Verizon is their dividend was uninterrupted during the financial crisis. In fact, they grew it.

Moser: Yep. It speaks volumes.

Lewis: That just says the type of business they have, how sticky it is for their consumers, and the fact that, as a business, they're not going anywhere. Jason, I know you have a name or two that you want to talk about.

Moser: Sure. For me, I look at businesses like Verizon and AT&T and think they're great considerations, and you're sticking sort of in that tech world. A name that just a few years ago probably wouldn't have been considered an income player or a dividend stock, but now we have to look at it that way, is Apple. Apple has hit a point where, it's such a big company, and beyond the iPhone, they haven't really made, I think, the impact people have been hoping for these past few years. Now, that's a product of a couple different things. I think Steve Jobs was a very special person, and obviously did a phenomenal thing in bringing that iPhone to market. Innovation is a lot more difficult, it's easier said than done. And I think that Tim Cook, for example, has done a wonderful job as the CEO since Jobs passed away. Shareholders have certainly won, the stock price has essentially doubled since then. But now, I think Tim Cook's legacy is going to be more on the capital allocation side, as opposed to the innovation side. I think that's the real opportunity for Apple, and I think that's the real opportunity for Apple shareholders, as long as you're looking at this from the correct perspective. 

That's not to say that the stock price can't and won't grow over the course of the next five or 10 years. But, I think the dividend is going to grow along with that. At 2% yield today, I think they have nothing but time and room to continue to raise that for years and years to come. Because, I just don't see the smartphone necessarily being disrupted, at least in the near-term. I think they're trying to come out with new products that potentially could be additive to it, like the Watch and whatnot. But generally speaking, the smartphone, whether it's an Apple product or a Google product or whatever, the smartphone has changed the game for everybody. So, that's going to be a pretty reliable driver for that business in the years to come, along with whatever else they may be able to bring to market. You look at a business with a balance sheet like they have, and the opportunities they have to allocate that capital, I think they're going to continue to reward shareholders with the dividend, they're going to continue buying back shares, and that should help that share price a little bit down the road as it reduces the shares outstanding. It's a name that I think is going to be around for a while. 

Lewis: And you look at the way they sit within the smartphone market, they are not your average Android handset manufacturer. They have their own ecosystem. We go back to the idea of something that is a barrier to other people coming in and grabbing your part of the market -- that's it right there. Most of the people that are iPhone owners probably own Macs, maybe own iPads, they love that compatibility across devices, and they're so used to that user interface that they become extremely loyal to it. I think that's something that insulates them from a lot of competitive pressure.

Moser: Yeah. I think, generally speaking, and we go back to that barriers-to-entry quality, it's probably not all that difficult for a company to get in there and offer some sort of a new smartphone. We see all kinds of interesting competitors.

Lewis: Google just hopped in with Pixel.

Moser: Exactly. And Google, that's actually a very interesting point there -- with Samsung's trouble, I think Google has an opportunity to really pick up a lot of share from Samsung users. Probably, I think Apple is going to be a little bit protected by that because of the ecosystem and the operating system stuff that you mentioned there. And, generally speaking, I think the longer that you use a given product like that iPhone, for example, and you're used to using it, there's a learning curve that comes with switching, and the older you get, you're less likely to want to make that switch and to take the time to actually learn how to use something new. So, there are plenty of barriers there, in the form of technology and economic barriers. And, really convincing people that you have something better. There's a reason why Apple's iPhones are expensive -- because they're really good. And I don't see that changing anytime soon.

Lewis: So, I think the tech space is probably not the best known for dividend payers. We typically think of growth when we think of tech. We just named two companies. But, is there anything outside of the tech world that catches your eye at this point?

Moser: I was looking at this, because next week, there's a business that's going to announce earnings -- Home Depot (HD -1.90%), to me, is a fascinating business. It's one where you probably wouldn't think much into it. Barriers to entry? No, it's a retailer, it's pretty easy to enter retail if you want. Sure, there's some economic barriers to get to that scale. You can't just overnight open up a business with 2,300 stores around the world. But, what Home Depot has done, to this point, and I foresee this in the future -- this is one of the more Amazon-proof businesses out there. So much of what we've talked about over the last five to 10 years, in regard to Amazon, and how quickly it's moved, and how it's disrupted the retail space and shaped it, as we moved to e-commerce -- Home Depot operates in a market where, truly, there is a lot of value in that physical presence. Most people really need to go to the store to figure out what they want. They know, maybe, what they want, in the sense of, "I need some fence posting," or something like that. But they don't necessarily know exactly what style, size, type, whatever. So you have to get to that store, No. 1 to figure out, and No. 2, probably, to get some advice from someone who could actually give you an expert opinion on what to get and how to use it.

Lewis: Yeah, I think most purchases at Home Depot, or just your average hardware store in general, involve a lot more hand-holding. I stained a desk I was making the other day, and I had to ask three different people at the hardware store what type of stain I should be using, and what type of finish I should be using on top of that stain. That's not something I want to buy online.

Moser: Nope, it's not. And for the stuff you feel like you can buy online, Home Depot has done a very good job leveraging that physical infrastructure in the form of all of those stores. They have a good, robust e-commerce business in the sense that you can order something online and go pick it up at the store. So, if you know what you need, you can get it from them, and you can even have it shipped. But in most cases -- and this has proven time and time again -- Home Depot does a very good job at driving traffic. This is a company where they're not going to be opening up a ton of new stores. So really, the growth is going to come from driving traffic to the stores, selling more stuff, potentially raising prices here and there, which I think they can get away with doing pretty well, and then, ultimately, from a profitability standpoint, bringing that down to the bottom line. And, they buy back shares at a pretty healthy clip, which has helped shareholders immensely. The five-year chart on the stock is incredible. The yield, eh, it's maybe 2% to 2.5% today. But again, I think it's a relatively steady, protected business. It has proven to be so. There's probably a little bit higher risk in a dividend world. But still, I think it's one probably worth looking at.

Lewis: I did a show with David Kretzmann a month or two ago, and we were talking about board members and corporate governance, and how board member incentives are set up across various companies. He absolutely gushed about the way that Home Depot's board incentives were set up. I'm forgetting the specifics now, but listeners, if you want to go back, it'll be somewhere in the archives from the last month or two. So, they seem like a best-in-class business, at least as top management goes, as well.

Moser: Yep, and that's important, because I think, for people who remember Home Depot from not all that long ago, the Nardelli years where he didn't really run that business so efficiently. There was a time where shareholders of Home Depot were thinking, "Wow, is this really the end? Should I be looking somewhere else?" But, Nardelli is no longer there. Obviously, management has a good vision, cares about shareholders, and that they have correct incentive packages can really do powerful things.

Lewis: That's the first half of the show. We're going to come back in the second half of the show, and talk about something that Jason and I disagree with when it comes to dividends. Before we do, this episode of Industry Focus is brought to you by Rocket Mortgage by Quicken Loans. If you've ever bought a home, you know how frustrating and time-consuming getting a mortgage can be. Rocket Mortgage brings the mortgage approval process into the 21st century by taking all the complicated, time-consuming parts of applying for a mortgage out of the equation. With Rocket Mortgage you can easily share your bank statements and pay stubs at the touch of a button, helping you get approved in minutes for a custom mortgage solution that's been tailored to your unique financial situation. Even better, with Rocket Mortgage you can do it all online with your phone or tablet. If you're looking to refinance your mortgage or buy a home, check out Rocket Mortgage today at quickenloans.com/fool. Equal Housing lender licensed in all 50 states, NMLS consumeraccess.org number 3030.

So, Jason, I teased that we have a little bit of a disagreement here on how we handle it. It's not that we don't like dividends, it's that what we do with them might be a little bit different. If you're receiving dividends from a company, you have a choice. Maybe it would be helpful to walk through an example. Say you're a Verizon shareholder. Come next January, you're going to get a $0.58-per-share dividend through the company's quarterly dividend program. If you have 10 shares, that's $5.78 coming to you. You can enjoy those dividends as cash, or you can decide you want to reinvest it through a dividend reinvestment plan, or DRIP, as it's commonly known. If you decide to DRIP the dividends, you will receive fractional shares of Verizon to the amount of the dividend you received. Say Verizon shares were trading at $47, you would have 0.123 shares given to you. In the first scenario, you have 10 shares of Verizon, $5.78 in cash. In the second scenario, you have 10.123 shares of Verizon. The important thing to note with all of this is, either way, you're paying taxes on the dividends, because it's realized income. I am someone who likes to DRIP my dividends. You are not. Do you want to explain why you choose not to?

Moser: I think, primarily, the reason why I don't -- my portfolio, today, at least, is not geared toward many dividend holdings. When I'm looking at stocks right now, and I tend to look at investing in one of two ways: you're either at a point in your life where you're really focused on growing your wealth, or you're focused on protecting your wealth. Now, there are all sort of subdivisions with in those two classes. But generally speaking, right now, my holdings are a bit more geared toward the growth side. And typically, those growth companies do not pay dividends. Now, I will say, I'm sort of copping out on this, but two of my holdings I view as, they DRIP for me. That's in Markel Insurance and Berkshire Hathaway. Now, they don't pay dividends. What they do, essentially, is management essentially says, "We think we can do more with the money rather than paying you a dividend." So, I'm kind of letting them DRIP for me, and reinvest in their businesses, because they're proven capital allocators. They have done a pretty good job thus far. Nice track records. I'm going to hang on to those stocks for a long time to come. But generally speaking, No. 1, my stock holdings are a bit more geared toward growth, so the dividends aren't there. And then, I think it's also a matter of figuring out your entire investment picture beyond stock. What do you have beyond stocks? Is it real estate? Do you have a 401(k), IRA? Whatever you may have, look at everything in total, and that can give you a better idea of if DRIP makes sense for you, if you have something that works in that same fashion in another asset. Just, for me, that's how it falls. I'm not anti-DRIP. I promise, I'm not anti-DRIP. I think it's actually a really wonderful tool for a lot of people. Honestly, if I had some more dividend holdings, I would probably throw some of those on that set-it-and-forget-it.

Lewis: Yeah, I'm someone who I think is pretty balanced in my growth and income. I own Exxon, I own Verizon, I have a couple other dividend players in there, but it's really just the stability that I like. A couple benefits that I see, and some things that people should maybe be mindful of -- with DRIP-ing dividends, you're effectively getting commission-free shares, which is nice. So, if you have an account below the threshold for free trading, as I do, you're paying $7 pretty much anytime you want to do anything, unless you're using Robinhood or something like that. So, this is a way that you can continue to accumulate shares in a company that you like for free, and not have to worry about those expenses. There's also an element of forced dollar-cost averaging, which is something that I like. Your buys are coming in at predetermined quarterly intervals, you aren't gaining a meaningful amount of shares whenever you do anything like this. But they do compound every time. I just ran the math on this -- say you own 10 shares of a company with a yield of around 4%. If you decide to DRIP those, you'll be sitting on around 20 shares 20 years later, which, if you're a long-term buy-and-hold investor, is nice, something to keep in mind. And that's really having done nothing else, just with all those shares being bought in those small fractional ways where your dollar-cost averaging. I will say, if you need the money, or you feel you might be over-allocating to income in your portfolio, then DRIP-ing doesn't make sense, if you want to maintain that balance of growth and income and not get pushed too far one way. I know I use it as a way to force myself to stay invested in income stocks and not spend so much time chasing growth.

Moser: That's a really good point you mentioned there, and I think it's important. You're protecting yourself against yourself, kind of. One of the reasons -- again, I don't have a lot of dividend holdings, but the ones that I do, I enjoy the fact that I can get a little extra cash in my portfolio, and then I can maybe start thinking about other stocks I want to buy. But that doesn't necessarily mean I'm going to pick the right stock and buy the right stock. I could still screw that up. So, I think that's really a very good point for investors, DRIPs and beyond -- finding ways and mechanisms that you can protect yourself from yourself. The dollar-cost averaging point you made is wonderful. I think many of us use that in some capacity. Maybe it's through our employer retirement plan here. I also have two daughters, and we opened up 529 plans for them when they were born, and we set it up so it was just a small amount of money that just goes into their plans every month regardless of what the market is doing. It's a set date -- boom, it just happens. Now, they're 10 and 11, and I looked at their 529 statements the other day, and I was floored at how they had gotten to where they had gotten. I mean, time is an unbelievably powerful force here. For DRIPs, it could be substantial. Patience, I don't think, is anyone's strong suit. When we talk about investing, a lot of people want to get rich quick, and that's not how it works, really.

Lewis: Yeah, I think much like the 401(k) approach to investing, it's a set-and-forget. You're not even worrying about it, then you look back two years later and you're like, "Woah! What just happened?" And it's fantastic.

Moser: And I love that. And I have that here with work. Again, that's sort of taking your total picture into account. Having a little bit of all of that, I think, is what every investor should strive for.

Lewis: Yeah. So, what you do with your dividends comes down to how well you know yourself, (laughs) and how well you can manage yourself. Well, listeners, that does it for this episode of Industry Focus. If you have any questions, or just want to reach out and say, "Hey," you can shoot us an email at [email protected]. You can always tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes or check out the Fool's family of shows at fool.com/podcast. As always, people on the program may have own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Jason Moser, I'm Dylan Lewis, thanks for listening and Fool on!