In this episode of Industry Focus: Tech, Dylan Lewis and Motley Fool contributor Brian Feroldi do a deep dive into dividend stocks. Discover some important concepts, including tax implications and what pitfalls you should be aware of. The guys also share some investing ideas, further research resources, and much more.
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This video was recorded on June 19, 2020.
Dylan Lewis: It's Friday, June 19, and we're talking about dividends. I'm your host, Dylan Lewis, and I'm joined by Fool.com's illustrious overlord of non-disgruntled-ness, [laughs] Brian Feroldi. Brian, how's it going?
Brian Feroldi: Dylan, it's going great. How are you doing?
Lewis: I'm good. As always, I enjoy reading your titles, and I try to keep them a surprise as long as I can. Folks that follow the show know that I basically put the outline out there and then Brian puts in whatever he wants as a title; usually, it's self-deprecating, but this one is a good one, you know, "overlord of non-disgruntled-ness," you're a very joyful person. [laughs]
Feroldi: I'm a very nondisgruntled person. [laughs]
Lewis: [laughs] I guess, there's a difference there, between being non-disgruntled and joyful. And [laughs] you're going with non-disgruntled [laughs] today.
Feroldi: Yeah, sure. [laughs]
Lewis: I have you on today, Brian, we are talking about dividends. And the reason we're talking dividends is because we got a question from a listener. "Can you guys do a show talking about how to pick good dividend stocks?" This one comes from K. Isle on our iTunes review page. Love this question, love getting reviews, especially five-star reviews from fans on iTunes, helps us out a ton and it gives us a sense of what people want. We haven't really done a deep dive into dividends in a while. I think we're probably due, Brian.
Feroldi: Yeah. Dividend stocks are incredibly popular with a subset of investors, and it makes complete sense why, right? You buy a stock, you own that stock, and magically income appears in your life. That's appealing.
Lewis: Oh, it's a wonderful thing. And I think it's an easy thing for new investors to wrap their heads around. I, at various points in my time at the Fool, have worked on our free products, and you know, some of that's our articles, some of that's our YouTube presence, our podcasts. And especially when I was working on our YouTube presence, I saw a lot of new channels oriented toward new investors, and they were that Robinhood crowd, and it was a lot of really dividend-focused investors. Because if you're just starting out, the idea of owning a business and having that business pay you pretty regularly is a pretty easy thing for you to understand. You don't have to get into some of the more advanced metrics of investing that can kind of make things a little cloudier.
Feroldi: Yeah. It also reminds me of some "investing" that people have done historically, like, with a savings account or a CD. They understand the concept that you put money into this thing and it produces a small bit of income for you. So that transitioning from there to dividend stocks is a natural progression.
Lewis: So we're going to treat this one as kind of a primer. We're going to go really basic and then get progressively more advanced throughout the show. I think just to get us started, you kind of hinted at this before, but what is a dividend? Let's start out with defining this.
Feroldi: So a dividend is a payment that is made by a company or corporation to its shareholders. Dividends are usually paid in cash. That's the normal way that companies pay dividends, but they can also be paid in other methods, such as with additional shares of stock or in some cases even types of property, for example. But most companies that pay dividends set a policy and then they follow it. In the United States, the most common dividend policy is to make a quarterly cash payment to shareholders.
Some companies do them monthly, others do them annually, but most companies in the U.S. pay out a fixed dividend rate per quarter. So as an example, some companies might say, our dividend policy is $0.25 per share per quarter, you annualize that over a year, that equals about $1 per share per year. And that model is pretty specific to the U.S. Other companies, especially in international markets, make dividend payments based on their earnings. So they might say, we'll pay out, say, half of our earnings, and that allows the dividend to kind of fluctuate. In good years, they pay out more; in bad years, they pay out less. Whereas in the U.S., most companies set a fixed dollar amount and then they pay that out consistently.
Lewis: I think part of the reason for that is, when we talk dividend investing, we're talking about a style of investing in a type of company that is very appealing to a specific kind of person and a specific kind of investor. And in the U.S., a big part of the reason why you have companies set that cadence of monthly or quarterly and then follow it is because they know by doing that, and then having a track record of consistently making those payments over time, they are going to attract income investors. You do see businesses every now and then issue a special dividend -- I'm pretty sure Costco did a couple years ago -- which is kind of a nice little windfall for whoever happens to be [laughs] holding shares at the time, but they're not nearly as predictable.
And really what companies are doing with their dividend policy is saying, "We have a certain amount of capital, we could reinvest this in the business, we could buy back shares or we could pay it dividends. And what we've decided is, we're able to invest enough in the company already, we still have some left over, and then we're making the capital allocation decision as to whether we want to be buying back shares or paying the dividend." They decide to pay the dividend.
Some businesses have done it for 5 years or 10 years, some businesses have done it for 25 years and they've really established themselves as dividend payers and become very attractive to dividend investors for that reason. But generally, at least in my view, if you're looking at different companies, you want to see people that have made the payments for a while and are making the payments regularly.
Feroldi: Yeah, that's a key component of dividend payment. To your point, Dylan, dividends are capital allocation decisions. So some companies choose to take all of their earnings and reinvest them into the business. They could also use those earnings to buy back stock, to pay down debt, to make acquisitions, to just have it sit on the balance sheet and grow, grow, grow. And one of those options that companies do have is to pay it out, give it out to shareholders, which essentially is a way of saying, "We have no idea what to do with this money, we have no [laughs] good ideas. Here, shareholders, you take it." And that's very appealing to a lot of people, because it's a more dependable source of return for investors when you can depend on a dividend coming at you on a consistent basis.
Lewis: Yeah. And I think what is appealing to a dividend investor is probably the last thing that a growth investor wants to see, [laughs] which is the company saying, "We really don't have anything better to do with this money, so we're just going to give it to you. And you know, the other option is we can invest this internally in growth initiatives that we think are going to meaningfully move the business forward." And, you know, some businesses, they just have such predictable cash flows, they're in such established markets, that it makes sense for them to instead attract a buy-and-hold investor that is going to just accept those payments over time.
If you're looking at dividend stocks, I think there are some key terms that you should know. And "dividend yield" is probably one of the biggest ones and one of the most talked-about ones if you're just getting started.
Feroldi: Yeah, so the dividend yield takes the payout per share and divides by the share price, and that division gives you the dividend yield which is almost akin to like an interest rate. So as an example, if a company paid out $1/share in dividends per year, and that stock was currently trading at $25, well, a $1 dividend divided by a $25 stock price is a 4% dividend yield. And obviously, this number can be higher or lower based on a huge number of factors. The lower the share price and the higher the dividend payout per share, the higher all over the dividend yields.
And it's always helpful to compare numbers to the S&P 500. So the S&P 500, the average dividend yield across the S&P 500 is about 1.9%. So companies that pay much more than that are considered high-yield stocks. Typically, about double that number is a high yield stock, so about a 4%. And under half that rate, so under 1%, would be a low-yield stock. But "dividend yield" is the key term to know.
Lewis: Another way to think about yield is, if there is zero capital appreciation or depreciation in the time that you own the stock. So you buy a stock on Day 1, at the end of the year you're still holding it, the share price is exactly the same. The yield is pre-tax what you have made on your investment. And it's worth emphasizing there "pre-tax," because you're going to be paying taxes on those dividend distributions. But that is just another way to, kind of, wrap your head around this.
And when you're looking at the feasibility of a dividend, you have to be looking at the payout ratio. This is another one of the big terms for us to be looking at. And this is kind of a measure of, really, how much cash is going toward these payments and how sustainable this dividend is.
Feroldi: Yes, that's an incredibly key point, Dylan. Dividends are options. The management teams do not have to pay dividends; it is completely an option on their behalf. You can stop paying a dividend, you can cut the dividend. And all of those things typically are bad for shareholders. So you have to know how sustainable a dividend is and how likely it is to continue being paid. And one metric that investors can use to judge that is the payout ratio. And this number is just a matter of how much does the dividend cost in comparison to how much profit a company makes?
So let's pretend a company pays out dividends of $500 million per year. So the dividend costs the company $500 million per year, but that company makes $1 billion per year in profit. That would be a dividend payout ratio of 50%. So the $500 million that the dividend costs, divided by the $1 billion in profit.
As a general rule, I like to look for companies that have a payout ratio below 60%. That does give companies plenty of wiggle room if they have, say, a bad year to continue to afford the dividend. But there's nuance involved when certain types of stocks called Real Estate Investment Trusts or REITs, are actually required by law to pay out 90% of their taxable income in order to qualify for special tax breaks. So with companies like that you always -- you know, you have to know that nuance ahead of time. But in general, the lower the payout ratio, the higher the likelihood that that dividend will continue to be paid and the better.
Lewis: It's helpful too to look at where that metric trends over time. There are businesses where a 60% payout ratio is a good thing and [laughs] businesses where a 60% payout ratio is a bad thing. And the only way to know that is to see over time what the numbers look like, because that's going to be a reflection of that income, really, you know, that denominator, because generally that dividend payment is going to stay the same unless the company makes an adjustment to the dividend program. And so, you know, if typically, they wind up in, you know, the 25% range and then all of a sudden they spike to 50%, that's worth digging into, because there might be something there. Whereas there are some businesses that generally hover in, like, the 70%, and that's fine, so long as they stay there and they're able to maintain the program that they've set in place.
Now, the businesses that are capable of maintaining these dividends and really, you know, attracting shareholders are known as Dividend Aristocrats. That's another key dividend term, Brian.
Feroldi: Yeah. So a Dividend Aristocrat is a company that has raised its dividend for 25 years in a row. The last 25 years, every year, it has raised its dividend. And it takes a special business to be able to do that. I mean, you think over the last 25 years, that's included the 2008 crisis, [laughs] COVID-19, the tech dot-com bubble burst. So really some [laughs] tremendously rocky times. So if a company can raise its dividend every year over that time frame, that should tell you that that is a very high-quality company and the odds of it continuing to do so for a long period of time are very good.
And since this is the Friday Tech show, there are actually two "tech" companies that are Dividend Aristocrats. The tech sector is not typically known for its dividend payments. In fact, out of the 593 companies that are listed as tech stocks, only about 133 of them actually pay a dividend. But there are two Dividend Aristocrats, and those companies are ADP, the payroll processing giant, and Roper Technologies, which is a software company that focuses on industrial. So those two companies, ADP and Roper, have increased their dividends for 25 years in a row.
Lewis: Yeah. And there's a lot of prestige that comes with being a Dividend Aristocrat. I think there's a stability and a kind of constant demand for your shares, because people are going to be expecting that payment. And to your point earlier there, Brian, if you can look at a business that has [laughs] managed to weather two pretty big financial crises, and really, I mean, we're kind of in the middle of one of these right now where a lot of businesses are being stress tested and you're starting to see the idea of dividend cuts coming, especially for folks that operate the commodity space, like, oil.
If you're able to look back and see that they have a track record of sustaining those payments even when things go poorly, that means that maintaining that payment is important to management, and they're putting themselves in position where even when times are good, maybe they're putting a little bit of cash on the side, because they're able to realize that they're not always going to be good and they want to make sure that they can maintain the solid financial position that they're in.
I think, with dividend stocks, Brian, there's this temptation to think that they are a totally different animal than the average stock. And while we've talked about, like, you know, all these kinds of dividend-specific metrics, the reality is, when you are buying a dividend stock, you are still buying a stock. [laughs] And so, the company needs to check all the normal boxes that it would for you in order to be something you should be buying.
Feroldi: Yeah. I would tell you that I, myself, am not a dividend investor, but I do own companies that pay dividends. And I think that distinction is important. If you are a "dividend investor," a lot of people -- the start of their research is the dividend, and that's like their sole focus. Some people say, "I'm only going to buy stocks that have a dividend yield of 3% or higher." My focus is always on the highest-quality businesses that I could find, period, and if they happen to pay a dividend, so be it.
So when you're looking for dividend-paying stocks, to your point, Dylan, all the things that we normally look for are just as important with a dividend payer as a non-dividend payer. So when you're on the hunt for dividend-paying stocks, you still want to make sure the company has high-quality -- wait for it! -- recurring revenue, Dylan. You want to see that the company has strong margin profile that are consistent over time, that they consistently grow their earnings, that they have a balance sheet with lots of cash and very little debt, a strong competitive advantage, a good corporate culture, an incentivized and high-quality management team. You want to make sure the company still has growth potential ahead of it and a history of raising its dividend each and every year.
So you still want to place an emphasis on all those same factors when you're hunting for good dividend stocks.
Lewis: You know, Brian, one thing that I meant for us to hit that we didn't talk about as we were going through some of the dividend metric stuff and some of the dividend-specific stuff is the idea of dripping and not dripping dividend. And for folks that are unfamiliar with that acronym, DRIP is dividend reinvestment plan, and this is what brokerages offer. And basically, the idea is, you can receive your dividends as cash or you can receive them as fractional shares. It doesn't really change your tax basis, you are going to be taxed pretty much the same way, but the difference is you are continuing to increase your position in that company if you decide to take them in shares, whereas if you're taking them in cash, you get the money, you can do whatever you want with them. Any specific preference for you on that one?
Feroldi: I, personally, always take the payments in cash on the dividends, because I want to be in charge of all my capital allocation decisions. So I am more than happy to have my dividends that I receive just continually pile up on my investment broker's cash balance, and then I choose when I redeploy that into what companies. I understand the appeal of dripping, and there's nothing wrong with it, I just personally am, I guess, a control freak and I want control over that. How about you, Dylan?
Lewis: [laughs] You're the CFO of your own domain, Brian. [laughs] I typically drip. And the reality is, for me, I like these businesses. I am, kind of like you, accidentally a dividend investor with the dividend positions that I have. They are good businesses that I like and I'm OK with incrementally building that position over time. I wouldn't do that if I didn't like the company and think that the prospects were only going to be getting better. But it's kind of a lazy way to increase your exposure to a business that you like anyways. That's the way that I look at it.
Feroldi: Yeah. I think that's perfectly fair. And I understand both sides of the strategy. To your point, if you really like a company and want to continually increase your ownership of it, there's nothing wrong with dripping it. But I would personally, again, rather make the capital allocation decisions for myself, which adds extra work for me. The nice thing about a drip is you kind of set it and forget it, so long as you like the company, but to each his own.
Lewis: Yeah. But you wind up with more cash on the side, and if you get an interesting investing idea, you can put some money behind it, whereas I would have to sell anything in order to do that. So two sides of the same coin there.
Let's talk a little bit about some pitfalls, because we were talking before about how this is a space that a lot of beginner investors are attracted to. And I think with that, you can look at the shorthand really fast and think, OK, I've got this. I know what to do. The reality is, there are some easy mistakes that people can make as they're just getting started with dividend investing.
Feroldi: Yes. There are definitely pitfalls and traps to be aware of. So the first thing to really know is, what kind of company is it? There are specific different types of companies out there called real estate investment trusts, which are REITs, or master limited partnerships, which are MLPs. And those are stock-like businesses but they actually are measured using different metrics than normal regular stock corporations. So for example, with REITs, one of the metrics that are used to judge earnings is something called FFO or funds from operations, or even AFFO, which is adjusted funds from operations. That's very similar to net income for a normal stock, but just the terminology is different.
And with MLPs, which are master limited partnerships, and are required by -- you know, they also payout, generally, big dividends and big yields, and they actually call them distributions, not dividends. So the terminology is a little bit different. And with some MLPs, you actually have to file an extra form at tax time called a K-1. So know what you're buying before you buy it. [laughs]
Lewis: Yeah. There's a variety of reasons why this is important. One of them is, you want to make sure that you're looking at the right metrics, for sure. You know, if you're buying something that is [laughs] legally obligated to make a certain amount of its income out as payments, that business is going to behave a lot differently than any standard business. So you want to be able to make apples-to-apples comparisons for any buying decision you'd be making.
And then the tax one is huge, because you could accidentally find yourself in a far more complicated tax position than you mean to. And actually, I've heard of people having to file taxes in states that they don't live in because they own MLPs and they are considered a partner in that business. And so if you're going to be buying anything that is kind of a slightly more sophisticated investing structure, make sure you know what you're getting yourself into. Maybe wade into that slowly rather than jumping into the deep end of the diving board, because [laughs] you really need to know what you're getting yourself into there.
I think one of the other pitfalls -- and this is kind of related with the tax conversation, Brian -- is you know that you're going to be getting income from these investments, and you want to plan accordingly. You know that you're going to be getting payments from these dividend stocks, and you are essentially setting up a known tax liability. And most of these businesses are businesses where you're hoping that principal stays the same, whatever you invest at least is going to stay where it is and you're going to be pocketing the payments. Hopefully that principal grows too. But you are putting yourself in a position where you know you are going to be paying taxes on the dividends. I think more often than not, it's probably better to own dividend stocks in tax-advantaged accounts.
Feroldi: Yeah. I think that that's completely fair. So an IRA, a Roth IRA, a 401(k). If you hold your dividend stocks through those investment vehicles, then you do not have to pay taxes on the gains that you have, whereas if you just held them in a regular brokerage account, you would have to pay taxes on the dividends that you receive. It gets more complicated when you hold MLPs and REITs in those accounts. So make sure that you [laughs] check with your tax professional and understand the ramifications before doing so.
But to your point about the taxation, Dylan, and it's important to know that there are different types of dividends. So there are qualified dividends, which are taxed at the capital gains rate, which is typically pretty low. But there's also non-qualified dividends that are taxed at the individual income rate, which can be much, much higher. So as always, the details matter.
Lewis: The details matter. And I think also, you're buying a different type of business here. And so, you know, if you're a growth investor, you know that it is incredibly likely that if you're successful, you're right 6 out of 10 times. And you are going to buy some stickers. And that's a bummer. You don't want to see your principal go down on any investment. But the hidden benefit of that is that you can offset some gains with your losses and decide "You know what, I am -- especially toward the end of the year -- looking at my portfolio, maybe it makes sense to sell out of some positions that have lost a lot of their value, I'm no longer interested in owning them," and offset some of the capital gains that I've experienced.
You get that benefit in an account that isn't tax advantaged. You know, your standard brokerage is great, but if you're doing that in a ROTH, [laughs] you're not really saving yourself any tax liabilities. And ideally, with these dividend businesses, they are steady businesses, you're not going to really have any capital gains -- or losses, I should say -- to report when it comes tax time, aside from the dividend distributions. So I think that's kind of another element of the tax advantage account side of this.
Feroldi: Yeah. Completely. But I think the final warning point here or the final pitfall here is probably the one that trips people up the most. And that is when people, when investors solely focus on dividend yield. And I will tell you, this tripped me up when I first started investing. I did a simple screen, when I was a brand-new "investor," -- because all I was really doing was buying and selling things -- I did a simple screen, where I looked for the highest dividend yields on the market and I found some companies, Dylan, that paid 22%. And I was, like, "Perfect, I'll buy this. I'm just going to hold it and I make 22% of my money. That's a market-beating return right there. What can go wrong?" Well, as you can imagine, a whole lot went wrong, because the dividend was soon cut and the share price fell 70%. So not only was I out that 22% dividend yield, but I got smashed on the capital return side too. So when you see a high dividend yield, that's usually a bad sign.
Lewis: Yeah, we talked about what goes into the yield, but it's worth double-clicking into that calculation for a second, because you have the dividend payments and then you have the stock price as the denominator. And that number can go up for one of two reasons. [laughs] It can go up because the numerator gets higher or because the denominator gets lower, and the numerator just hasn't caught up, you know. So if you're thinking about the inputs there. Share price gets cut dramatically over time and maybe business prospects aren't looking as good as they have in the past, but the company hasn't updated its dividend policy yet to reflect that.
And so, what you wind up with -- going back to that example you had of, I think, $1 in dividends and $25 in share price. You know, if that gets cut down to $12.50, the business gets cut in half. Well, the dividend yield doubles. But I have to imagine that company isn't going to maintain that $1 payment in perpetuity. [laughs]
Feroldi: Yeah. The market is not stupid. When stocks are usually, largely priced appropriately. So when you see a yield that is 2X or 3X or 4X the market, that's Wall Street's way of saying either "We don't trust the dividend payment, there's something wrong" or "We don't think the share price is going anywhere." So if you just did a quick screen of some of the highest-dividend-yielding tech stocks, Dylan, here's what I see. I see Canon, the camera company, offers a 7% dividend yield right now. Xerox, still around apparently, Xerox offers a 7% dividend yield. And then you have some tech giants of yesteryear that are also out there. So IBM: 5.3%. Seagate: Technology, which makes hard drives, 5.2%. Nokia: 5%. Hewlett Packard: 5%. All of them pay big dividend yields, but I don't know about you, Dylan, I have no interest in any of those businesses.
Lewis: [laughs] Yeah. Our listeners might be familiar with Jason Moser's basket of stocks. And usually, they're baskets of stocks that you'd want to invest in. I think, looking at, what is it six names, these are six companies I wouldn't touch. [laughs] This is old tech here. And businesses that don't really have particularly good prospects going forward. The yield is up, because in most of these cases, the share price has been bid down pretty dramatically over the last couple of years.
Feroldi: Yep. And if you look at these performances versus the S&P 500 over the last five years, all six of these businesses have underperformed. And, Dylan, it's also possible that there could be value in one or two of these stocks. I mean, just because it has a high yield doesn't automatically mean it's an avoid, but for me, if you're an investor and you're looking for dividend yields and you are screening, your first inclination would be like, "Wow! These companies are amazing. Look how high their yield is." All we're saying is, it's not that simple. It's very easy to get caught in the high-dividend-yield trap. So you have to go further with your research.
Lewis: Yeah. And I think the other thing that comes up when you're fixating on yield is, if that is what you are using to look at the value of dividend stocks, you are missing the total-return element of things. And that's super-important. And so when we're talking total return, you have the dividend yield. And you know, for some businesses that will exist, in other businesses it won't, but then you also have capital appreciation. And those are really the two factors that are going to be driving total return, which is basically what you get for holding something, all things considered.
And so, you know, say, a dividend yield is 2% and the shares go up 5% in the year, your total return is effectively about 7%. Now, notice the capital gains there drove a much larger portion of that total return figure, even in just that example, than the dividends did. And I think that's what dividend investors will often lose sight of is the fact that there are really good gains to be enjoyed by investing in stable businesses that pay dividends, but maybe they're down in the 1% or 2% range. They aren't those highfliers, but they're much better businesses. And they wind up giving people much better returns.
Feroldi: Yeah, when I look at my portfolio, most of my dividend payers pay under 1% yield, which is just something that is not attractive to tons of income investors. And I get that, because if you need, if you are relying on income to fund your lifestyle today, a 1% dividend yield is just not going to do it for you. But if you look at the companies there on a total return basis, which I think you absolutely should, the numbers get substantially better.
And it's also worth pointing out that if a company has a low dividend yield, it could be because their payout ratio, or the amount that they devote to the dividend, is incredibly low. So if they only devote 20% of their profits to the dividend, you're naturally going to have a very low dividend yield, but that also gives the company plenty of runway or plenty of room to increase that dividend over time and grow it. So that's something else to just keep in mind.
Lewis: Yeah, that low yield could also be a reflection of the fact that share price [laughs] has appreciated dramatically over time, and the dividend policy hasn't quite kept up. And that's a good sign. [laughs] That's not a bad thing. It might result in a number that doesn't look so impressive for yield, but what it means is that people that have actually owned the stock have enjoyed some pretty significant share price appreciation.
Now, Brian, we can't talk dividends without also throwing some investing ideas out there. I've got some kind of boring ones, but you have an interesting one. So I'm going to let you go first, because this is probably a name that some folks aren't familiar with.
Feroldi: Sure. So the company that I want to highlight, that's a dividend payer that I like a lot, is Equinix (NASDAQ:EQIX), ticker symbol EQIX. So this company is a REIT, which is a real estate investment trust. And, again, if you were solely looking at dividend yield, you would look at this company, which again, is a REIT, and it has a dividend yield of 1.5%, and you'd probably be like, "Yawn! Pass, not interested." And just move along. However, when you dig deeper, there is a lot to be excited about for this company.
So Equinix is a data center-focused REIT. So they are the biggest owner and operator of data centers in the world. So they have 200 data centers spread around five continents. And data centers are facilities that allow companies to store and distribute data. And Equinix, as the biggest one, has almost 10,000 customers, including some huge names that lots of people are familiar with: Oracle, Verizon, they recently expanded their partnership with Zoom Video Communications. They actually have half of the Fortune 500 listed as customers.
So if you believe that there are long-term growth drivers in place for continued usage of data centers -- and I'll throw out a couple, how about autonomous driving, how about augmented reality, how about the Internet of Things, how about cloud computing? All of those things are likely to significantly increase the demand in data centers for many, many years to come. And Equinix is in a great spot to take advantage of that demand. So even for 2020, in a year when lots of real estate investmenttTrusts are struggling, this company is expected to grow its revenue about 7% and its adjusted funds from operations [AFFO] -- so, again, it's a metric that's kind of like earnings -- that's expected to grow about 6%. And while its dividend yield is low, it only pays out about 40% of its funds from operations [FFO] as a dividend. So there's still lots of room in there for the company to grow.
And what I just said might confuse people, because I said before that REITs are required to pay out 90%. So they are required to pay out 90% of their taxable net income, but that's not the metric that you judge REITs by, you judge them by funds from operations. So that taxable net income includes all kinds of charges that artificially lowers it. So Equinix is well within that 90% payout ratio, but a more appropriate one is funds from operations. Again, Dylan, details matter. In general, this is a very high-quality REIT. It's a tech-focused REIT, it's a play on the long-term demand for data centers.
And the total returns on this thing are beastly. I mean, over the last five years, this is a company that has given investors a 207% total return; by comparison, the S&P 500 is up 63%. And the longer you zoom out, the better returns you get. So not only do you get a small and fast-growing dividend with this company, but I think the chances for capital appreciation are also very high.
Lewis: Yeah. And so, for folks that are just hearing about REITs and are getting interested in them, I would highly, highly, highly recommend checking out articles from Matt Frankel. He's one of our colleagues. He does writing for Fool.com, he also does writing for Millionacres, one of our sister companies that's real estate focused, and he does a great job breaking down REIT, and just the real estate market in general. And as a matter of fact, we're going to put the link to our REIT Center, where it kind of goes through REIT basics and covers all of the different industries that REITs then operate in, just so that people can, kind of, get that next step in reading and not blindly buy anything [laughs] based on what we're talking about here, they have the tools to kind of follow up.
Brian, I said that I'd be plugging some boring companies. The reality is, you don't have a lot of choices when it comes to good dividend stocks in the tech space. You threw out ADP, and that's kind of an interesting one as a Dividend Aristocrat. It's a little boring for me, I think there are some slightly more interesting ones out there. And I would say, you can keep it simple and still get some great returns with companies like Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL). People are going to yawn with this, but if you look at these two businesses, yields at around 1%, not exactly what dividend investors are looking for, but let's go back to that total return idea from before.
Those companies that you threw out; I'm just going to cherry-pick two here. Xerox, down 50% on a total return basis over the past year. IBM down 5% on a total return basis. So even factoring in that dividend payment that you're getting, you're losing money on those investments. Apple and Microsoft, up 80% and 49% over the last year. And if you look over three years, on a total-return basis both of them are up over 150%, while IBM and Xerox are both negative. And so I think these businesses highlight the fact that you need to focus on total return. And you can get a nice dividend payment kicker while getting some awesome share price appreciation if you're investing in good businesses.
Now, Brian, I mean, both of these are $1.5 trillion companies. So I don't know [laughs] that share price appreciation is going to be that dramatic going forward, but I think it's hard to argue that these companies are not in excellent financial position and really just kind of stalwart businesses.
Feroldi: Completely. Both of those businesses have infinity cash on their balance sheets. They have revenue growth potential. They have wide moats. They have a strong culture, strong management teams, and growth opportunities. And while their yields are low, the dividends do not consume a big portion of earnings. So I agree with you 100%. I think investors in both of those businesses can count on the dividend to continue rising for many, many years to come. But between the two, I would be more excited about Microsoft. But how about you, Dylan?
Lewis: You know, I think you're probably right. And it pains me, because I'm an Apple shareholder and I don't own Microsoft [laughs] shares, despite the wonderful run that they've been on over the last three or five years. What I like with both of these businesses -- and I think you can just blindly buy them both if you wanted to -- those payout ratios are low. So for the folks that are dividend focused, I think Apple is like in the 20s and Microsoft is in the low 30s. So there's probably room for them to increase those dividends over time. They might do that as growth becomes harder and harder to come by, but they've proven to be companies that the normal rules of size and scale don't seem to apply to. They've both managed to find growth in really incredible ways.
I think larger growth is going to be easier for Microsoft just because they are rooted in software. The scale of software tends to work better. Apple's been pitching a software narrative for a while, but the reality is, most of their money is still coming from hardware. And we're still figuring out what those upgrade cycles look like, especially as they go for some of those higher-priced phones.
Feroldi: Yeah, I sold my Apple over 100% ago, so I guess I really shouldn't be down on it. But, no, I think both of those companies have very bright futures ahead. But to your point, I like selling software a heck of a lot better than I like selling hardware. So for that reason, I would pick Microsoft, but I think both of those companies are great, great investments for dividend investors to look at.
Lewis: So there you have it. Was it K. Isle? Our user who wrote in on iTunes, that is our breakdown of dividend stocks, K. Isle. I'm seeing now in our notes. And we're happy to do these. We love getting ideas for shows. You can write into us IndustryFocus@Fool.com. You can tweet us @MFIndustryFocus. You can leave us an iTunes review with some comments or questions and we'll be sure to address them.
Brian, thanks so much for hopping on and talking dividends with me today.
Feroldi: Sure thing. And if the listeners want to tweet me some potential titles for myself, that would be great. [laughs]
Lewis: [laughs] Where can they reach you on Twitter, Brian?
Lewis: All right. And I am @WilyLewis. And our producer, Austin Morgan, who doesn't tweet as much about stocks but is very active on the meat game, what is your handle?
Austin Morgan: It is @austinjmorgan.
Lewis: @austinjmorgan. And you know, actually, I did see someone on Twitter asking about barbecue tips. So you know, that those are the handles to follow. If you're looking for the intersection of fin tweet and barbecue tweet, [laughs] we have you covered.
Feroldi: We have that niche nailed down. [laughs]
Lewis: [laughs] That's going to do it for today's show, folks. If you're looking for more of our stuff, subscribe in iTunes or wherever you get your podcasts.
As always, people on the program may 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.
Thanks to Austin Morgan for all his work behind the glass today. For Brian Feroldi, I'm Dylan Lewis. Thanks for listening, and fool on!