Receiving dividends is one of the major reasons people invest in the stock market. One of the biggest problems faced by the new investor, or those trying to control their portfolio for the first time, is that the financial world is full of gabble.
Dividends would be a case in point. Knowing the right dividend-paying companies to invest in is a very vital part of dividend growth investing.
Researches show that the U.S. stock market has been one of the greatest long-term wealth generators in history, recording a compound annual growth rate of about 9% since the late 1800s.
Dividend stocks have traditionally been preferred by investors because they provide guaranteed returns to shareholders, typically paid out annually out of the company’s profits.
Its strategy is simple: you buy stocks that are paying dividends and have been growing those dividends for a significant number of years in the past.
Read on as you discover all about dividend growth investing.
What Is Dividend?
Basically, the dividend is your profit in a company you own. You don’t necessarily have to establish a company to own it. Buying shares- stocks from a publicly listed company also grants you ownership of a company.
In return for buying stocks, the company gives you basic rights. Firstly, you have an opinion in selecting the board of directors for the company, Then you get paid a share of the company’s profit as authorized by the board of directors.
This payment is called a dividend. Hence, the amount of dividends you get is dependent on the number of shares you own in the company. For example, if a company pays 10 cents per share, an investor with 100 shares would receive $10 in cash. Dividends may be paid out as cash or in the form of additional stock
Dividends could be a good retirement option as long as you make intelligent choices. The more dividends you reinvest, the more shares you own. This is why the key is to reinvest these dividends. However, dividends are not entirely guaranteed as they are at the mercy of the board of directors.
Types Of Dividend
There are three regular types of dividends. They include;
#1. Cash Dividend
This is the normal payment of your portion of a company’s gain.
#2. Stock dividend
This is when the company decides to pay its shareholders by allowing them partial or whole shares in each share owned.
#3. Extraordinary dividend
When the company comes to a conclusion to pay outstanding cash to the shareholders, it is called an extraordinary dividend.
Investopedia states that dividend yield is an estimate of the dividend-only return of a stock investment. Since the yield is based on the price of the shares, it will fluctuate over time.
The dividend yield is calculated as; annual dividends per share/price per share.
Dividends are measured in percentages. It is the ratio of how much the company will pay to the price of the shares.
There are four important dates to note regarding dividends. These dates are;
#1. Declaration date
This is the date the company declares the payable dividend and must be approved by the shareholders.
#2. Date of record
This is the date when the company records that you are part of its stakeholders to receive the dividend.
#3. Ex-dividend date
The ex-dividend date is set one business day before the record date. It is when the dividend eligibility expires. If you buy a stock on this date or after, you wouldn’t be eligible for the dividend payment.
Shareholders of dividend-paying companies are typically eligible as long as they still own the stock before the ex-dividend date.
#4. Payment date
This is the date when the shareholders receive the dividend payment. Sometimes, a company may choose to pay dividends in the form of stock.
Why Do Companies Pay Dividends?
Investors look for companies with a proven record of dividend growth over the years because the growth of the dividends shows that the company’s financial health is in check.
As a result, companies offer dividends to lure investors and increase the share price. They pay dividends after they cover their expenses and business reinvestments. Older companies are more expected to pay dividends because they require fewer capital reinvestments. Hence, they grow their annual dividend and share the profit with their shareholders.
It is therefore important for you to be wary when choosing investments.
Note: Companies that undergo financial strain are more likely to cut their dividend or not pay at all. This sends a negative signal to the investors who in turn sell their investments to avoid heavy financial loss.
What Is Dividend Growth Investing?
Dividend growth investing is an operational investing technique that involves buying and possessing a range of shares in order to receive a regular income from your investments. This income is besides any growth your holdings experience as the stock in it gains value.
Dividend growth investors build a basic investment portfolio by looking for companies with a track record of paying reliable and growing dividends over the years.
Companies that experience growth over the years, cover their expenses, and still have a continuous flow of cash compared to the former year are considered good for dividend growth investing. These companies slowly boost dividend payments due to their steady growth.
Dividend growth investing is also proportional to time. A study shows an 82% increase in dividends rate reinvested over a 50-year period.
This means that in a company with a little start-out dividend rate, the initial dividend worth may look insignificant. However, accumulating these dividends over the years and reinvesting gives a much worthwhile dividend amount.
Dividend Growth Investing Strategies
There is two main dividend growth investing strategies that dividend investors target at.
- High dividend yield
- High dividend growth rate.
#1. High Dividend Yield
This strategy centers on lagging companies that have enough cash flow. The companies fund high dividend payments and in turn generate rapid income for the investors. It is crucial that investors get to know the real reason behind the high dividend yield and determine if its continuous.
#2. High Dividend Growth Rate
In this technique, the investor buys dividends at a lower rate from companies that are growing quickly over the years. This strategy generates a long-term income.
A proper illustration of these dividend growth investing strategies is as follows;
Stock XYZ has a dividend yield of 4.00%. The dividend is increased annually by 6% and its payout ratio is 70%.
Stock 123 has a dividend yield of 1.00%. Its payout ratio is 15% and is increased annually by 20%.
If you choose the second option, you’d end up generating more income in the long run than in Stock XYZ. A more practical example is Mcdonald’s stock market.
Different dividend investors may choose one strategy over the other. This decision depends on if the income to be generated is for short term or long term period.
Regardless of if you invest in companies with high yield or those with growing payouts, dividend investing poses a strong way to make income.
Dividend Growth Investing Sub-Strategies?
Strategies differ from investor to investor. However, the root of all the techniques revolves around the following;
- Acquiring and building shares in companies who raise their dividends each year
- Buying shares across different sectors to avoid relying on one section of the economy.
- Ensuring the dividend growth is sponsored by profits, not debts.
- Developing long term share relationship with the company makes you eligible for deferred taxes and increases your capital growth.
How To Start Dividend Growth Investment?
As an investor, the most important thing to you is generating more income with your investments. However, in dividend growth investing, you must make the right choice of investment. To start dividend growth investing, you should do these.
#1. Checkmate The Company
The first step to dividend growth investing is that you must check the company for these three factors.
- Firm and well-established business
- More probable to raise their dividends annually
- Unlikely to reduce or suspend their dividend in the course of time.
#2. Choose A Dividend Investment Strategy
Decide if you will invest using the high yield strategy or the high growth rate strategy.
#3. Select A Method Of Investing
Choose if you would want to;
- Buy Dividend-Paying Stocks Directly or
- Joint Funds and Exchange Traded Fund (ETF)
Buying Dividend-Paying Stocks Directly
As an investor, you can decide to carry out your researches and invest directly in a company. You can create your investment portfolio based on your intentions-that is, either for a dividend or growth of capital. This decision gives you maximum control over the components of your investment portfolio.
Acquiring shares directly from a company means you would invest in companies that meet your criteria. It also gives you a first-hand experience of being a stock trader and the “no management fees” rule.
The main focus is if you can build and maintain an investment portfolio as it comes with a lot of burdens
Joint funds and ETF
An easier way to get your dividend growth is to invest in joint funds and exchange-traded funds (ETF). Here, you have access to functional management from professional stock managers. Although the management comes with a fee, it brings you closer to your objective.
Joint funds enable investors to achieve immediate and epic diversification. They work by pooling your investment with other investor cash and acquiring many company shares to carry out the funds’ investment strategy. They can invest in 10 companies or more, and some include as many as 1,000 companies.
The investment strategies of funds are very versatile and may give access to equal markets where you have little knowledge and would be hard to research or trade-in yourselves. The Joint fund manager exerts authority over the holdings of the fund, you lose the ability to make changes to your holdings.
Some Joint-funds go further to charge ‘upfront investment fees’ of up to 5% of your investment which will wear down your capital before you even begin.
Avoid joint funds that charge an initial fee. This is against the industry standard, and any bid to charge this sends a simple signal that the fund is not seeking to attract ‘smart money’.
Dividend growth investors look at their portfolio as an income-generating machine
Is Dividend Growth Investing Risky?
Dividends are not entirely guaranteed, as they are subject to the economy, company, and stock market conditions. However, a good way to minimize the risk is to be wary of companies with high dividend yields. The average dividend yield is between 2% to 5% depending on stock market conditions as seen in the S&P 500 index.
So, if you come across dividend stocks with an over 8% dividend yield, it is advisable that you run a thorough background research on such companies. Chances are they could be in a serious financial crisis and need investors to invest. Income generated with a very high dividend yield is usually immediate- short-term. The results of your research will enable you to make wise choices
Dividend growth investing is a long-term solution. It relies on the selection of companies that will surpass the rest of the stock market.
Also, dividend growth stocks can help you avoid the vile and potentially harmful day-to-day changes of the market, which no one truly understands, and instead focus on investing for the long term.
I hope this helps your investment decision.
All the best!