Dividend investing offers a chance to create a stream of income in addition to the growth in your portfolio’s market value from asset appreciation. Buying stocks that pay dividends can reward you over time as long as you make the right picks.
I’m a dividends investor, simply, I buy strong blue-chip companies with a wide moat that pays dividends.
What Is Dividend?
A dividend is the distribution of reward from a portion of the company’s earnings and is paid to a class of its shareholders. Dividends are decided and managed by the company’s board of directors. Dividends can be issued as cash payments, as shares of stock, or other property, though cash dividends are the most common. Along with companies, various mutual funds and exchange-traded funds (ETF) also pay dividends.
What is Dividend Investing?
Dividend investing is an investment approach of purchasing stocks that issue dividends in an effort to generate a steady stream of passive income. Companies distribute cash dividends to their shareholders periodically during their fiscal year, but most issues them on a quarterly basis.
Dividend investors are mainly interested in a company’s dividend payout ratio and dividend yield. A dividend payout ratio between 40% and 50% indicates that the company distributes almost half of its retained earnings to its shareholders while the remaining is invested in the launch of a new product or to lower the short-term debt. A dividend above 3% yield considered attractive may lead to a good cash income.
key metrics, Dividend investors use
Before buying any dividend stock, it’s important to know how to evaluate them. The following metrics can help understand how much to expect, how safe a dividend might be, and whether to avoid a particular dividend stock.
- Dividend yield: The annualized dividend, represented as a percentage of the stock price. For instance, if a company pays $1 in annualized dividends and the stock is $20 per share, the dividend yield would be 5%. Yield is also useful as a valuation metric (for instance, by comparing a stock’s current yield to historical levels) and can be helpful to identify red flags. The key thing to know is that, while a higher yield is better, a company’s ability to maintain the dividend payout — and, ideally, grow it — matters even more.
- Payout ratio: The dividend as a percentage of a company’s net income. If a company earns $1 per share in net income and pays a $0.50-per-share dividend, its payout ratio is 50%. In general terms the lower the payout ratio, the more sustainable a dividend should be.
- Total return: The overall performance of a stock, the combination of dividends and gains or losses from a share price change. For example, if a stock rises by 6% this year and pays a 3% dividend yield, its total return is 9%.
- EPS: Earnings per share. In general, a company must earn more than its dividend in order to sustain it, and this metric normalizes its results to the per-share value. The best dividend stocks are companies that have shown the ability to regularly grow earnings per share over time. Companies that consistently grow earnings per share often have strong competitive advantages. The result is a company that can keep paying its dividend and potentially increase it.
- P/E ratio: The price-to-earnings ratio divides a company’s share price into earnings per share. P/E ratio is a valuation metric that can be used along with dividend yield to determine if a dividend stock is fairly valued.
- Dividend growth: a company’s history and ability to raise the dividend over time
Why Dividend Investing?
1. Get Paid to Wait:
Dividends allow an investor to get “paid to wait”. Historically dividends have provided 43% of the S&P 500 total return. Dividends provide an ongoing return while waiting for capital appreciation.
2. Dividend Growth Compounding
The benefits of exponential growth are multiplied by growing dividends. This is because both the number of shares (from reinvestment) and the dividends per share are growing. The exponential power of dividend growth compounding can provide competitive returns regardless of whether the price of the stock increases in value or not.
3. Take Advantage of Corrections and Bear Markets:
Investors savvy enough to reinvest dividends during corrections and bear markets purchase more shares with the dividend while the prices are lower. Later, when prices recover, the return is actually enhanced by the temporary fall in the stock price. Reinvesting dividends and accumulating more shares during corrections and bear markets greatly boosts dividend growth investing returns in the long run.
4. Capital Preservation Quality:
Dividend-paying companies are more mature and stable than the average company. These stocks usually hold up better in down markets than more speculative stocks. This is especially true when a value approach with a margin of safety is used when selecting stocks.
5. Create an Income Stream:
Dividends provide a regular income stream. Most stocks pay a quarterly dividend, but a well-constructed portfolio of dividend stocks can provide a consistent monthly income stream.
6. Inflation Hedge:
The big disadvantage of fixed-income investments is that the income stream doesn’t grow. Even a 3% inflation rate will destroy 50% of the buying power of your principal in just 24 years. Dividend stocks provide the ability to receive income that increases and maintains the purchasing power of your principal and income.
Why you should not focus only on Dividend?
It’s better to buy a dividend stock with a lower yield that’s rock-solid than chasing high yield that may prove illusory. Undervalued strong companies with a good dividend growth record that pays dividends over 3% is a big catch for any investor.
There are some companies that break the rules but it is still worth invest in, for example: Microsoft and Apple, these 2 rock-solid growth companies pay small dividends but they have a very potential upside that will enlarge your portfolio if you time them well.
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No.1” – Warren Buffett
So yes I’m a dividends investor, I love dividends but I added many other parameters to my dividend investing strategies like value investing. There is one thing we all have in common is buy and hold forever.