Dividend Growth Investment Strategy
The Dividend Growth Investment Strategy is a relatively simple way to increase your overall income. Here at Above the Green Line, we have the following resources surrounding this approach:
What is a Dividend?
Dividends are regular payments made by a company to its shareholders. The amount of these payments is based on a multitude of factors such as the profit and the amount invested. Dividends are a consistent way for companies to distribute revenue back to its investors. In the United States, dividends are normally given quarterly, though some companies may pay monthly or semi-annually. It is important to keep in mind that not all stocks pay dividends, so if you are looking to employ the Dividend Growth Investment Strategy, you will want to choose stocks that pay regular dividends.
Significant Components of a Dividend
If you are looking to invest in stocks that pay out dividends, you must be aware of the concept of an ex-dividend date. In order to receive dividends from a company, an investor must own the stock by the ex-dividend date. If purchased after this date, the investor will not receive the dividends from that quarter.
In addition to the ex-dividend date, an investor should be familiar with dividend yields. According to NerdWallet, dividend yields even the playing field for investors. Let’s say you purchased a $10 stock that paid $0.10 quarterly ($0.40 per share annually). This example would have the same yield as a $100 stock that paid $1.00 quarterly ($4.00 annually). Both scenarios represent a 4% yield. There are two ways for a stock’s dividend yield to increase. The first is if the company raises the dividend, the second is if the stock price goes down while the dividend remains unchanged. This is because the price of a stock and its dividend yield are inversely related. For dividend yields, a general rule of thumb is to be wary of a dividend yield above 4%. Anything higher than this can hint that the dividend payout is unsustainable. However, there are some exceptions to this. A quick way to measure a stock’s dividend safety is to check its payout ratio. Generally, investors should look for payout ratios of 80% or lower.
Types of Dividends
The most well-known type of dividend is paid on a company’s common stock. Common stock is a security that represents ownership, but common stockholders tend to be at the bottom of the priority list when it comes to the ownership structure. Another type of dividend that is infrequent in its nature is called a special dividend. A special dividend is a payout on all shares of a company, but it does not occur regularly. Rather, a company will issue special dividends when there are profits of which they do not have a need for. Similar to special dividends, preferred dividends are a less common form of dividends. Preferred dividends are issued to an owner’s preferred stock. When it comes to dividends, preferred stockholders have higher priority than commons stockholders. These dividends normally yield more than common stocks, but they are generally fixed quarterly or monthly payments.
Choosing the Right Stock
Investing in stocks that pay dividends can provide a stable source of extra income. When it comes to employing a Dividend Growth Investment Strategy, an investor should seek out companies that increase their dividend payout yearly and thus beat inflation. Additionally, dividends are more likely to be paid out by companies that no longer need to invest a large sum of money into their business. Thus, investors utilizing the Dividend Growth approach should invest in well-established companies. Once deciding upon a dividend yield, these established companies are expected to maintain their dividend payout, even through hardships.
S&P 500 Dividend Aristocrats Index
The S&P 500 Dividend Aristocrats Index is a compiled list of companies in the S&P 500 with a history of increasing their dividends for at least the past 25 years. Typically possessing 40 to 50 companies, the S&P 500 Dividend Aristocrats Index includes stocks with a total dollar market value of over $3 billion and an average trading volume of at least $5 billion. Its primary objective is to analyze the performance of well-known companies and rebalance them each January. If a company fails to increase its dividends that year, it is removed from the list.
The company stocks within the S&P 500 Dividend Aristocrats Index have historically outperformed the S&P 500 by 1% each year. The ultimate strength of this index lies not only in the consistent increase of dividends paid out by the companies but also in the performance of the companies, which is why investing in these stocks can be a powerful way to employ the Dividend Growth approach. A common way to obtain exposure to the list of dividend aristocrats is through Exchange-Traded Funds (ETFs). An ETF involves a collection of securities that regularly follow an underlying index.
One criticism that the S&P 500 Dividend Aristocrats Index faces is that the companies occasionally may use share buybacks in order to increase their dividends. A share buyback occurs when a company purchases its own outstanding shares. The dilemma lies in the possibility that a company is overpaying for its shares while still increasing dividends, meaning it might not be acting in the interest of the shareholder.
Why Dividend Growth?
As previously stated, dividends are significant in a portfolio’s overall return. From 1930 to 2017, dividends accounted for roughly 42% of the S&P 500 Index’s total return. As presented in the chart below, there have been decades where dividends accounted for over half of the market’s returns. If an investor were to instead purchase a growth stock (or a stock that does not pay dividends), the only way they could earn a return is through share price appreciation.
While growth stocks have their merits, the market is volatile and this appreciation is not always guaranteed. A Dividend Growth stock is beneficial as it will provide investors with a steadily growing income that can be reinvested if they so desired.
In addition to attaining a consistent source of income, Dividend Stocks have generally outperformed the market. As seen in the chart below, companies that regularly pay and grow their dividends have surpassed non-dividend stocks. This is because companies that pay out dividends are long-term focused and tend to have a more conservative management style. Since they are paying out dividends, there is little room for acting irresponsibly and tossing
money around. If the dividend is at risk, the share price could easily plummet.
Maybe one of the greatest appeals of Dividend Growth stocks is their relation to retirement. A study done by Jack Garner in 2008 concluded that if an investor were to only invest in the 100 highest-yielding dividend stocks, the outperformance of this portfolio would allow for a withdrawal of 5% annually. This is an increase of 1% from a common retirement strategy developed by William Bengen that advocated for a 60% stock, 40% bond portfolio that allowed for a 4% annual withdrawal. Garner’s study was so powerful that it was later endorsed by Bengen.
Overall, Dividend Stocks can be wonderful investments as they aid in avoiding market volatility and the plight of human nature. These small yet consistent increases in wealth can give their investor’s a sense of financial independence and consistency that is difficult to come by in the investing/trading world. If you think that the Dividend Growth Investment Strategy is for you, the key is to get started as quickly as you can, to thoroughly inspect your chosen stocks, and to stay disciplined.
At Above the Green Line, we apply a mixture of rules to help us determine which stocks are best long term for building a Dividend Growth Portfolio. Click here to see our current Dividend Growth Portfolio.
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