Dividend investing is very popular, especially now that the interest rate on savings accounts are so low. But there are things you should know if you want to invest in dividend. Globaltrader24 lists 10 things you have to know about dividend investing.
1. Dividend determines to a great extent your profitability
The final return you obtain as an investor consists of three things: capital gains, dividend, and in case you invest in another currency: appreciating currencies. Investors often think most of their return comes from capital gains, but the long-term trend shows that dividend also plays a crucial role.
The power of dividend is evident especially in the long term, when investors reinvest the received dividends. Research shows that more than 40% of the total return originates from dividend, dividend growth and dividend reinvestment.
2. Dividend is not obvious
To receive dividends you have to own shares in a company that pays dividends. The amount of the dividend is not fixed, except for preference shares. The management of the company may also decide not to pay a dividend, for example because it thinks reducing debt or investing in new research is more important.
3. Dividend comes in different forms and not always at the same times
As a shareholder you can get paid in cash (cash dividend), but you can also get additional company shares (stock dividend). A company that is paying dividends shows to outside world that it is in good financial health.
But paying dividends by giving investors more shares is a weaker signal. Because by issuing more shares, earnings per share declines.
In addition, the frequency with which dividends are paid can vary from time to time. Many US companies pay dividends on a quarterly and many European companies twice a year.
There is also a difference between ordinary dividend and a special dividend. A normal dividend stems from the profit a company makes. A special dividend may be paid if there is excess cash available, for example after the sale of a business unit.
4. High payouts are a red flag
The payout ratio indicates the percentage of earnings that is paid as a dividend to shareholders and is between 0 and 100%. If a company pays a higher dividend than what it has earned in profits, you should be very cautious and closely examine why a company does this. If companies pay more than they make profits, that dividend is not sustainable for the long term. It cannot hurt once, but be aware for too high payout ratios.
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5. A lot of dividend is not always attractive
A dividend of 10% looks very attractive on paper, but is it really that attractive? It is questionable whether this part of the profits is actually paid. There are plenty of examples of companies that offered a high dividend, but eventually announced to lower their dividend because they couldn’t live up to expectations. Telecom Provider KPN is a good example of this.
There is another reason why a high dividend is not necessarily a positive thing. Some critics say that some companies who have excess cash simply have no positive investment projects and therefore pay dividends to keep shareholders satisfied.
6. Dividend payers and dividend growers
Dividend paying companies can be divided into two types. There are stocks that offer high dividend yields, but where the growth is quite limited (dividend payers). On the other hand, there are stocks that offer a low dividend yield but pay out more profits each year to its shareholders (dividend growers).
Dividend payers usually have a stable business model which gives them a reasonably predictable cash flow. Because they can be pretty certain about the amount of profit they are going to make, they can pay a high dividend.
Dividend growers are more opportunistic in nature. These companies are often less mature and are often in cyclical sectors such as the IT sector. Microsoft and Apple are good examples.
7. Emerging markets; the driving force behind dividend growth
America and Europe have a long tradition of paying dividends, but the growth in dividend payments comes mainly from emerging markets. Of every $ 7 which is globally distributed in dividends, one dollar is coming from emerging countries.
In 2009, the BRICS (Brazil, Russia, India, China and South Africa) distributed $ 34.7 billion in dividends. In 2013 this had already risen to $ 80.9 billion. China in particular was responsible for this, because Chinese companies increased their dividends by 156%.
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8. More durable than buyback programs
If a company’s management wants to return cash to its shareholders it has two options. It can either pay out dividends or repurchase shares. In case of the latter, the number of shares outstanding is reduced, thereby increasing earnings per share outstanding: more value for shareholders.
Paying dividends however, is a more convincing signal for a business going well. Repurchasing own shares can be done with the money that is left after the payment of dividends, but it depends on how much money there is left and how much the price of the share fluctuates. Thus, the amount and frequency of a share repurchase are not stable.
Dividend is much more durable. Companies will do everything to maintain, and preferably increase, the dividend that they pay.
9. Dividend stocks offer protection against inflation
Inflation causes money to lose its value. For investors seeking an income from their investments, it is therefore important to at least grow their income with inflation. Then the purchasing power remains the same. Dividend stocks historically have turned out to be able to keep up with inflation quite well.
10. Dividend Aristocrats
There are quite a few companies that have a long history of paying dividends and most of them are in the USA. For example, there is the company Stanley Black & Decker which has been paying dividends since 1877. But there is also the oil giant Exxon Mobil (1882) and Coca-Cola (1893).
You can invest in these ‘old’ dividend companies via the ProShares S&P 500 Dividend Aristocrats ETF. Only companies that have increased their dividends every year for twenty-five years are eligible for this ETF.