3 Reasons to Consider Dividend Growth Investing
It’s easy to make investing too complicated. I spent the better part of half my life doing this. I made all the mistakes. All of them, and in the most embarrassing fashion.
If you read to the end of this article, I hope to help you — just maybe — avoid doing likewise.
I day traded. Chased growth stocks. Thought I was a big shot with a huge number of shares in penny stocks. These “approaches” tend to not work out for most investors. Day traders end up at zero. You’ll fail if you try to time the market. And penny stocks go bankrupt. They take the suckers down with them.
Don’t do any of this. These aren’t the mistakes to learn from. They’re too costly.
Here’s the deal — maintain an insanely low cost of living, allocate your income wisely, save regularly for your needs and goals, and invest every penny you have left.
Keep your investment options simple and straightforward.
Here’s one way to do it and three reasons for your consideration.
What is Dividend Growth Investing?
Some companies take a portion of their profits and return them to shareholders via regular cash payments. We call these cash payments dividends. Here’s an illustration of how it works:
- You own 1 share of a stock.
- The stocks pays an annual dividend of $1.00.
- Each quarter, the company pays you $0.25.
Dividend growth investors tend to take that cash payment and reinvest it in more shares of the stock. Some opt to keep the cash payment and use it to fund some aspect of their lifestyle or other investing activities.
If you own 100 shares of a stock with a $1.00 annual dividend, you’ll receive a $25 quarterly dividend (100 X $0.25). It’s that simple.
I invest exclusively in stocks that pay dividends. Here are three reasons why.
You Narrow the Playing Field
It’s tough to pick stocks. I needed a way to whittle down the universe of publicly-traded companies.
While you shouldn’t freely invest in a company just because it pays a dividend, if you pick sound companies with a solid track record of paying and, hopefully, increasing their dividends, you’ll probably end up in good shape.
It’s Easy to Find Good Dividends
I primarily use Seeking Alpha to do my research. You can follow a basic process because there’s really no need to do otherwise.
I pull up a stock quote, click on “dividends,” and look at three key metrics.
Super straightforward. Companies can increase the size of their dividend. For example, Verizon presently pays a $2.51 annual dividend. If it increases it by 2.51% (its 5-year average growth rate), it will jump to $2.57.
Generally speaking, you want to buy stock in companies that consistently increase their dividend payments. This can be a sign of strength.
Some companies have increased their dividend payments every year for more than 25 years. We call these firms “dividend aristocrats.” Others, such as Verizon and Apple, aren’t quite there yet, but could very well be on their way. I own both of these companies, as an indication of the type of dividend stock I look for.
Dividend yield is simply a ratio of how much a company pays out relative to its stock price. If you own 100 shares of Verizon, it’s worth roughly $5,966. At its 4.2% yield, you can expect approximately $251 in annual dividend income. It doesn’t take a math whiz to see how this adds up.
Be forewarned — a high dividend yield isn’t necessarily a good thing. If Verizon stock gets hammered, it’s dividend yield will increase. If you’re confident the stock will rebound and Verizon will continue to increase its dividend, all’s relatively well in your world. This is why you can’t look at dividends in isolation. You must consider them alongside an analysis of the actual company.
Verizon’s 52.65% payout ratio indicates that it pays out 52.65% of its earnings in dividend payments. This is on the high side, but not alarming given the pandemic and the business Verizon is in.
By comparison, Apple’s payout ratio is 25.25%. Apple returns less to shareholders via dividends and uses more of its income to repurchase its own shares (a story for another day) and reinvest in its business.
A sky-high payout ratio can indicate something’s wrong. Maybe a company is struggling to meet its current dividend payment. The business might not be churning out free cash flow. The dividend could be in jeopardy.
As you study companies and assess dividends, much of this becomes intuitive. Like anything else, it takes time and practice to build familiarity with the concepts.
You’ll Be Less Likely to Panic Sell Stocks
I love dividend stocks because they give me something other than share price appreciation to focus on. Stocks go up and down. Always have, always will. At times, the stock market will experience extreme volatility. This can rattle nerves. And rightfully so.
When my stocks dropped, I used to panic sell. This is the worst move you can make. You miss the opportunity to buy low. You take losses ahead of what is often an inevitable rebound.
With dividend stocks, you tend to focus less on the stock price (though you should not ignore it) and more on the income stream. If you’re reinvesting dividend payments, you can buy more shares on reinvestment when the stock drops. This compounding effect builds wealth.
Dividend growth investors look at their portfolio during market downturns and take a relative sigh of relief knowing their dividend income stream remains intact and growing. If you’re in strong companies that can weather pandemics or bear markets, you’ll rest even easier.
My investing personality used to be to panic. Making the move to exclusively use dividend stocks as my wealth-building vehicle provided the calm I require to be an effective investor.
Risk exists in most forms of investing. Dividend stocks pose risks. Because not all companies are well run with sound long-term growth prospects.
This said, if you buy best of breed companies on a regular basis and reinvest all dividends, you’re setting yourself up to have a solid shot at long-term success.
By ardently adhering to dividend growth investing, my stress level — generally and in relation to money — dropped considerably.
I know my personality. And I know I must match my investing philosophy and style to the potentially toxic parts of it. Consider personal finance via this relatively intimate lens and you’ve effectively fought and won half the battle.