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There is no single way to invest, each investment strategy offers potential rewards and poses certain risks. The right strategy or strategies for each investor depends on their personal objectives, financial circumstances and risk tolerance. However, one strategy worth considering is investing in dividend growth—that is, investing in companies with a strong track record of paying regular and growing dividends.
Although there are no guarantees, dividend-paying companies are often considered to be more stable and less volatile than other companies. Stock prices generally fluctuate, often as a result of factors unrelated to a company's underlying performance. Dividend growth can be a better way to determine a company's financial strength and future prospects.
When evaluating market returns, many investors focus exclusively on price appreciation. But historically, dividends have been a significant component of total returns.
A recent study by Hartford Funds examined the impact of dividends on the S&P500 index from 1960 to 2021. During that period, the contribution of dividend income to total returns averaged 40%. The study also revealed that 84% of the S&P 500's total return over the same period is attributed to “reinvested dividends and the power of compound capitalization.” Hartford also reported that, since 1973, the shares of companies that consistently increase their dividends exhibited higher returns and lower volatility than the shares of other companies.
On the other hand, it's important to understand the difference between dividend growth and dividend yield. Yield is the annual dividend per share as a percentage of the share price. For example, if a company's annual dividend is 5€ per share and the share price is 100€, its dividend return is 5%. Dividend growth, on the other hand, measures the percentage change in dividend payments from year to year. If a company pays a dividend of 5€ per share in the first year and 5.50€ in the second, the dividend growth is 10%.
Dividend yield can be an important metric, but dividend growth is generally a better indicator of dividend trends over time. Suppose, in the example above, that the company's share price falls to 50€ in the second year and that its dividend per share falls to 3€. In that case, the company's dividend yield actually increases to 6%, but its dividend growth rate drops to -40%. Typically, companies that regularly increase their dividends also regularly increase their profits.
Healthy dividend growth can be a good indicator of a stock's potential. But there are no guarantees that dividends will not be reduced or that stock prices will not fall in the near future. Rather than relying solely on dividend growth statistics, it's important to look behind the numbers to assess whether a company has a strong balance sheet, healthy cash flow, and a management team committed to maintaining dividend growth while reinvesting in the company. According to Hartford, “Corporations that consistently increase their dividends have historically exhibited strong fundamentals, robust business plans and a deep commitment to their shareholders.”
A useful indicator for evaluating dividend growth potential is the distribution rate. This is the percentage of a company's net income that is paid in the form of dividends. A company with a high distribution rate—one that is barely earning enough to cover its dividend payments—may be vulnerable to future economic or competitive pressures.
Investing in dividend growth isn't for those looking for quick returns. It is a long-term strategy that seeks to invest in stable companies with consistently growing dividends and to harness the power of compound capitalization. And if they choose to or reinvest dividends, they can be an additional source of income. For this reason, many retirees invest in dividend-paying stocks.
Like any investment strategy, there are risks associated with investing in dividend growth, including the risk of losing your initial investment. But it can also be a valuable component of a well-balanced and diversified investment portfolio.
Investing in dividend growth represents a long-term strategy that can bring stability and sustained growth to your investment portfolio. However, it is essential to consider double taxation when these dividends come from abroad. In this context, Dividend Refund is positioned as the perfect partner to manage this process, ensuring that investors receive the maximum return on their international investments without the associated tax problems. With our experience and dedication, we can help you optimize your returns and simplify the dividend tax claim process. Trust Dividend Refund to manage international red tape resulting from double taxation of dividends efficiently and effectively.
Source: Lenox Advisors
