How Dividend Investing Works

When it comes to investment returns, some investors may only look at the impact of rising stock prices on their portfolios. However, consideration of dividends should also play an important role. Dividends have produced about 40% of the S&P 500’s total returns over the past 90 years.

Including dividend income in a portfolio can give an investor a powerful way to pursue total returns. Stocks that offer consistent dividend growth and sustainable yields may reflect superior quality.

What Are Dividends?

Dividends are portions of a company’s earnings distributed to shareholders, usually on a quarterly schedule. Companies that offer dividends are often well-established with consistent earnings, making them a potentially lower-risk investment. Dividend investing is a strategy centered on purchasing stocks that more often pay regular returns. Investors favor this approach for its potential to provide a steady income stream, which can be especially appealing in retirement.

Of course, since there is always some risk in investing, dividends aren’t always guaranteed. For instance, some dividend-paying companies will temporarily lower or suspend payouts in response to earnings losses resulting from events such as the pandemic or economic downturns.

But over the long term, dividend-paying stocks have historically outperformed non-dividend-paying stocks in terms of total return. This is because companies that pay dividends tend to be more profitable and have more consistent earnings growth, which can lead to higher stock prices and capital appreciation over time.

Since dividend stocks belong to firms that regularly allocate a share of their profits back to shareholders, these companies often operate in established, mature industries, where reinvestment opportunities are fewer. This is what prompts the firms to distribute earnings as dividends.

Smaller, still growing companies tend to reinvest earnings back into their businesses. Younger investors with longer time horizons may be less interested in dividend stocks or income investing. These investors might focus more on such growth stocks, with the potential for price appreciation over time

Dividend Strategies

Dividends can serve as a hedge against inflation, as companies that increase dividends often outpace the inflation rate, maintaining the purchasing power of the income received.

Moreover, reinvesting dividends can significantly enhance total returns over time through the power of compounding. This strategy involves using dividends to purchase more shares, thereby increasing the future dividend payouts.

Dividend stocks can also introduce stability to a portfolio. Stocks that pay regular dividends are usually less volatile than non-dividend-paying stocks, as regular payouts can provide a cushion during market downturns. Furthermore, companies that maintain or grow their dividends in adverse market conditions demonstrate resilience, which can bolster investor confidence.

Dividend Yield

Thanks to the power of compounding, reinvesting dividends—rather than cashing them out—can significantly boost returns, which is a good reason why understanding how dividend yield works is so important.

The dividend yield is a securities annual dividend payment expressed as a percentage of its current price. To put it another way, dividend yield is a ratio that shows how much income is earned in payouts per year for every dollar invested in a stock, mutual fund, or exchange-traded fund (ETF).

Since the yield is based on the stock price, any changes in the price will affect the yield. If the price falls and the dividend remains the same, the yield will increase and vice versa.

Important Dividend Dates

• Announcement date: Dividends are announced by company management on the announcement date (or declaration date) and must be approved by the shareholders before they can be paid.

• Ex-date: The date on which the dividend eligibility expires is called the ex-dividend date or simply “the ex-date.” For example, if a stock has a specific ex-date of say, “Monday, May 5,” shareholders who buy the stock on or after that day will not qualify to receive the dividend. Shareholders who own the stock one business day prior to the ex-date, say on “Friday, May 2,” or earlier, qualify for the distribution.

• Record date: The record date is the cutoff date, established by the company to determine which shareholders are eligible to receive a dividend or distribution.

• Payment date: The company issues the dividend payment on the payment date, which is when the money is credited to investors’ accounts.

Companies can pay out dividends in different ways, depending on their financial situation and their priorities.

Conclusion: Make Dividends Work for You

The dividend yield can play an important role in evaluating a stock’s return on investment, but it shouldn’t be the only factor you consider when choosing your investments.

To make sure your investments are sound for the long-term, look at dividend yield as part of the big picture, alongside other metrics such as performance versus major benchmark indexes and corporate fundamentals. Yields from 2% to 6% are generally considered to be good, but there are plenty of factors to consider when deciding if a stock’s yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.

If you’re retired or you are approaching retirement age, you may be looking to build a portfolio of income-generating assets. Investors in this camp prefer dependable, sustainable dividend yields for the long term.

If your goal is to create an income stream, you might simply look for stocks with above-average dividend yields over a longer period. But if you’re a growth-oriented investor who isn’t looking for immediate income, consider investing in stocks that have a track record of increasing their dividends as company cash flows and profits increase.

As always, if you have any questions about this report or any other questions, please reach out to Bowen Asset at  info@bowenasset.com or (610) 793-1001.