The Power of Investing in Dividend Paying StocksSubmitted by: Chris E Chamberlain
Stocks with higher dividends, for years, were considered safer investments. Similar to a company that pays higher salaries and gives higher raises over time. A shift occurred in the 1990’s, though, as companies with extremely high growth prospects (but little, or no, earnings) came to dominate the landscape. That’s not to say these companies were completely without merit…the internet (and technology, in general) ushered in a new paradigm of truly transformational companies with spectacular growth prospects.
But making a bet on a company’s future growth is exactly that…a bet on future growth. While, dividends reflect the health of a company’s growth right now.
Things are beginning to change. The wild capital appreciation in the 90’s allowed investors to bet on tiny internet companies that were little more than ideas…and make millions from huge run-ups in the stock when things hit big. Since 2000, however, the story has changed. Capital appreciation is no longer considered an entitlement by participants in the equity market and dividends have now become an increasing source of reliable returns. As John D. Rockefeller once said, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”
Another important characteristic of dividend returns is their stable nature. A stock’s dividend is the less volatile component of its total return and is much more predictable than price appreciation which is a function of a wide array of factors like speculation, market sentiment, macro-economic factors, etc.
From 1989 to 2008, the volatility of the S&P BMI index was 13.96%, while the annual volatility of dividends was only 0.27%!
Of the stocks included in the S&P 500 Index, 256 began or increased their dividends in 2010, compared to only five that stopped or decreased their dividend, according to Standard and Poor’s. And 42 of those stocks had increased their dividends each year for the past 10 years.
In “The Future for Investors,” Jeremy Siegel advocates a long term dividend-reinvestment strategy based on research showing that dividend-paying stocks have outperformed non-dividend payers over time. The same can be said of today’s dividend payers. The S&P 500 Dividend Aristocrats have outperformed the S&P 500 Index over the one-, three-, five-, 10-, 15-, and 20-year periods ended Dec. 31, 2010.
Now that we’ve established that dividend paying stocks are an integral part of building sustained wealth over time, the next step is to narrow our focus on which dividend paying stocks to invest in. Especially if we’re deciding to invest for the long-haul, it’s important to remind yourself that you’re not just buying a stock…you’re actually buying a fractional ownership in a company. And in return for this ownership interest you will be entitled to any cash earnings that management decides to pay out in the form of dividends. Remember, however, that not all dividends are created equal and several factors must be considered before committing your hard-earned cash. Approach this problem as if you were buying the entire company…not just making a few mouse clicks on Etrade.
So, what should you consider when choosing a dividend paying stock?
1. Initial yield – what does the stock yield today? This is, after-all, the point of investing in dividend-paying stocks…to get the dividend, so it should compare favorably to other dividend-paying instruments, namely bonds & bank CDs. The current environment happens to be extremely favorable for dividend investing but over the years this hasn’t necessarily always been the case.
2. The reliability of the dividend – this is an important point. Many people get seduced by a super-high dividend only to see the company cut it in order to save cash. A lot of companies did this in 2008 and in many cases, it was actually a prudent deployment of capital. After all, if a company is facing bankruptcy or cutting its dividend in order to build up its balance sheet, the dividend should go…but that’s little consolation if you were an investor counting on that dividend.
About the Author: DividendInvesting101.com is a free resource dedicated to one goal: Helping people achieve massive income through High Dividend Stocks. Few people realize how quickly a robust stream of income can be built with much less money and time than they thought. Let us help you start building wealth...one dividend check at a time.
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