While dividend stocks may be viewed by some investors as mature, lower-risk companies that do not offer a high level of capital growth potential, they could deliver surprisingly strong total returns in the long run.
Dividends suggest that a company is in good financial health, while a rising dividend may indicate that company management is positive about its future earnings growth rate. Furthermore, with investors continuing to demand high yields, stocks that can offer impressive income outlooks may become increasingly popular over time. This may lead to higher capital growth, as well as the opportunity for investors to generate growing returns in the long run.
Dividend demand
As ever, there are a large number of investors who are seeking to generate an income from their portfolios. This may be because they are retired, or could be due to them wanting a second income, for example. Either way, stocks that are able to display a solid track record of dividend growth, as well as the potential to beat inflation when it comes to future dividend rises, could become popular among income-seeking investors. Over time, increased demand from investors may reduce their yields and increase their stock prices.
Financial strength
While it is always worth checking the balance sheet strength and cash flow of a company before buying it, a track record of dividend payments can provide guidance on its financial strength. For example, a stock that has a long history of paying growing dividends may be more likely to have a stable financial future than a company which has a patchy record of dividend payments. This could equate to lower risk which, in turn, may lead to investors placing a higher valuation on it over time.
Increasing optimism
The potential for a rising dividend may indicate that company management is becoming increasingly positive about its prospects. This could be due to improved trading conditions, or the potential impact of a new strategy, for example. Either way, a fast-rising dividend may indicate that the company in question has the capacity to generate improving levels of profitability that will allow it to afford to raise the level of shareholder payments. This could lead to investors becoming increasingly positive about the prospects for the stock, which may mean that a higher rating is required.
Reinvestment
The strategy of most investors is to buy low and sell high. However, one challenge in doing so is a lack of cash which is available to invest when there is a bear market. Dividend stocks can be useful in providing this, since resilient and robust companies with defensive business models may be able to maintain their payments to shareholders during challenging periods for the wider economy.
Those dividends can then be redeployed to buy high-quality stocks trading at lower prices. As such, dividends can provide a useful cash inflow for investors during a variety of market conditions. This can be used to strengthen their portfolios during the most opportune periods.
