While dividend investing might be boring for some investors, unlike many other jazzy investment strategies, it could be exciting for others. If done right, dividend investing could reap significant rewards for investors over a longer period.
Let’s see how investors can make the most of dividend stocks.
Dividends are basically a part of the company’s profit shared with its shareholders. They can be paid annually or even quarterly. Some companies even pay dividends monthly.
However, not all companies pay dividends. Some retain profits for future investments or expansions while some pay back their shareholders as gratitude.
So why not all the investors invest in dividend-paying companies? Well, many believe that mature companies that are out of exciting investment opportunities pay dividends. That’s true for many companies as well.
Dividend yield and growth
So how should one choose a great dividend stock? There is not actually one way. Dividend yield could be an important parameter to look for.
Stocks with very high yields, however, could be risky and unsustainable. Along with yields, stable dividend growth plays an important part in driving investors’ returns over the long-term.
For example, top utility stocks Canadian Utilities and Fortis have been increasing their dividend payouts for more than 45 years. Thus, their consistent dividend payment history indicates predictability and stability. They offer a yield of 4.2% and 3.3%, respectively. Their stable earnings facilitate stable dividends.
In the last five years, Fortis has returned almost 80%, including dividends, while Canadian Utilities has returned approximately 25%. While capital gain formed a large portion of Fortis’s returns, dividends acted as a cushion against Canadian Utilities’ volatile stock.
Thus, it should be noted that a long dividend payment history with a superior yield may not necessarily account for the best dividend stock.
The payout ratio is another important aspect to look for when mulling a dividend investment strategy. It’s the portion of the company’s earnings given away in the form of dividends to shareholders.
Mature companies generally have a larger payout ratio as their investment needs are relatively lower compared to growing companies. For instance, e-commerce titan Shopify doesn’t pay dividends.
At the same time, Canadian telecom giant Telus had an average payout ratio of close to 80% in the last five years.
Sometimes companies do report payout ratios higher than 100%, which means it paid dividends more than its profits during that particular period.
Dividends were funded by reserves or by debt. This represents the poor financial health of the company, and its dividends might not sustain longer.
When a company declares a dividend, it also announces the ex-dividend date, record date, and the payment date. One needs to buy shares before the ex-dividend date and hold on to it at least until the record date to receive dividends. The record date is when the company checks whether your name appears in its books to allot dividends.
However, recommend holding for a longer period to accumulate dividends over a period and reap compounding benefits. One could use the cash distribution to buy new shares in order to increase the size of the portfolio without any external funding.
As earlier stated, mature companies with stable revenues and earnings pay stable dividends. One could look for a forward-looking dividend commentary from the company management.
For instance, Fortis aims to increase its dividend by 6% per year for the next five years — reasonable growth in my view. Dividend investing is indeed one of the best long-term investment strategies.
Over a period, a company with steadily growing dividends could help you build your fortune.
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Fool contributor Vineet Kulkarni does not have any positions in the stocks mentioned.