In this article, we discuss 10 things every dividend investor should know. If you want to read more about dividend investing, go directly to have a look at 25 Things Every Dividend Investor Should Know.
10. Dividend Reinvestment Plans (DRIPs):
Dividend Reinvestment Plans, or DRIPs, allow investors to automatically reinvest their dividend payments into additional shares of the company’s stock, often at a discounted price. This can help investors build their holdings in a particular company over time, potentially increasing the long-term returns of their investment. Reinvested dividends can play a significant role in investors’ overall returns, particularly over the long term. According to a report by Hartford Funds, reinvested dividends represented 69% of the S&P 500’s total return since 1960.
Forbes cited Shiller’s data and also highlighted that reinvested dividends remained crucial to overall market return in the past. The report mentioned that since 1971, the S&P 500 delivered an annual average return of 7.58%, which grew to 10.51% when dividends were reinvested.
These reports show that reinvesting dividends can help to compound an investor’s returns, as the additional shares purchased with the dividends can generate additional dividends themselves. This can result in a snowball effect, where the total return from the investment gradually increases over time. In the past 20 years that ended October 31, 2022, 39% of the S&P 500’s total returns were derived from the reinvested dividends, as reported by The Vanguard Group.
9. Dividend-Paying Companies Tend to Have Higher Earnings Growth:
Dividend payments are typically made from a company’s profits or earnings, so a company that is generating strong earnings growth may be more likely to pay dividends. Consistent growth in payouts mainly provides an indication of the respective company’s financial strength and stability. For instance, despite last year’s challenging environment, companies in the S&P 500 distributed a record $565 billion to shareholders in dividends, up from $511.2 billion in 2021.
8. Dividend Stocks Can Generate Higher Returns Than Bonds:
Dividend stocks have historically outperformed bonds as they have the potential for both capital appreciation and dividend income. Whereas bonds typically offer only fixed interest payments. According to a study by Hartford Funds, from 1972 to 2020, the average annual return of dividend-paying stocks in the S&P 500 was 9.25%, while the average annual return of bonds in the Bloomberg Barclays U.S. Aggregate Bond Index was 7.28%.
7. Dividend Stocks Can Provide Downside Protection During Market Downturns:
Dividend-paying stocks can provide some downside protection during market downturns, but, as mentioned before, they are not immune to market volatility. According to a report by Morningstar, dividend stocks performed well during periods of economic slowdowns that started in July 1981, March 2001, and December 2007. The report also mentioned that dividend-growth strategies also fared well during recessionary periods. In trailing five years through July 2022, dividend growth equities delivered an annual average return of 9.93%, compared with a 7.56% return of income strategies.
Capital Group cited data from Fama and French and revealed that high-dividend stocks have shown a more attractive 30-year downside capture ratio of 76%, compared with a 124% of non-dividend stocks.
6. Dividend Stocks Are Less Sensitive to Changes in Business Cycle:
Dividend stocks can be less sensitive to changes in business cycles compared to non-dividend-paying stocks, but this can vary depending on the specific stock and industry. These stocks tend to be in industries that are less cyclical and more stable, such as consumer staples, healthcare, and utilities. These industries tend to provide essential products and services that people need regardless of the state of the economy, making them less sensitive to changes in business cycles.
5. Dividend Stocks are a Valuable Source of Income for Investors:
Dividend-paying stocks provide regular dividend payments to shareholders, which can provide a steady stream of income. Additionally, dividend payments can potentially increase over time as the company grows and profits increase. Over the years, dividends have contributed significantly to an individual’s personal income. According to a report by S&P Dow Jones Indices and the Bureau of Economic Analysis, dividends as a source of personal income stood at 8.5% in the fourth quarter of 2022, compared with 3.2% in the first quarter of 1980.
4. Preferred and Special Dividends:
A preferred dividend is a regular dividend that is paid to preferred stockholders before common stockholders. Preferred stock is a type of stock that typically pays a fixed dividend, and the dividend amount is usually specified in the company’s articles of incorporation. Preferred dividends are generally paid quarterly, and the amount is usually based on a percentage of the stock’s par value.
On the other hand, a special dividend is a one-time, non-recurring dividend that is paid by a company to its shareholders. Special dividends are typically paid when a company has excess cash and wants to distribute it to shareholders. Special dividends can be paid in addition to regular dividends, and the amount of the special dividend is usually determined by the company’s board of directors.
3. Tax Benefits of Dividends:
Dividend stocks can provide certain tax benefits to investors, depending on the type of dividend and the investor’s tax situation. Qualified dividends, which are dividends paid by U.S. corporations and certain foreign corporations that meet certain criteria, are taxed at a lower rate than ordinary income. In contrast, non-qualified dividends, which are dividends that do not meet the criteria for qualified dividends, are taxed at the same rate as ordinary income. This means that non-qualified dividends are subject to higher tax rates, which can reduce the after-tax return for investors.
Additionally, dividend-paying stocks can provide certain tax benefits for retirement accounts such as individual retirement accounts (IRAs) and 401(k) plans.
2. Investors Should Pay Attention to Company Fundamentals:
When investing in dividend stocks, analysts recommend considering the respective company’s fundamentals and overall financial health. For this reason, investors should focus on companies that maintain and grow their dividends over time as these companies have strong balance sheets and solid fundamentals. Charles Schwab reported that over the past 40 years that ended in 2020, stocks that grew or initiated dividends delivered an annual average return of 13.74%, compared with a 10.3% return of companies that cut their dividends. During this period, stocks that did not pay dividends returned 9.60%.
1. Dividend Coverage:
Dividend coverage is a measure of a company’s ability to pay its dividends from its earnings or cash flow. It is calculated by dividing the company’s earnings or cash flow by the amount of dividends it pays.
If a company has high dividend coverage, it means that it is generating enough earnings or cash flow to comfortably pay its dividends. On the other hand, if a company has low dividend coverage, it may be at risk of cutting its dividend if its earnings or cash flow declines.
Dividend coverage is an important metric for dividend investors, as it can help them assess the sustainability of a company’s dividend payments.
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