In this article, we discuss 25 things every dividend investor should know. If you want to read further about dividend investing, go directly to have a look at 10 Things Every Dividend Investor Should Know.
Investors tend to gravitate towards investments that provide them with income, and dividend stocks are particularly popular in this regard. These stocks stand out for their ability to generate consistent income streams. Dividends represent a share of a company’s profits that are allocated to its shareholders either as cash payments or in the form of additional shares of stock. Investing in dividends may appear simple at first glance, as it involves investors anticipating regular payments on a quarterly, monthly, or yearly basis. However, this investment strategy involves a multitude of considerations when selecting suitable stocks. Key factors include the growth rate of dividends, the compounding impact of reinvesting dividends, payout ratios, cash flow analysis, and dividend yields. Understanding these elements is essential for making informed decisions when venturing into dividend stock investments.
One of the key factors that greatly attracts investors is the consistent increase in dividends over time. Stocks that consistently raise their dividends have historically demonstrated superior performance, delivering enhanced returns to shareholders. These types of stocks become particularly valuable during periods of financial instability or economic downturns when investors seek reliable income streams. Examples of top dividend stocks renowned for their sustained dividend growth include Johnson & Johnson (NYSE:JNJ), The Procter & Gamble Company (NYSE:PG), AbbVie Inc (NYSE:ABBV), Colgate-Palmolive Company (NYSE:CL), and PepsiCo, Inc. (NASDAQ:PEP). These companies have consistently rewarded shareholders with growing dividends over the years.
Investing in dividends offers multiple avenues for investors to explore, and when executed effectively, it has the potential to create substantial wealth for individuals. For this reason, we have compiled a list of 25 things every dividend investor should know.
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26. Dividends Aristocrats Delivered Double Digit Returns in Up and Down Markets:
The age-old debate of investing in dividend growth or high-yield stocks continues to reappear within the dividend investing realm. Between these two, dividend growth is currently the favored option in the market as investors seek out strategies to grow their income over time. In this regard, investors turn to dividend aristocrats, which are the companies that have raised their payouts for 25 consecutive years or more. These stocks have delivered strong returns over the years regardless of market conditions. Between February 2005 and December 2023, dividend aristocrats delivered a 12.50% return in falling interest rate periods and an 11.5% return in rising interest rate periods, according to data by Bloomberg.
25. Dividends have Contributed Significantly to Total Market Returns:
Over an extended period, dividend-paying stocks have played a substantial role in driving the overall returns of the market. A study conducted by Hartford Funds revealed that between 1940 and 2023, dividends accounted for an average of 34% of the total return of the S&P 500 Index. Additionally, during decades such as the 1940s, 1960s, and 1970s, where total returns were below 10%, dividends made a significant contribution to the overall returns. Another study conducted by S&P Dow Jones Indices highlighted the impact of dividend-paying stocks on overall investment returns throughout the 2000s. According to the report, dividend income accounted for approximately 68% of the total returns during that decade.
24. Dividend Stocks Have Outperformed Non-Dividend Stocks Over the Long-Term:
Stocks that do not pay dividends have consistently underperformed dividend-paying stocks over time, particularly in certain market situations. For instance, during market downturns such as the one witnessed in 2022, where the S&P 500 Index dropped by over 18%, dividend-paying assets demonstrated their capacity to shield investors from significant losses. In 2022, stocks listed in the S&P 500 that distributed dividends experienced a decline of 11.1%, while those that did not pay dividends suffered a much steeper loss of 38.7%.
Analyzing the performance over the long term reveals the robust returns delivered by dividend-paying companies. Research from Hartford Funds indicated that from 1973 to 2023, companies distributing dividends achieved an average annual return of 9.17%. In contrast, non-dividend-paying companies yielded a significantly lower average return of 4.27% over the same period. Furthermore, companies that maintained consistent dividend policies throughout this timeframe returned an average of 6.74%.
23. Dividend Stocks Can Provide a Hedge Against Inflation:
During market downturns, investors often grapple with concerns about their investments, particularly exacerbated by the impact of inflation. Fortunately, dividend stocks have demonstrated resilience during inflationary periods compared to other asset classes. According to a report by Hartford Funds, between 1970 and 2022, there were eight such inflationary periods, during which dividend-paying companies consistently outperformed their non-dividend-paying counterparts. The report highlighted the 1970s as one of the most notorious periods of American inflation, driven by surging oil prices. Despite market challenges, dividends played a pivotal role, accounting for a significant portion of returns, with as much as 73% of the S&P 500’s returns attributed to dividends during this time.
One of the main reasons for this outperformance of dividend stocks is their tendency to generate substantial free cash flow. Unlike growth-focused companies that prioritize reinvestment for expansion, dividend-paying companies have established revenue streams and financial stability, making them more resilient in slowing growth or recessionary environments. Their ability to maintain consistent dividend payments reflects their sound financial health and adaptability during adverse market conditions.
22. Dividend Stocks Have Outpaced Inflation Over the Years:
Over time, inflation gradually diminishes the purchasing power of currency, posing challenges for income investors. However, dividends offer a notable advantage during periods of high inflation due to their potential for growth compared to fixed bond coupons. Research from BlackRock underscored this, revealing that over the past 150 years, dividends from U.S. companies have experienced an average annual growth rate of 3.7%, outpacing the average annual inflation rate of 2%.
Wisdom Tree conducted research confirming that dividends have consistently surpassed inflation rates. Their findings indicate that between 1957 and 2022, dividends experienced an average annual growth of 5.7%, exceeding the inflation rate by more than 2%. Similarly, from 1990 to 2022, dividends from the S&P 500 grew by 5.61%, while inflation only saw a growth of 2.64% during the same period. This highlights the ability of dividends to provide investors with a hedge against inflation and potentially enhance their purchasing power over time.
21. Dividend Stocks are Less Volatile than Non-dividend Stocks:
The regular dividend payments paid to investors act as a buffer during market downturns, providing stability to the stock’s price. In addition to this, companies that pay regular dividends to shareholders have stable cash flows and established business models, which can lower the volatility. Wisdom Tree reported that stock prices are over two times more volatile than dividend stocks. The firm gathered data from the last 64 years and highlighted that there were only six instances during this period where dividends decreased, and only one of those cases saw a decline of over 5%. In comparison, stock prices experienced declines in 18 of those years, with the most severe yearly decline surpassing 40%. The report also mentioned that on average, stocks fell by more than 11% annually during that period.
Companies that regularly grow their dividends are particularly less volatile than other asset classes. According to a report by S&P Dow Jones Indices, when the market experienced declines between December 31, 1999, and March 31, 2022, the S&P High Yield Dividend Aristocrats showed better performance compared to both the S&P Composite 1500 and the S&P 500 High Dividend Index, outpacing by 140 basis points per month and by 49 basis points per month, respectively.
20. The Payout Ratio is an Important Metric to Consider in Dividend Investing:
The payout ratio is one of the most useful important metrics for evaluating dividend-paying companies. This mainly analyses how much of a company’s income is being distributed among its shareholders in the form of dividends. A high payout ratio is not considered healthy, as it shows that a company is paying more than it can afford. On the other hand, a low ratio indicates that a company is maintaining more earnings for reinvestments and to fulfill shareholder obligations. According to analysts, the dividend payout ratio of between 35% and 55% is considered healthy as it shows that the company has enough money left over to reinvest for growth.
The Wellington Management did a detailed study on that and categorized dividend-paying stocks in the S&P 500 into quintiles based on their dividend yields and payout ratios. The highest dividend-paying stocks, representing the top 20%, comprised the first quintile, while the lowest and non-payers constituted the fifth quintile. Over nine decades, from 1930 to 2019, the study examined the performance of each quintile. Results showed that second-quintile stocks outperformed the S&P 500 in seven out of nine periods, accounting for 77.8% of the time. The first and third quintiles tied for second place, outperforming the index in six out of nine periods. However, fourth and fifth-quintile stocks performed less favorably, outperforming the index in only four instances each. One explanation for the outperformance of second-quintile dividend stocks compared to the first quintile is their lower average dividend payout ratio. The first-quintile payout ratio averaged slightly above 70%, while the second-quintile payout ratio averaged just over 40%.
19. High-Yield Dividend Stocks Can be More Volatile:
Investors often consider high dividend yield as an advantageous feature when investing in dividend stocks. However, high yields are not always practical as this could be a sign that the stock price has fallen significantly, which could be a sign of an underlying issue within the company. In addition to this, high-dividend stocks can be more volatile because they are more sensitive to changes in interest rates and market conditions. The Wellington Management study discovered that stocks with the highest levels of dividend payouts and yields have shown strong performance over time. However, they didn’t perform as well as stocks that pay high, though not the absolute highest, levels of dividend payouts and yields.
According to analysts, a dividend yield between 3% and 5% is generally considered healthy as this range creates a balance between being neither excessively high nor too low. According to a report by Nuveen, global dividend-paying companies with a more moderate yield (0-3%) typically exhibit stronger potential for earnings growth, more robust profitability metrics, and higher profit margins in comparison to high dividend-yielding companies (those with yields above 3%) and companies that do not pay dividends at all. These factors often contribute to reducing risk, particularly during periods of heightened market volatility.
High dividend yields, when combined with a track record of consistent dividend growth record, can offer great investment opportunities for investors. Altria Group, Inc. (NYSE:MO), Verizon Communications Inc. (NYSE:VZ), Telephone and Data Systems, Inc. (NYSE:TDS), and British American Tobacco p.l.c. (NYSE:BTI) are some of the best stocks in this regard as these companies have consistently raised their payouts for years and also boast above-average dividend yields.
18. An Elite Group of Dividend Aristocrats:
As mentioned above, dividend growers take the lead among investors when it comes to investing in dividend stocks. The S&P 500 Dividend Aristocrats Index seeks the performance of companies that have raised their payouts for at least 25 consecutive years. The Procter & Gamble Company (NYSE:PG), AbbVie Inc (NYSE:ABBV), Colgate-Palmolive Company (NYSE:CL), and PepsiCo, Inc. (NASDAQ:PEP) are some examples of dividend aristocrat stocks that are popular among investors. Their ability to raise dividends consistently stems from their strong balance sheets and stable cash generation. Due to these qualities, these stocks have performed better than others over the course of history. According to a report by S&P Dow Jones Indices, the Dividend Aristocrat index has shown a notable capacity to protect against downturns, as evidenced by their upside and downside capture ratios. The report highlighted that these stocks have outperformed the S&P 500 around 69.34% of the time during down months and approximately 43.6% of the time during up months. Dividend aristocrats also delivered an average excess return of 1.05% in down months over the broader market index. In addition to this, the index experienced lower drawdown levels compared to the S&P 500.
The outperformance of dividend aristocrats also brings in the factor of high dividend yields, highlighting the advantage that dividend growers hold over those with simply high yields. ProShares reported that dividend growth has consistently demonstrated strong performance regardless of the direction of the interest rates. According to the report, from May 2005 to December 2023, the Dividend Aristocrats index delivered an 11.55% return in rising interest rate periods, compared with a 10.46% return of high-yield dividend stocks, represented by the Dow Jones U.S. Select Dividend Index. Similarly, in falling interest rate periods, dividend aristocrats returned 12.50%, surpassing a 7.90% return of high dividend stocks. Overall during this period, dividend growers yielded a 12% return, outperforming high-yield stocks, which delivered a 9.27% return.
17. Dividend Growth Rate is Crucial to Dividend Investing:
The importance of dividend growth cannot be emphasized enough as it reflects the company’s financial health and strength. The consistency in growing dividends shows that the company is generating sustainable earnings and has confidence in its future payouts. Abrdn reported that dividend growers and initiators delivered a compounded return of 10.68% from December 2002 to December 2022, significantly outperforming dividend cutters and eliminators, which returned 2.70% during this period. Non-dividend payers were also behind companies with regular dividend growth, returning 9.25% within this timeframe.
16. Dividend Growers Usually Have Strong Cash Flow:
Dividend growth and strong cash flow go hand in hand because this serves as a testament to the company’s financial health and stability. These companies generate reliable and consistent earnings from their main operations, which provides a solid foundation for maintaining and growing dividend payments over time. In addition to this, these companies can smoothly invest in growth initiatives, research and development, and other strategic opportunities with the ample cash that they generate.
Following in the trend, analysts are positive about dividend growth in the future as the cash on the corporate balance sheets has increased significantly over the years. According to a report by Global Market Intelligence, 13 non-financial S&P 500 companies collectively hold cash and investments of over $1 trillion, as of September 2023. These include some of the strongest dividend companies, such as Chevron Corporation (NYSE:CVX), Exxon Mobil Corporation (NYSE:XOM), and UnitedHealth Group Incorporated (NYSE:UNH).
15. Dividend Capture Strategies:
The data we have mentioned in this article so far highlights the importance of dividend stocks in the long run. However, some investors also exploit dividend equities for short-term gains through a strategy called dividend capture strategy. The goal of this approach is to secure the dividend payment while minimizing exposure to the stock’s price movements. The ex-dividend date is the day on which a stock begins trading without the dividend payment included in its price. Investors who own the stock on or before the ex-dividend date are entitled to receive the dividend payment.
14. Dividend Stocks Can Be Found Across a Variety of Sectors and Industries:
Dividend stocks are found across a variety of industries and sectors, including technology, healthcare, consumer goods, finance, utilities, and more. Certain sectors pay higher dividends compared to others and have varying dividend yields. Real estate and utilities sectors exhibit the highest dividend yields, averaging around 4%. On the other hand, though the tech sector merged as the winner in 2023, it tends to offer lower yields, averaging below 1%. As of 2023, the energy sector has taken the spotlight for raising its dividends and launching debt reduction programs, replacing both utilities and real estate. Both these sectors have announced various dividend cuts throughout the year, mainly due to fluctuating interest rates. That said, these three sectors still make up the best investment options for income investors as there are a lot of undervalued opportunities within them, according to Morningstar chief US market strategist David Sekera.
13. Dividend-Focused Exchange-Traded Funds (ETFs) Are a Good Way to Build Diversified Portfolios:
What could be better than owning one dividend stock? Investing in a basket of dividend stocks and dividend ETFs offers exactly that. ETFs, or exchange-traded funds, are investment funds that trade on stock exchanges and hold a diversified portfolio of stocks from various sectors and industries. By investing in dividend ETFs, investors can gain exposure to a wide range of companies, effectively eliminating risks associated with investing heavily in a single sector or stock. Dividend ETFs were popular among investors in 2022 but due to the tech rally last year, these funds also saw a decline in their inflows. Nevertheless, dividend funds gathered a total of $3.9 billion in 2023, which, unfortunately, is their lowest annual collection since 2009 (see 11 Best Dividend ETFs to Buy Now)
12. Dividend Stocks Are Not Immune to Market Downturns:
The prices of dividend stocks can also fluctuate as these equities are not completely immune to market downturns. They can provide a hedge against inflationary periods, but that performance mainly depends on a number of factors. Dividend payments aren’t guaranteed, unlike the interest payments from the Treasuries. Companies can reduce or eliminate their payouts at any point in time, a risk that became evident during the pandemic of 2020 when approximately 68 out of roughly 380 dividend-paying companies in the S&P 500 either suspended or decreased their dividends.
11. Dividend Stocks Can Outperform the Market During Fed Rate Hikes:
High-interest rates have been a cause of worry for investors since 2022. In our article titled 13 Best Dividend Stocks For Rising Interest Rates, we highlighted that between March 2022 and July 2023, the Federal Reserve implemented a series of 11 rate hikes to the federal funds rate. In addition to this, interest rates in the broader bond market rose, leading to increased borrowing expenses for both businesses and individuals. In this aspect, dividend stocks have offered investors a sense of relief as they typically hold up better during periods of high-interest rates.
According to a report by ProShares, dividend growth strategies, which include companies that have raised their payouts consistently for years, are often considered reliable approaches that perform effectively across different interest rate climates. These strategies have demonstrated strong performance over the years regardless of fluctuations in interest rates. The report further mentioned that portfolios investing in dividend growth stocks can experience both capital appreciation and increasing dividend income streams, even in rising interest rate environments.
10. Dividend Reinvestment Plans (DRIPs):
Dividend reinvestment plans, or DRIPs, allow investors to automatically reinvest dividends into additional shares of the company’s stock. Through this strategy, investors are able to compound their investment over time without experiencing transaction costs. In addition to this, investors can gain long-term benefits from their dividend investments as dividends are automatically reinvested without any additional action from the investor.
A report by Wisdom Tree illustrated the remarkable power of compounding, where reinvesting dividends increased wealth accumulation over time, along with playing a significant role in the market’s overall returns. The report mentioned that dividends and reinvested dividends have accounted for 69% of the market’s returns since 1978. This means that if someone had made an investment of $10,000 in the stock market in 1978 and consistently reinvested their dividends, their investment would have grown to over $1.6 million in 2023.