Dividend stocks are an excellent source of passive income and can be extensively used for building long-term wealth. I build the base of my portfolio out of dividend stocks for a number of reasons, as shown below.
Companies that pay a regular dividend have been shown to provide great returns over time. Some studies reveal that companies that pay a dividend outperform companies that do not pay a dividend in the S&P 500. They grow steadily during bull markets and yet are fairly good at reducing losses during recessions. Don’t buy into the myth that dividend-paying-companies offer a lower return just because they are “safer”.
When you invest in a company that does not pay dividends, you only have one way to profit: capital appreciation (increase of the stock price). Your only desired outcome is to watch the stock price go up, and that compromises 100% of your returns. A company that pays growing dividends, however, offers two streams of growth: dividend income and capital appreciation.
It’s important to invest in things you understand. Out of all the companies I evaluate for investing, I feel most competent at evaluating dividend-paying companies. Seeing historical dividend growth and comparing current yield to previous yield are two extra metrics, among others, that dividend-paying companies have over companies that do not pay a dividend.
A dividend is pretty good evidence that a company is shareholder friendly. When looking for a company to invest in, it’s important to note that a great company might not make a great stock. A great company might be overvalued in terms of share price, or it might not care about creating shareholder value. Companies that pay dividends are taking care of the shareholders, and are likely to keep doing that.
It is my hypothesis that dividend-paying companies use capital more efficiently. Firstly, paying a dividend requires solid cash flow. This means that a company has to have its financials in order to know how much it can reasonably pay over the long term. Secondly, a company that has less capital to work with (due to paying some capital as dividends) will stick to investing in its best ideas, not simply all of its ideas. This means that they return money to you, the shareholder, and then use the rest to invest in only their very best ideas. The best part is that you can reinvest your dividends into buying more shares, so you can fully embrace all of their best ideas.
Dividend stocks are generally less volatile than companies that do not pay a dividend. This is especially true if you invest in large-cap dividend payers. Dividend-paying companies are an excellent option if you want to take control of your own finances (individual stock selections) without having to check on each of your companies every day. If I have a portfolio of 8 stable dividend payers and 1 obscure Chinese small-cap, guess which one I’m going to be tempted to “check on” every day? This also means that dividend paying companies are excellent companies to start investing with, and are perfect for someone who is interested in building some serious wealth without feeling the need to think about investing 24/7.
The amount by which the company directors decide to raise dividend payouts in a given year says a lot about their confidence for the future. Past history is one thing to take note of, but the future is what really matters to investors, so it’s great to get insight into managerial confidence. If management is unsure or pessimistic about the future of their company, they are likely to keep dividends conservative. If management raises dividends by a considerable amount, it shows they see great promise in their future. This is because companies that focus on increasing dividends each year have to conservatively manage their dividend payouts to ensure that they don’t bite off more than they can chew, since if their projections don’t work out right, they may have to cut dividends, and that always gives horrible press and angers shareholders. When a company raises dividends by a noteworthy amount, it’s likely that management is optimistic about long-term future performance.
When you retire, you can keep all of your dividend investments and rely on the passive income of dividends. Once you buy into a dividend paying company, if you’ve made a wise investment choice and that proves to be a good investment for decades, you could literally hold onto that investment for the rest of your life.
Let me know what you think about dividends in the comment section below.