What is a dividend growth investing strategy?
Dividend Growth Investing is an investment strategy that focuses on investing in stocks or a company that has a history of paying regularly or growing their dividend payments over time.
This approach is based on the idea that companies that consistently increase their dividends are financially stable, have strong cash flows, and are likely to continue to grow their dividends in the future.
Dividend growth investors look for companies with a high dividend payout ratio, a low debt-to-equity ratio or almost nil, and a sustainable dividend policy.
The goal of this strategy is to receive a growing stream of income from the invested capital, which can provide a hedge against inflation and help generate wealth over the long term.
What is a dividend?
A dividend is part of a company’s earnings that are paid out to the shareholders. It is a method of profit sharing done by the management to its shareholders, it is most likely to be paid on a quarterly or annual basis.
These dividends are paid in cash which is credited into your bank account. Investors can use this cash to purchase additional shares or use the money elsewhere.
Read more: This 1 DIVIDEND paying stocks in India can make you rich
Dividend yield vs Dividend growth
Dividend yield tells investors how much the company offers in dividends compared to its stock’s share price.
Eg: The stock price of a share is $50, which offered a $2 dividend per share last year. In this case, the dividend yield would be 4%
Dividend Yield = Dividend per share/ Share price.
Dividend growth tells investors how much that stock’s dividend has grown over a period of time. As a company grows, it may increase the dividends paid to investors, which may indicate stability.
Eg: A company’s current annual dividend is $2.5, but last year the company offered $2.25 in dividend. The dividend growth rate is 11%
Dividend growth rate = {current annual dividend/ last year’s annual dividend} -1
Both parameters are important and to be considered together.
Beyond Dividend Yield
Most investors can make the mistake of dividend investing by solely focusing on dividend yield. In general, sectors like utility tend to have a high dividend yield. Focusing on one sector can be a peril to your portfolio. Then what?
As a responsible investor, you need to mitigate the risk of your portfolio through a step by step process. They are,
Sector diversification:
Sector diversification is an important part of a successful dividend growth investing strategy and it is important for dividend earnings. A simple dividend strategy focuses purely on yield, wherein as growth strategy likes to be more diversified across sectors.
This step ensures your portfolio can withstand periods of volatility and crashes.
Focus on Factors:
Since dividends are generated from a stock’s earnings, a dividend is a proxy for company performance than the size of the yield. That’s why factors such as free cash flow, earnings, and future growth prospects are so critical in your selection of stocks.
These factors ensure that the company is well-positioned itself to increase its payout in the future. High yield doesn’t offer such protection.
7 Reasons for dividend growth investing strategy:
There are several reasons why someone might choose to pursue a dividend growth investing strategy:
Regular Income:
The most obvious benefit of investing in dividend-paying stocks is the regular income stream they provide. This can be especially beneficial for retirees or anyone looking for a reliable source of passive income.
Inflation Hedge:
As dividends increase over time, the income from dividend-paying stocks can help keep up with inflation and maintain purchasing power.
Potential for Capital Appreciation:
In addition to the income from dividends, dividend growth stocks can also appreciate, offering the potential for capital gains.
Quality of Companies:
Companies that consistently increase their dividends are typically well-established, financially stable, and have a track record of generating consistent earnings.
Diversification:
Dividend growth investing can be a way to diversify a portfolio beyond traditional bonds, as it offers exposure to equities while still providing a steady stream of income.
Reduced Volatility:
Historically, dividend-paying stocks have shown lower volatility than non-dividend-paying stocks, offering a potentially smoother ride for investors during market downturns.
Compound Growth:
As dividends are reinvested, the income from dividends can compound over time, leading to potentially significant growth of invested capital.
Risk of dividend growth investing:
Limited Upside Potential:
While dividend-paying stocks can provide a steady stream of income, they may not offer the same potential for capital appreciation as higher-growth, non-dividend-paying stocks.
Dependence on Dividends:
Dividend growth investing relies heavily on a steady stream of dividends, which can be affected by economic conditions or changes in a company’s financial situation.
Low Yield:
Some dividend growth stocks may have lower yields compared to other dividend-paying stocks or bonds, which can be a disadvantage for investors seeking high income.
Reduced Flexibility:
Once an investment is made in a dividend growth stock, the investor may be locked into a long-term investment, as selling the stock could trigger capital gains taxes and disrupt the income stream.
Potential for Dividend Cuts:
Companies can reduce or eliminate their dividends at any time, which can impact the income stream and reduce the overall return on investment.
High Valuation:
Some dividend growth stocks may be priced at a premium, making them more expensive and reducing potential returns.
Market Risk:
Dividend growth investing is still subject to market risk, and the underlying stocks can still lose value if the overall market declines.
Final Thoughts
