Many investors regard dividend paying stocks as uninteresting, low-return investments. Dividend paying stocks are normally more mature and reliable than high-flying small-cap firms, whose volatility can be very exciting. Though some may find this uninteresting, the combination of a steady dividend paying stock and rising share prices may provide an earnings opportunity that is persuasive enough to get excited about. My advice to you: Do NOT overlook Dividend paying stocks.
Understanding how to compare dividend-paying firms can let us see how dividends can help us increase our returns. A high dividend yield is commonly thought to be the most important metric; however, a yield that is significantly higher than that of other stocks in an industry may mean a depressed price rather than a good dividend (dividend yield = annual dividends per share/price per share). As a result of the falling stock price, a dividend cut or the elimination of the dividend may be on the horizon.
The most significant indicator of dividend power is not a high dividend yield, but rather a high company performance,
which you can learn about by looking at its dividend history, which should grow over time. Looking for such companies can be very rewarding if you are a long-term investor.
Dividend Payout Ratio
The dividend is a very important metric. if a company’s dividend payout ratio remains constant, say at 4%, the company expands, the 4% represents a greater and larger sum. (For example, 4% of $40, which equals $1.60, is higher than 4% of $20, which equals 80 cents.)
As an example
Let’s say you put $1,000 into Joe’s Hot Chocolate by purchasing ten $100-per-share shares. It’s a well-managed company with a P/E ratio of 10 and a payout ratio of 10%, resulting in a $1 per share dividend. That’s respectable, but nothing to brag about considering you just get 1% of your investment back in dividends.
However, since Joe is such a good businessman, the business grows slowly, and the stock price is about $200 after many years. However, the dividend ratio has remained unchanged at 10%, as has the P/E ratio (at 10); as a result, you are only getting 10% of $20 in profits, or $2 per share. Even if the payout ratio remains stable, the dividend payment increases as earnings rise. After you paid $100 per share, the effective dividend yield has increased to 2%, up from 1% previously.
Jump forward a decade, and Joe’s Chocolate Company is thriving as an increasing number of North Americans flock to warmer, sunny climates. Since splitting 2 for 1 three times, the stock price continues to rise and now stands at $150.
This means that your $1,000 investment in 10 shares has risen to 80 shares (20, 40, and now 80 shares) valued at $12,000.
If the payout ratio stays stable and we proceed to assume a P/E of 10, you will now receive 10% of earnings ($1,200) or $120 or 12% of your initial investment!
So, even though Joe’s dividend payout ratio did not adjust as a result of his company’s growth, the dividends alone provided an excellent return — they significantly increased your total return, as well as capital appreciation.
Many investors have used this dividend-focused approach for decades by purchasing shares of well-known companies like Coca-Cola (Nasdaq: COKE), Johnson & Johnson (NYSE: JNJ), Kellogg (NYSE: K), and General Electric (NYSE: GE) (NYSE: GE). We saw how profitable a fixed dividend payout can be in the previous example; imagine the earning power of a business that increases so fast that it can raise its payout. Between 1966 and 2008, Johnson & Johnson did exactly this every year for 38 years.
If you had purchased the stock in the early 1970s, the dividend yield on your initial shares would have risen at a rate of about 12% per year between then and now.
Dividends alone would have earned you a 48 per cent annual return on your initial investment by 2004!
Many people don’t look at dividends the way they should be. A lot of the time they are viewed just as a nice bonus on the massive return you will make. But seeing your dividend payouts compound over time can be a nice sight indeed!
- Dividends are a popular way for people to get investment income from their portfolios.
- Dividend yield and dividend payout ratio are two important metrics to consider for investors.
- Dividend ratios normally growl slowly. But often investors still rely on them
- When it comes to reinvesting dividends, the power of compounding can be a very profitable technique.
All these points are to be looked at when investing in my opinion. I was lucky enough to learn about dividends early in my life and since then they are a major factor in my portfolio.
When taking dividends into consideration the investor is thinking for the loin-term. Dividends are one of many bonuses to think about when investing long-term but there are many more. Take a look.