Yield Wealth Through Dividends

In my previous post I discussed the basics on dividends.  I left off telling you that the large majority of stock market returns over the past century have resulted from the reinvestment of dividends.  In this post I’ll tell you why dividend paying stocks outperform their non-dividend paying counterparts, and how you can begin yielding wealth through dividend investing.

Why Dividend Paying Stocks Outperform

1. Strong Financials - Companies that pay dividends tend to be more financially stable than non-dividend payers.  In order to payout dividends, a business must have the free cash flow and financial strength to support the payments.  This means that dividend payers usually have robust profits and manageable debt levels.  A long history of consistent dividend payment is a good sign that a business is fiscally fit.  Likewise, watch out for companies that have stopped or reduced their dividends; as this is a sign of financial distress.

2. Shareholder Friendly Management – When making an investment in a stock, it’s important to remember that the quality of the company’s management is almost as important as the business itself. Decisions by management have an enormous effect on the value of your stock.  This is why it’s vital that the firm’s executives have it’s shareholder’s best interest at heart.   Executives that squander cash on frivolous spending and unwise acquisitions do a disservice for shareholders.  While, companies that distribute a portion of their cash flow in the form of dividends are constantly rewarding their shareholders.  Dividend payments (especially increasing ones)  are a good sign that your company has a shareholder friendly management team.

3.  Buffer In Bear Markets – Dividend paying stocks tend to outperform non-payers even more during bear markets.  The reason for this is because as the price of a stock falls, it’s dividend yield increases. This effectively increases the stock’s attractiveness to investors.  For example, a $50 stock paying $2 per share in dividends yields 4%.  If the price of the stock falls to $40 than the stock is now yielding 5%.  During market selloffs there comes a point where investors looking for income will begin buying up shares in high yielding stocks.  As a result, dividend payers tend to fall less than non-dividend payers in bear markets.

4.  Dividend Growth – Many companies that pay dividends are the market leaders in their industries. This allows them to grow revenues and profits year after year.  As their profits grow, the amount of dividends they payout per share tend to increase as well.  Investors holding shares for many years benefit from this because the yield on their investment increases and compounds.  

For instance, let’s say you purchased 100 shares of Procter & Gamble (PG) at $61.25.  In the first year you would be paid $1.60 per share for a yield of 2.6%.  Now lets assume that over the next decade PG increases it’s dividend by 9% per year.  (PG is famous for increasing their dividend annually so this is reasonable).  In 10 years the dividend would have more than doubled to $3.79 per share and your investment would be yielding you more than 6% each year.  Keep in mind that this is only a simple example of the power of dividend growth.  Here’s another great example.

Begin Yielding Wealth

Now that you know the advantages of dividend investing, you can begin using it as part of your investing arsenal.  Start looking for companies with long histories of increasing their dividends.  Also make sure any company your buying into has the cash to keep paying it’s dividend in good times and bad.  You can ensure this by researching the stock’s dividend payout ratio.  

To get you started you may want to check out the S&P 500 Dividend Aristocrats.  These are the top dividend paying stocks that have increased their dividends annually for the past 25 years.  As for my recommendations, I personally own the following dividend payers… Diageo (DEO), Philip Morris International (PM), Heinz (HNZ), Procter & Gamble (PG), and Nike (NKE).  As always, remember to do your own research before investing.