8 Reasons to go with Dividends

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.

Performance

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”.

Diverse Returns

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.

Valuation Competency

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.

Shareholder Friendly

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.

Company Diligence

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.

Simplicity

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.

Management Projection

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.

Retirement

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.

Further Reading:
What is a Dividend?
Dividends: An Investor’s Edge

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Comments

  1. RobberBaron says:

    Thanks for this. I think I would adjust the diversification element to acknowledge share buy-backs as a stream of revenue, sort-of. It does increase share values, sort-of, though it doesn’t put cash in share-holder hands.

  2. Go dividends! I like the simple list in the article. As a long time investor, I totally support your dividend focus. It gives an extra level of security in risky assets. Keep it up!
    (this one went in my post for tomorrow)

  3. the tinge i like about dividend stocks is you always make money even in down markets. i have 4 dividend stocks that reinvested buy 1 plus shares a quarter. duk,se,xom,pfe

  4. Great website! Thank goodness I found what I need. My goal is to buy and, hold , good dividend-growth stocks for my wife who currently does not work so as to have decent passive income when in retirement. She’s 46 years old and and has about $60,000.00 in an IRA at schwab. How can this website help me/us?
    Dr Leyva

  5. Hi luis,

    This website provides weekly stock analysis articles to give readers potential dividend investment ideas, in addition to education articles. You can also check out my recommended reading list of other dividend blogs on my right sidebar.

  6. Hi Dividend Monk. An excellent blog, and I agree with all your points here. The fact that dividends provide regular income, as well as potential capital appreciation is the real bonus. Once more people stop buying overpriced mutual funds, and start investing in big blue-chip companies that pay dividends, the sooner they can keep their own money working for them :) PS I’ve put a link to your site, keep up the good work.

  7. Ralph Kuhn says:

    Matt,
    I’m new to this site and so far I like what I’m reading. Now, at 73, I look for a shorter time line, meaning I want to concentrate more on dividends. Capitol appreciation would be the icing on the (stock) cake. This site has the clearest explanations with regards to dividends and education that I’ve read. Looking foward to the next e-mail.
    Ralph

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