Power of Dividends

There are  many reasons to focus on dividend stocks and dividend yield and perhaps the most compelling is that after you have created a portfolio of dividend stocks you no longer have to really care about the stock price. All you really care about is that you receive the dividends at a regular basis (cash flow) and that the dividends continue to grow.

Naturally there is always the option to sell the stock but ideally the objective should be to hold the stock for a very long time.

The key advantages behind investing in Dividend stock are:

  • Peace of mind
  • Minimal effort
  • Limits trading fees and tax to a minimum

Dividend growth vs. Dividend yield

For the long term investor maximizing the portfolios current yield is not as attractive as securing that you set up a portfolio of companies which consistently increases the dividends and thus the income. The 5 and 10 year Dividend Growth Rates are key to look at as well as YoC (Yield on Cost) at for example 5 years to get an understanding of how the companys dividends have developed in the past. What the YoC at 5 years tells you is the yield you would have now if you invested 5 years ago.

Example

If you compare three different stock (A-C) and find that stock A has a high dividend yield (4%) but typically does not increase its dividends whereas company C pays a low dividend of 2% but in return has a history of increasing dividends by 10% every year the table below gives an indication of what it will mean if those dividend growth rates are maintained over a longer period of time. For the long term dividend investor Stock C is the clear winner.

Dividend % Div. growth rate 5-year YOC 10-year YOC 20-year YOC
Stock A 4% 1% 4,2% 4,4% 4,9%
Stock B 3% 5% 3,8% 4,9% 7,3%
Stock C 2% 10% 3,2% 5,2% 13,7%

Selecting stocks with a history of consistently increasing dividends by 10% or more annually is a good starting point; given that the dividedn pay-out ratio stays at a reasonable level.

Dividend reinvesting

Reinvesting the dividends adds significantly to the long-term outcome. The math behind this is very simple, but still escapes many investors.