The dividend investing technique is definitely something you've heard about. It entails purchasing stock in firms that provide consistent, high-quality dividends, then letting the stock sit until you wish to acquire more.
What is a dividend growth strategy, and how does it work? Dividend growth investing is appropriate for a dividend-paying firm that grows year over year, covers its expenses, and generates more excellent cash flow than the previous year consistently. Due to their continued expansion, these companies typically gradually boost their dividends to shareholders.
Sub-Strategies for Dividend Growth Investing
Though each practitioner's tactics vary, the dividend growth approach often entails a combination of the following:
- Invest in solid firms that boost their dividends at a rate equivalent to or substantially higher than inflation each year.
- Holding positions for a long time (sometimes decades) to benefit from deferred taxes permits more capital to work for you and more dividends to be paid to your family.
- Diversifying among industries and sectors to ensure that your income stream isn't overly reliant on a single economic sector
- Ensure that dividend growth is fueled by increased levels of actual underlying earnings rather than debt.
- Having a diverse portfolio of equities from other countries allows you to receive dividends in multiple currencies, reducing your dependency on a single government.
Look at Swiss food giant Nestle, which has grown its cash dividend over the last few decades, if you need a visual representation of a successful dividend growth stock
. An investor who never bought another share of stock after the first was granted ever-increasing quantities of money from their portion of the coffee, tea, chocolate, and other products sold in practically every country has been paid ever-increasing sums of money.
Going for the Biggest Stream of Net Present Value Dividends
The total value of an asset in the future, discounted to the present value of a currency, is known as the net present value. This is founded on the notion that the money you have now will be more valuable in the future.
Assume you have the option of purchasing one of two stocks. Which do you think would be better for your investment portfolio
- The dividend yield for Stock A is 3.00 percent. The dividend has consistently been increased by 5% annually by the board of directors, and the dividend payout ratio is currently at 60%.
- The dividend yield for Stock B is 0.50 percent. The company is expanding at a breakneck pace, with 20 percent increases in diluted earnings per share (EPS) not uncommon during the last five years. Almost often, the dividend is increased as a result. The current dividend payout ratio for the stock is 10%.
If all other factors are equal, you'll probably choose Stock B if you follow the dividend growth investment approach. It may sound counterintuitive, but holding it will result in you receiving greater aggregate dividend checks than if you owned Stock A. This is because Stock A has a tremendous net present value, which means you'll have more money to work
in the long run.
This will be true if the growth can be sustained for an extended period of time. Your yield-on-cost (dividend to the price paid) begins to overtake the slower-growing company as earnings rise and the dividend increases with profits.
The yield-on-cost ratio compares how much you bought for stock to how much you get back in dividends. It's a metric useful to a single investor but not too many others.
When the primary firm reaches its total capacity, much of the surplus created each year will be unable to be effectively reinvested. A shareholder-friendly management team will return the excess cash
to shareholders through dividends or stock buybacks when that time comes.
McDonald's and Walmart, for example, have provided great case studies in the past. The dividend yields were not extremely high in the early years when these companies marched throughout the United States
(and later, the world). However, if you had purchased the stock, you would have received a sizable dividend yield on your cost basis within 5-8 years, depending on the time period.
Growth Is Indicative of a Healthy Operating Environment
Which circumstance would allow you to sleep better at night: owning a firm that pays a reduced dividend today but has rising sales and profits each year or owning a company that pays a considerable dividend today but has a slow, probably significant, decrease in its primary business? If you believe that a successful business requires some additional security, you might want to try this investing method
This strategy has a lot of merits. The board of directors in the United States, in particular, are unwilling to boost the dividend if they feel they will have to cut it later. As a result, a raised dividend rate on a per-share basis is frequently interpreted as a vote of confidence from those with the most intimate knowledge of the income statement and balance sheet.
Even accomplished men and women who are qualified enough to be voted to such a high post are susceptible to self-deception when it serves their interests. However, it is a reliable indicator in the majority of cases.
Maintain as much passive income as possible.
Dividend growth stocks produce considerably more passive income
than many comparable financial products, allowing you to keep more money in your pocket. This is the case because qualified dividends are taxed at a lower capital gains
rate than ordinary dividends, which are taxed as ordinary income.
Shares of stock maintained in regular, taxable brokerage accounts
, on the other hand, have a stepped-up cost basis when you die and pass them to your heirs. That implies that if you bought $10,000 worth of Starbucks at its IPO and watched it grow to $750,000, your heirs will receive the inheritance tax-free (as long as you stay under the estate tax thresholds), and the federal and state governments will let them believe they paid $750,000 for it. That implies they'd owe no capital gains taxes if they sold it today for $750,000.
Frequently Asked Questions (FAQs)
When should you sell dividend growth investments?
Dividend growth investments should be among your longest-held investments, but this is a personal question that depends on your approach and goals. Rather than a one-time boost in stock price, dividend growth investment focuses on a continual source of passive income. There's no reason to sell if there's nothing wrong with the core firm and the dividend is growing. Some people sell when their investment approach changes, such as going through a significant life event.
How much yield should investors look for when it comes to dividend growth equities?
Comparing firms to a dividend stock ETF may make the most sense if you're using a dividend growth plan. You can compare the yields of similar assets to see how much return to expect from your investment
. For example, if a dividend ETF yields 2%, you might want to hunt for firms that pay a dividend yield of at least 2%.