The case for dividend investing
Dividend investing – particularly dividend growth investing – is the
process of creating a diversified portfolio of ETFs whose underlying
companies have the ability to pay and grow their dividend over the long
haul. Dividend growth is often an indicator of well-managed companies that
have the proven ability to generate reliable earnings.
Over the past 30 years or so, reinvested dividends have contributed nearly
35% to the S&P/TSX Composite Total Return Index, representing, on
average, an additional 2.7% of returns per year.
Growth vs. Yield
While some investors may be lured by a stock’s dividend yield, it’s
important to realize that much of the power of dividend investing derives
from compounding and reinvesting dividends. Consequently, it’s important
for investors to identify companies that are financially stable and able to
consistently grow their dividend payments from future profits. As Figure 1
illustrates, dividend-paying equities – especially dividend growers – have
vastly outperformed their non-dividend-paying peers.
The power of compounding
Companies with consistent dividend growth are especially appealing to
investors. Consider the following numbers: If you invest in a stock that
pays $1 in dividends annually and costs $25 per share, it means it yields
4% at the time of purchase. If the company increases its dividend 10 cents
every year, in 10 years that same stock you bought for $25 will be paying
out $2 in dividends, a much improved 8% yield on your initial $25 purchase.
And those numbers get even better when you reinvest those dividends to
purchase additional shares.
With bond yields at historic lows after 2008, investors began searching for
higher income yields on the equity side of the equation, (i.e.,
dividend-paying equities). Now that rates are finally rising, dividend
stocks are coming under pressure as an income alternative. Despite this
rising-rate environment, dividend-growth investing remains attractive for a
number of reasons.
With the S&P 500 recently marking its longest bull run in history this
past August, North American equity markets show few signs of weakness.
Because many of the dividend growers are companies that benefit from higher
global growth, they are able to return profit to investors through
increased dividend payments. Therefore, the outlook for dividends should
remain strong. Additionally, dividend growers tend to be more stable
companies, so dividend ETFs can potentially provide a measure of downside
protection during periods of market instability.
Finally, while interest rates have been on an upward trajectory in 2018,
the U.S. 10-year bond yield has now stabilized below the 3% threshold.
Unless bond yields climb significantly, dividend-growing companies (and
dividend ETFs) continue to be an attractive yield source for investors and
Mark Brisley is Managing Director and Head of Dynamic Funds, one of
Canada’s largest asset management companies. With over 25 years of
industry experience, Mark is responsible for the firm’s strategic
execution, day-to-day business operations and business development.
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