The value of dividends
Building a portfolio around dividends boosts earnings. The reason, in short, is three-fold. First, dividends put more money in your pocket. As a shareholder of a dividend paying company, you’re entitled to these regular payments that supplement your investment returns. Second, companies that pay dividends are healthy and with strong long-term prospects.
Their strong balance sheets are the very reason they’re able to afford such payments. Third, many investors wisely choose to set these dividends to reinvest automatically. The result of the decision is a dollar cost averaging effect in which the purchasing of additional shares occurs at the highs and lows. Ultimately, this prevents the problem of investing at high prices only to suffer greatly during a downturn.
Dividends are so valuable that entire strategies have emerged to capitalize on them. The most popular of these is the “Dogs of the Dow” approach. The idea is simple: Invest in the ten highest dividend-paying stocks within the Dow Jones Industrial Average (DJIA). The appeal of the concept is that you’re rewarded with better dividends while also embracing companies that are priced lower and poised for a rebound.
This belief stems from an expectation that all companies in the DJIA are solid long-term investments and a higher dividend is a means of attracting investors to a lagging stock that still has excellent upside potential. The results are encouraging. From 1957 to 2003 the strategy outperformed the Dow by approximately 3% delivering an average annual return of 14.3%.
Other, more speculative investors sometimes use a “Dividend Capture” strategy. The idea is to hold a stock for the minimum amount of time necessary to earn the dividend. Once the investor has the dividend in hand, they simply sell the security and immediately invest in another stock scheduled to pay a dividend. By repeating this process the investor, in theory, can earn dividends on an almost daily basis. Again, this is speculative and presents challenges like capital gains tax and excessive brokerage fees.
Dividends have an incredible magnifying effect on returns. Over the ten years spanning 2005 to 2015 the DJIA rose nearly 65%. However, when you include the added value of the regular dividend payments, the true growth amounts to 114%.
Choosing dividend-paying stocks is wise not only for the value of the payment but because of what the dividend represents: a sound company. Historically, non-dividend paying companies display greater volatility compared to their dividend paying brethren.
Finally, a dividend is often a sign of a company’s ability to thrive. Case in point: between 1927-2014 dividend paying stocks delivered returns of 10.4% annually while the non-dividend paying equities returned only 8.5%.
A critical time for dividends
In recent month the U.S. Federal Reserve has signaled their intention to continue raising rates. These policies create a strong climate for dividend-paying companies. Researchers examining an 88-year period ending in July of 2015 discovered that high-dividend stocks outperformed the total market by 2.4% annually. The opposite effect can occur during periods of decreasing rates according to the researchers. However, the current conditions in the U.S. market all but guarantee several rate increases in 2017 alone.
Given all the data and research supporting the value of dividends, it is no surprise that some of the most successful managers and hedge funds employ a strategy to capitalize on these payments. Delve deeper in KINFO analytics to see how the pros use the strategy to outperform the market and compound their aggressive returns.