Dividend growth investing as a long-term strategy (2024)

Investment and Asset Management

There’s no one way to invest.Every investment strategy offerspotential rewards and posescertain risks. The appropriatestrategy or strategies for youdepends on your personal goals,financial circ*mstances and risktolerance. However, one strategyworth considering is dividendgrowth investing — or investingin companies with a solid recordof paying regular, increasingdividends.

Although there are no guarantees,dividend-paying companies areoften viewed as more stable andless volatile than other companies.Stock prices generally fluctuate,often as a result of factors unrelatedto a company’s underlyingperformance. Dividend growth canbe a better way to determine acompany’s financial strength andfuture outlook.

Significant Contribution to Returns

When evaluating market returns,many investors focus exclusively onprice appreciation. But historically,dividends have been a significant component of total returns.

A recent study by Hartford Fundsexamined the impact of dividendson the S&P 500 Index from 1960through 2021. Over that period,the contribution of dividend incometo total returns averaged 40%.The study also revealed that 84%of the S&P 500’s total return overthe same period is attributableto “reinvested dividends and thepower of compounding.” Hartfordalso reported that, going back to1973, the stocks of companies thatconsistently grow their dividendsexhibited higher returns and lowervolatility than stocks of othercompanies.

Growth Vs. Yield

It’s important to understand thedifference between dividendgrowth and dividend yield. Yieldis the annual dividend per shareas a percentage of a stock’s priceper share. So, for example, if acompany’s annual dividend is $5 per share and its stock priceis $100, its dividend yield is 5%.Dividend growth, on the otherhand, measures the percentagechange in dividend payouts fromone year to the next. If a companypays a dividend of $5 per share inyear one and $5.50 in year two,dividend growth is 10%.

Dividend yield can be an importantmetric, but dividend growth usuallyis a better indicator of dividendtrends over time. Suppose, in theabove example, that the company’sstock price falls to $50 in yeartwo and that its dividend pershare drops to $3. In that case,the company’s dividend yieldactually increases to 6%, but itsdividend growth rate falls to –40%.Typically, companies that regularlyincrease dividends also regularlyincrease earnings.

Behind the Numbers

Healthy dividend growth canbe a good indicator of a stock’spotential. But there are noguarantees that dividends won’tbe cut or that stock prices won’tdrop in the near future. Ratherthan relying on dividend growthstatistics alone, it’s important tolook behind the numbers to assesswhether a companyhas a strong balancesheet, healthy cash flowand a managementteam that’s committedto maintaining dividendgrowth while reinvesting
in the company.According to Hartford,“Corporations thatconsistently growtheir dividends havehistorically exhibitedstrong fundamentals,solid business plans,and a deep commitmentto their shareholders.”

One useful metric inevaluating dividendgrowth potential is the payoutratio. This is the percentage ofa company’s net income that’spaid out in the form of dividends.A company with a high payoutratio — one that’s earning barelyenough to cover its dividendpayouts — may be vulnerable toeconomic or competitive pressuresdown the road.

Think Long Term

Dividend growth investing isn’t forthose looking for quick profits. It’sa long-term strategy that seeks toinvest in stable companies withconsistently increasing dividendsand to take advantage of thepower of compounding. And if you choose not to reinvestdividends, they can be anadditional source of income. For this reason, many retirees invest in dividend-paying stocks.

Like any investment strategy, there are risks associated withdividend growth investing,including the risk of losing youroriginal investment. But it can also be a valuable componentof a well-balanced, diversifiedinvestment portfolio.

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