The following is a guest post by Al Ramsay of Dividend Stocks Online.
If you’re wondering where to invest, the stock market is offering many compelling reasons to consider dividend stocks.
25 years ago, dividend investing was considered a fundamental part of every investor’s portfolio. Investors received a portion of a corporation’s profit as a “dividend” (or return) on their investment. Companies that paid a dividend were financially stable “widow-and-orphan” investments.
But then came the bubble years. And double-digit gains became common. In fact, it wasn’t uncommon to see share prices double, even triple, seemingly overnight. An article in iStockAnalyst sums up the mood of investors. “In the late 1990s investors forgot about fundamentals and bid up stock prices to unsustainable levels … investors were betting that earnings would keep increasing at a faster rate over the future. ”
We know how that story ended, and many investors are still struggling with portfolios that have lost significant value. This has brought dividend stocks back into focus. Dividend stocks provide a healthy yield per share that can help grow or rebuild a portfolio. Rather than being a flight to safety (high yield stocks still contain some risk), the dividend investor should consider these stocks to be a flight to quality.
But are dividend stocks right for you? Here are three key reasons why you should consider adding dividend stocks to your investment portfolio.
Dividends indicate strength and stability
The stock market meltdown of 2008 put a renewed emphasis on the importance of fundamentals. Companies that issue dividends have balance sheets that show real profits and manageable levels of debt.
Issuing a dividend enhances a company’s transparency. Companies that run their business to maximize cash generation can keep a positive free cash flow to cover dividend payments even when earnings are down.
Second, although a dividend may be raised or lowered after earnings are reported, history has shown that once companies begin to issue dividends, they are very reluctant to stop issuing them. For example, AT&T has increased their quarterly dividend for 26 consecutive years. Dividends also make a strong statement about how the management of the company feels about future earnings ability.
Dividends provide a source of steady income
As stocks that pay dividends are becoming more popular their yields are the best in years. Yield is calculated by dividing the company’s annual dividend payment by the cost of a share (i.e. a dividend of $1 per share with a share price of $33).
And with the Federal Reserve keeping interest rates at or near 0%, dividends are a better alternative than most other “fixed income” investments. The yield on a 10-Year Treasury bond, for example, is currently less than 3%. Whereas many dividend stocks are producing yields of 4% or more.
If you’re nearing retirement, these high yields can make dividend stocks an attractive way to supplement your income.
But yield is only one reason to consider dividend stocks. Investors who don’t need the income from their dividends today need to consider the total return they can receive by reinvesting their dividends. The concept is pretty straightforward, you use the dividend you receive to buy more shares of the company, which in turn provides you with more dividend income.
Why does this work? That leads to our last point.
Dividends are a defense against volatile markets.
Many studies show that dividends have accounted for approximately 40% of the total stock returns over the past 80 years. With the performance, or lack thereof, of the stock market over the past 10 years, that’s enough of a reason to consider dividend stocks.
But the real beauty of dividend investing is that it works regardless of which way the market moves. That’s because a cash dividend payment is always positive. In fact, in bad times dividend growth should be higher than earnings growth.
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