Investing in a stock means you have bought a small piece of ownership of that business. Dividend stocks differ from normal stocks in that they pay you for owning them. When a company elects to pay dividends, they are giving a portion of company profits to the owners.
Stocks that reward their owners with actual cash payments (in the form of dividends) have outperformed stocks that do not pay dividends. From January 31st 1972 through December of 2012, dividend stocks averaged 8.8% a year returns. Non-dividend paying stocks averaged 1.6% a year returns.
Source: Ned Davis Research & Chase Investment Insights, page 4
The complete guide to dividend stocks will explain why dividend stocks make excellent investments, how to find dividend stocks, and what perils to avoid. This guide is for you if you are looking to upgrade your investing strategy through dividend stocks.
Dividends Matter
Don't let anyone tell you dividends don't matter. They are wrong. As mentioned above, dividend stocks have returned 8.8% a year on average versus 1.6% a year for non dividend paying stocks over a 40 year period. This is not a fluke. About 42% of total returns have come from dividends alone since the 1920's. The fact that dividends have accounted for about 42% of total returns since the 1920's shows just how important a factor dividends are in your investing plan.
Source: Ned Davis Research, Business Insider
Dividend stocks and dividend investing are important considerations for any investment plan. We know that:
By focusing on dividend stocks, you are giving yourself the greatest chance to compound your wealth through investing. Ignoring the evidence of outperformance of dividend stocks is a costly mistake that individual investors should avoid.
Dividend Stock Investing Philosophy
The underlying philosophy of dividend stock investing is that a stock's value is the sum of its discounted future dividend payments. This makes intuitive sense. The value of any asset is the total of its expected future cash flows, discounted back to present value with an appropriate discount rate. There is no reason stocks should be any different.
Dividend stock investors aim to focus on what they can control; investing in stocks that reliably pay dividends. Stock prices are volatile; dividend payments much less so. By focusing on the income you receive from your investments rather than the price of stocks, you can minimize the anxiety that comes with falling stock prices.
Dividend stocks are like fruit trees. As they grow through time, they produce more fruit (dividends). You can either plant the fruit to grow more trees (reinvest dividends into other dividend stocks) or eat the fruit to live on (use dividend income to cover living expenses). Sticking with the tree metaphor, the following Warren Buffett quote discusses the importance of long-term thinking in investing:
“Someone is sitting in the shade today because someone planted a tree a long time ago” – Warren Buffett
Understanding Terminology: Dividend Yield & Payout Ratio
The dividend yield is simply the annualized dividend payment divided by the current share price. If a stock paid $3 a year in dividends and had a stock price of $100 it would have a dividend yield of 3.00%:
Here's the math: $3 / $100 = 3.00%
The dividend yield tells you how much return on your investment from dividends you can expect to make. The highest yielding stock in the S&P 500 is Transocean (Ticker: RIG) with a dividend yield of 18.40%. The lowest yielding stock in the S&P 500 (that pays a dividend) is Cigna Corporation (Ticker: CIG) with a dividend yield of just 0.04%. The current median dividend yield in the S&P 500 is around 2%. A range of 0% to 5% is around the ‘normal' range for dividend paying stocks. If a stock has a much higher yield than 5%, it is likely a high-risk situation (stock price falls due to risk, driving up the dividend). Dividend stocks with extremely high dividend yields are likely at risk of cutting their dividend payments.
