In this article, we discuss 25 things every dividend investor should know. If you want to read further about dividend investing, go directly to have a look at 10 Things Every Dividend Investor Should Know.
Dividend investing is an investment strategy that focuses on investing in companies that pay dividends to their shareholders. Dividends are a portion of a company's profits that are distributed to its shareholders in the form of cash payments or additional shares of stock. One of the main goals for dividend investing is to generate stable income for shareholders and to benefit from potential long-term capital appreciation of the stock.
When investing in dividend stocks, investors often pay attention to companies that have raised their payouts over the long haul. Moreover, these companies perform better during periods of economic downturns because of their stable cash flows and solid balance sheets. Chevron Corporation (NYSE:CVX), Medtronic plc (NYSE:MDT), NextEra Energy, Inc. (NYSE:NEE), and The Sherwin-Williams Company (NYSE:SHW) are some companies that have rewarded shareholders with decades-long dividend growth.
Though dividend investing can be a conservative approach, it can help investors create long-term wealth if done properly. For this reason, we have compiled a list of 25 things every dividend investor should know.
25 Things Every Dividend Investor Should Know
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25. The Significance of Dividends to Total Returns:
Dividends have significantly contributed to market returns over the years. According to a report by Hartford Funds, dividend income has accounted for 41% of the S&P 500's total return on average from 1930 to 2022. The report also highlighted that from 2000 to 2009, the S&P 500 delivered a negative return to shareholders mainly due to the dot-com bubble burst in March 2000. However, dividends provided a 1.8% annualized return during this decade.
24. Dividend Stocks Have Outperformed Non-Dividend Stocks Over the Long-Term:
Dividend stocks have delivered a solid performance in the past, outperforming their non-dividend counterparts in terms of total returns. Hartford Funds reported that dividend payers delivered an average annual return of 9.18% from 1973 to 2022, compared with a negative 0.60% return of the non-dividend payers. During the same period, the S&P 500 index returned 7.68%.
Last year's continuous interest rate hikes and growing inflation caused the stock market to report its worst year since the Global Financial Crisis of 2008. The S&P 500 declined by over 18% in 2022, compared with a less harsh drop of 7.6% in the S&P 500 Dividend Payers. During the year, the S&P 500 Non-Dividend Payers fell by 21.1%, significantly underperforming dividend stocks.
Another report by Fidelity Investments revealed that the performance of dividend cutters and eliminators was not up to par historically. These securities underperformed the market by 20% to 25% during the year leading up to the cut.
23. Dividend Stocks Can Provide a Hedge Against Inflation:
Dividend stocks are defensive in nature and can provide a hedge against inflation. Dividend payments from companies tend to increase over time and can potentially keep pace with rising prices. According to a report by Fidelity Investments, dividends represented over 54% of the market's returns during decades when inflation was high. The report further mentioned that during the 1940s, 1960s, and 1970s, dividends represented 67%, 44%, and 73% of the market's returns, respectively. During these decades, inflation averaged above 5% and total returns were lower than 10%.
22. Dividend Stocks Have Outpaced Inflation Over the Years:
Not only did dividend stocks deliver solid returns during high inflationary periods, but the dividend growth of the companies also outpaced inflation over the years. From 1971 to 2021, dividends paid by companies in the US have grown by 3.7% per year, compared with a 2% growth in inflation per year, as reported by BlackRock. Another report by Wisdom Tree also highlighted the strong performance of dividends relative to inflation. The report mentioned that the S&P 500 dividends have grown by 5.73% from 1957 to 2022, compared with a 3.68% growth in inflation during the same period.
This suggests that dividend payments have grown at a faster pace than inflation, which can help to maintain the purchasing power of the income generated by dividend-paying stocks. The Vanguard Group, an American investment management company, also reported that the US dividend growth has surpassed inflation by five percentage points over the 20 years ending October 30, 2022, and by 2.1 percentage points over 100 years.
21. Dividend Stocks are Less Volatile than Non-dividend Stocks:
Dividend stocks are comparatively less volatile than other equity investments. When investors receive a dividend payment from a company, it provides a positive return on their investment, regardless of whether the stock price is rising or falling. This can help to reduce the overall volatility of the investment, as the dividend payment can offset any decline in the stock price. According to a report by Wisdom Tree, in the last 64 years, dividend levels declined in only six of those years, whereas stock prices fell in 18 of those years in comparison. The report mentioned that stock prices were over two times more volatile than their underlying dividend cash flows.
20. The Payout Ratio is an Important Metric to Consider in Dividend Investing:
The dividend payout ratio is the percentage of a company's earnings that are paid out in dividends. A high payout ratio may indicate that a company is paying out more than it can afford, while a low payout ratio may indicate that a company is retaining more earnings for future growth. According to analysts, the dividend payout ratio of between 35% to 55% is considered healthy as it shows that the company has enough money left over to reinvest for growth.
Hartford Funds analyzed the dividend payout ratio of dividend stocks within the Russell 1000 by dividing them into five quintiles. The study found that companies paying the highest level of dividends have not performed well as those with moderate payouts and yields. This group of dividends had an average payout ratio of 40% from 1979 to 2022 and also beat the market by 78% during the same period.
19. High-Yield Dividend Stocks Can be More Volatile:
High-yield dividend stocks can be more volatile as these stocks may be more sensitive to changes in interest rates and market conditions, which can impact the value of the stock. According to a report by AllianceBernstein, the MSCI USA High Dividend Yield Index Index, and the FTSE High Dividend Yield Index underperformed the broader market in over seven of the last ten years through 2021.
According to analysts, dividend yields between 3% to 6% are considered healthy as they can provide a reasonable level of income for investors. However, it is not the same with all high-yield dividend stocks. For instance, in some industries, such as utilities and real estate investment trusts (REITs), higher dividend yields may be more common and considered healthy due to the nature of the business model and the need to generate consistent income for shareholders. Investors should always look for the respective company's business model and dividend sustainability to make investment decisions. For example, companies like Altria Group, Inc. (NYSE:MO), Verizon Communications Inc. (NYSE:VZ), Telephone and Data Systems, Inc. (NYSE:TDS), and British American Tobacco p.l.c. (NYSE:BTI) have above-average dividend yields but also possess strong dividend histories and solid balance sheets.
The S&P High Yield Dividend Aristocrats tracks the performance of companies with over 20 years of consecutive dividend growth and had an average yield of 3.5% from December 31, 1999, to December 31, 2018. The index generated a total return of 590.3% from December 1999 to June 2019, with dividends accounting for 57% of the total returns, according to a report by S&P Global. During the same period, the S&P Composite 1500 delivered a total return of 215.2%.
18. An Elite Group of Dividend Aristocrats:
Dividend Aristocrats are the companies in the S&P 500 that have increased their dividend payouts to shareholders for at least 25 consecutive years. Chevron Corporation (NYSE:CVX), Medtronic plc (NYSE:MDT), NextEra Energy, Inc. (NYSE:NEE), and The Sherwin-Williams Company (NYSE:SHW) are some popular dividend aristocrats. These companies become top choices for investors because of their financial strength, stability, and commitment to returning value to shareholders. Moreover, these companies tend to perform better during periods of high inflation. This group of dividends outperformed other asset classes when inflation closed out with a 6.5% annual reading in 2022. The S&P 500 Dividend Aristocrats reported a 6.21% drop last year, compared with an 18.1% decline in the broader market.
Historical analysis of such stocks also shows their strong performance over other asset classes. According to Merrill Edge, an American financial services company, the S&P 500 Dividend Aristocrats delivered an annual average return of 12.13% from 1990 through 2018, compared with a 9.96% return from the broader market during the same period.
17. Dividend Growth Rate is Crucial to Dividend Investing:
Yes, the dividend growth rate is a crucial factor in dividend investing, as it reflects a company's ability to increase its dividend payouts to shareholders over time. Companies that are able to consistently grow their dividend payments at a healthy rate are often considered to be strong and stable investments, as this indicates that they have a strong and growing cash flow and are committed to returning value to their shareholders. Chevron Corporation (NYSE:CVX), Medtronic plc (NYSE:MDT), NextEra Energy, Inc. (NYSE:NEE), and The Sherwin-Williams Company (NYSE:SHW) are favored by investors due to long dividend growth streaks.
Over the years, companies that have raised their dividends have delivered strong returns to shareholders in comparison with non-dividend payers and dividend cutters. According to a report by Washington Crossing Advisors, dividend growers and initiators delivered an annual average return of 11.6%from 1972 to 2014, compared with a 3.4% return of the dividend cutters during the same period. RMB Capital referred to data by Ned Davis Research and Hartford Funds and revealed that dividend growers returned 9.62% from 1972 to December 31, 2018, versus a negative 0.79% return of the dividend cutters. During this period, the S&P 500 delivered an annual average return of 7.30%, underperforming dividend growers.
Analysts always recommend investing in companies with strong dividend growth tracks as compared with high-yield dividend stocks. Nuveen reported that dividend growers with modest yields delivered a 26.8% return on equity in 2022, compared with a 20.4% return on stocks with yields above 3%. See our list of the 15 best large-cap dividend growth stocks to buy now.
16. Dividend Growers Usually Have Strong Cash Flow:
Strong cash flow is an important factor in dividend investing, as it enables companies to fund their dividend payments and continue to increase them over time. Dividend growers often have strong and growing cash flows. This is because companies that are able to increase their dividends are typically generating higher profits and cash flows, which allows them to return value to their shareholders through increased dividend payments. Some examples of dividend growers are Medtronic plc (NYSE:MDT), Chevron Corporation (NYSE:CVX), NextEra Energy, Inc. (NYSE:NEE), and The Sherwin-Williams Company (NYSE:SHW).
Analysts have given a positive outlook on dividend growth as cash on corporate balance sheets remains stable. According to Moody's Investor Services, US companies have at least $2 trillion in cash, with technology companies taking up a quarter of it. Companies that grow their dividends typically review their cash flows before paying dividends to ensure they have the financial resources to meet their obligations to shareholders, according to Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.
15. Dividend Capture Strategies:
A dividend capture strategy is an investment technique that involves buying a stock just before its ex-dividend date and selling it shortly after the dividend is paid. The goal of this strategy is to capture the dividend payment while minimizing exposure to the stock's price movements. The ex-dividend date is the day on which a stock begins trading without the dividend payment included in its price. Investors who own the stock on or before the ex-dividend date are entitled to receive the dividend payment.
14. Dividend Stocks Can Be Found Across a Variety of Sectors and Industries:
Dividend-paying stocks can be found across a variety of sectors, including but not limited to utilities, consumer staples, healthcare, financials, and technology. Companies from different sectors may have varying dividend policies, payout ratios, and growth rates, depending on their industry dynamics and business models. For example, utility companies are often viewed as stable dividend-paying stocks due to their predictable cash flows and regulated business models.
Similarly, energy companies also pay strong dividends to shareholders and have grown their dividends steadily in recent years. Morningstar reported that dividends in the energy sector have grown by 401% since 2018, compared with an 86% dividend growth in the rest of the US market. According to Bloomberg, five of the S&P 500's ten biggest dividend boosts came from the energy sector in 2022. Chevron Corporation (NYSE:CVX) and NextEra Energy, Inc. (NYSE:NEE) are some of the best dividend stocks from the energy sector.
13. Dividend-Focused Exchange-Traded Funds (ETFs) Are a Good Way to Build Diversified Portfolios:
Dividend ETFs typically invest in a diversified portfolio of stocks across various sectors and industries, providing investors with exposure to a broad range of companies and reducing the risk of concentrated exposure to a single stock or sector. Considering the current inflationary environment and consistent interest rate hikes, investors are also considering dividend ETFs. According to Wall Street Journal, there are nearly 180 dividend ETFs in the US with total assets amounting to over $384 billion. The report also mentioned that through April 14 this year, investors poured over $2.8 billion into dividend-focused ETFs.
12. Dividend Stocks Are Not Immune to Market Downturns:
Dividends are not completely immune to market downturns, as companies may experience declines in earnings and cash flows during economic recessions or periods of market volatility. In such environments, companies may face pressure to cut or suspend their dividends to preserve cash and maintain financial stability. The most recent example of such a phenomenon was seen during the recent pandemic of 2020. During the year, nearly 190 US-listed companies stopped paying dividends and 33% of them hadn't restored their dividends, as of December 31, 2022. Moreover, dividend cuts and suspensions amounted to over $220 billion between the second and fourth quarters of 2020, CNBC posted.
11. Dividend Stocks Can Outperform the Market During Fed Rate Hikes:
Dividend stocks have exhibited strong performance in high-interest rate periods. According to Global X, half of the high-dividend stocks' returns came from dividend payments in periods with high-interest rates from January 1960 to December 2017. During the same period, high-dividend stock portfolios delivered an annual average return of 13.02%, compared with a 10% return of the S&P 500. Moreover, high-dividend stocks outperformed the market in seven out of ten rising interest rate periods during these years.
Another report by Forbes also highlighted that dividends remained crucial to overall market return in the past. The report mentioned that since 1971, the S&P 500 delivered an annual average return of 7.58%,
