When you think about a stock's performance, you probably think about how much the stock price has gone up or down. But performance is really total return, which is price increase as well as income. And income from a stock is the dividend that the stock pays back to you. There's an old saying about why it is wise to invest in dividend-paying stocks: "They pay you while you wait." Dividends are obviously an important consideration for individuals who need income, but they should also be in the minds of investors seeking to preserve and grow their capital.
Basically defined, a dividend is a periodic payment from a company's earnings to its stockholders. Most dividends are paid in cash four times a year, and they must be voted on by the company's board of directors before each payment. Dividends can be increased, decreased, or cancelled, depending upon the company's profits. The amount of the dividend you receive is equal to the proportional share of the stock you own in the company.
A company's dividend record is an indicator of that company's past and potential future strength. A company with a dividend history, therefore, generally also has a positive earnings history. Choosing to invest in a company that grows its earnings and its dividends on a consistent basis is a smart way to ensure long-term performance and a good night's sleep, since a dividend increase is a sign of confidence by management. Dividends can also help a portfolio appreciate in a period of declining interest rates.
Unfortunately, a common casualty of industry deregulation is the dividend. But a dividend that is maintained or that grows will provide a meaningful contribution over time. That's something to remember when everyone is chasing growth stocks.
Consider, for example, how far technology stocks fell from their peaks in 2000. Technology stocks are notorious for not paying dividends. But if they had been yielding even as little as one percent at their peak, would they have declined as much as they subsequently did? Probably not. In a low interest rate environment, a stock yielding 1% is unlikely to lose 80% of its value because it would then be yielding 5% and would be attractive for its income. But a number of tech stocks did, indeed, lose 80% or more of their values with frightening ease - partly because they had no yield support. People who are kicking themselves now about having invested in certain money-losing dot-coms could have potentially avoided their errors if they had been more focused on dividend-producing companies.
Dividend-yielding stocks also give you the advantage of being able to reinvest those dividends to buy additional shares of stock in the company. Dividend reinvestment plans, or DRIPs, are automatic, easy ways to increase your investment. DRIPs are offered by companies to their shareholders as a way to buy stock directly from the company. The plans reinvest all or partial dividends paid into more stock. The advantages of such a plan are numerous, with the most obvious being that you don't need a large amount of money to start. You can take advantage of dividend reinvestment with as little as one share of stock. Most companies allow investors to purchase additional shares through a DRIP for nominal fees, or often for no fee at all. DRIPs are gaining in popularity, with more investors searching for consistent, long-term performance.
A consistent, dividend-yielding stock may be a wise choice for today's investor, especially in a company offering a dividend reinvestment plan. Dividend reinvestment plans force investors to buy stock on a regular basis and to hold on to that stock. As a result, investors adopt a long-term horizon and often invest small amounts of money on a regular basis. And that is a strategy that almost always pays off.
Updated: January 1, 2013
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
© 2013 Wilmington Trust Corporation.