When it comes to investing, knowing your risk tolerance is key to success. It will allow you to decide if you want to go for high-risk and higher rewards, or to go slow and steady with your money. For those who want to slowly build their wealth over time without too much risk, then the dividend growth strategy might be for you.
Many investors tend to think that dividend-paying companies are boring, low-return investment opportunities. There is some truth to this as such companies can’t compare to the high-flying and more volatile investments. However, the combination of a consistent dividend with an increasing stock price can offer an earnings potential great enough to excite those who have the patience for it.
While this strategy is neither better or worse than other investment options, it can still have a place in an investor’s portfolio. This will depend on your financial goals and risk tolerance.
What is a dividend?
A dividend is a sum of money that is paid regularly by a company to its shareholders, usually from its own profits. In general, dividend amounts and frequency tend to vary greatly based on a company’ profitability and other board decisions.
Companies can issue dividends in different forms. For example, there can be cash dividends, property dividends, and special one-time dividends. Dividends offer great flexibility to investors as they provide an income stream that is separate from an asset’s capital appreciation. As such, they can be very enticing for income-focused investors.
Dividend payments are divided into either ordinary dividends or qualified dividends, each of which comes with different tax treatments. Ordinary dividends are considered income by the government. The taxation of dividends in Malaysia is subject to a single-tier system. This means the income is taxed once at the corporate level only. The dividend payments received by shareholders from companies under this system are not subject to tax.
What is dividend growth investing?
Dividend growth investing is a long-term investment strategy. It mainly focuses on buying shares in companies that are well known for regularly increasing their dividends. The main appeal of this type of strategy is that it offers the potential for a consistent and growing income stream over a long period of time. This is particularly helpful for investors who are seeking to supplement their regular income, especially all the way to retirement.
For example, Forbes recently named Texas Instruments Inc. as one of the best companies to hold dividend shares right now. Once known for their calculators, the company has since entered the semiconductor market and has seen strong earnings growth with an expected 10% yearly earnings per share growth over the next five years. The company has also steadily raised its dividend amount, averaging 14.9% yearly increases over the last five years.
However, keep in mind that like any other investment strategy, dividend growth investing is not foolproof. While it is generally a less risky venture, there are several intricacies that you need to be aware of in order to be successful. You will need an understanding of dividends, the difference between dividend growth and dividend yield and how to calculate the dividend growth rate as the bare basics.
Dividend growth vs dividend yield
Dividend yield and dividend growth are two core concepts that every investor should know about if they plan on utilising this strategy. Dividend yield is basically the annual dividend income per share divided by the market price per share. This gives you a general idea of the income generated by every unit of cash invested in a company.
On the other hand, dividend growth refers to the annual rate at which the dividend amount increases. While high yields may be more attractive to most, a stable but growing dividend can result in higher income streams in the long run. For example, companies with high dividend yield may not sustain it forever, while companies with a history of growing dividends can provide increasing income over time.
|The annual rate at which the dividend amount increases.
|The annual dividend income per share divided by the market price per share.
|Lower returns but more stable.
|Often offers higher returns sooner.
|Less risky but plenty of capital growth potential.
|Risker but offers potential for larger income.
How to calculate dividend growth rates
As mentioned above, calculating the dividend growth rate is a key part in ensuring the success of this strategy. Simply divide the dividend that is declared in the current year by the dividend declared in the previous year.
For example, let us assume that a company’s dividend was RM1 last year and it’s RM1.05 this year. In this case, you can calculate the growth rate by subtracting 1.00 from 1.05 to get 0.05. Then, to express it as a percentage, you would then say that the dividend growth rate was 5%.
This rate will give investors a general idea of how rapidly the company’s dividends are increasing. High growth rates can indicate that a company has strong financial health and performance with a potential for even greater returns in the future.
Look for a history of strong dividend growth
There are several strategies for dividend growth investing. For one, you could try investing in what are known as dividend aristocrats. These are companies that have increased their dividend payouts for at least 25 consecutive years. Some examples include Amcor plc and 3M Company. This method can be a reliable way to gain an income stream as these companies tend to be industry leaders or pillars that have stood the test of time with stable earnings.
You could also focus your attention towards industries that have a history of strong dividend growth. These can include things such as utilities and consumer staples. These types of industries tend to be less impacted by economic downturns and disasters and provide good stability for your portfolio. Many businesses that were labelled “essential services” during the COVID pandemic a few years ago fall under this category.
It’s important to note that these strategies are not definitive and the best strategy will always depend on each individual’s own risk tolerance, financial goals, and investment personality.
Risks of dividend growth strategies
Like any other investment, dividend growth investing comes with its own share of risks. There are occasions where a company either cuts or eliminates their dividends. For example, earlier in 2023, Intel had cut its dividends by over 65%. Shareholders who usually received a dividend of $1.46 per share saw their payments drop to just 50 cents per share.
However, this issue can be solved somewhat easily by diversifying your investment portfolio across a number of sectors and companies. Having multiple income streams from dividends can mitigate such disasters in the future.
Overall, the dividend growth strategy is ideal for investors looking for a steady stream of income with a somewhat predictable and stable schedule. While there are still risks involved, it can be considered a low-risk venture and perfect for those with lower risk tolerance.