Dividend stock investment has been widely regarded as a means to generate income during retirement. But it's not just an investment to prepare for retirement. Dividend investing creates an opportunity to reinvest in assets that have fallen in price because they generate a certain amount of return on the operation of the portfolio.
The same compounding rate applies when reinvesting dividends. Of course, as money moves from business to shareholders, taxes create frictional costs. However, the more shares you hold, the greater the dividend, so it is good to keep collecting. Dividend stock investment is compounded not only for the difference in stock price but also for additional dividend income, so the longer the investment period, the higher the yield.
When investing in dividend stocks, many investors make the mistake of investing only by looking at the dividend yield. Dividend stock investment, like common stock investment, investors must determine the business growth and safety of a company. The best dividend stock investment is that dividends grow as the company grows.
What is dividend?
Dividends are cash or stocks that are paid out quarterly or annually to shareholders of a company's profits. Dividends can be used to predict the growth potential of the company. Companies that are still in the early stages of business do not have enough dividend capacity to reinvest profits for business expansion. Firms with mature business do not have much room for business expansion, so they pay their profits as dividends for shareholder value.
Dividends are not fixed like interest on bonds. Dividends are set annually according to the decision of the board of directors. If business operations are difficult, dividends may be reduced or stopped at any time at the decision of the directors.
Dividend stock investment
Dividends are not a fixed amount, but investors can use them as a source of income. Different companies have different payout dates, so retirees can organize their portfolios so that dividends come in every month instead of their monthly salary. Young investors have an advantage in reinvesting dividends into their portfolio unless immediate cash flow is required.
Dividend stocks can earn higher returns than bonds when interest rates are low like now. If the stock price falls, the dividend can offset the loss. You can also get higher dividend returns by reinvesting dividend stocks at lower prices.
Reasons for the company's dividend payment
Adequate dividend payments are an indication of a good company's financial position. Companies can attract shareholders with dividends to support the stock price. In general, companies reinvest their operating expenses and business and allocate the remaining profits. That is why companies with mature businesses have a high payout ratio.
Companies that do not pay dividends
In the case of a fast-growing start-up, you may not be able to afford to pay dividends as you reinvest all the profits of the company into your business. Investors who want the company to grow can be more delighted as the company's profits are not wasted in taxes. In this case, dividends are not paid, but the stock price rises as the long-term corporate performance rises.
Firms with mature business may also stop paying dividends. This is the case when entering into a new business with higher added value or when the economic feasibility of an existing business declines. The former case is a good reason to increase the company's stock, while the latter may be the time to sell stock. You should check if your financial soundness is deteriorating or if your overall profitability is falling.
Check dividend payout ratio and dividend growth rate
When judging dividend stocks, you must check your dividend payout ratio. Dividend payout ratio is the share of dividends in a company's net profit. Dividend payout ratio helps determine how sustainable a company's dividend policy is. Companies with too high a dividend payout may struggle to expand their business and make it difficult to pay that level of dividends in the future. A company with a moderate dividend payout ratio of 10 to 40% can get a higher return on long-term investments for 10 to 20 years. With this dividend payout ratio, the dividend yield is 1~3%.
The most suitable dividend payout ratio is the amount of surplus profit remaining after the company has sufficiently reinvested profits in the business. When the company grows through successful reinvestment in the business, not only the dividend but also the stock price rises. You can get dividend yields that are significantly above the fixed interest rates paid on bonds.
To find companies with growing dividends, investors first look for companies whose dividends have doubled over the past 10 years. In this case, the dividend growth rate is about 7.2%. You should look for companies with a dividend growth rate that is at least above the 2-3% increase in inflation. That way, it will be a much more successful retirement investment than investing in an pension that only hedges inflation.
After that, we look for companies with steadily increasing dividends every year. At least there should be no dividend cuts. Investors must determine whether the company thus identified can afford to pay dividends in the future and can grow. You need to understand your business structure and invest in a clear prospect. These companies often have a dominant market share and high barriers to entry. In addition, in the case of a business that requires too much debt, it is difficult to pay stable dividends as profitability is affected by interest rates. Companies that do this business should be avoided.
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