Dividend growth investing focuses on buying stocks in companies that regularly increase their dividends. Unlike strategies that prioritize high-yield stocks, this approach emphasizes the growth of dividends over time. It’s important to note that this strategy isn’t inherently “better” than others, but may align best with an investor’s financial goals or risk tolerance. A financial advisor can help you identify income-producing investments, including dividend growth stocks.
What Is a Dividend?
A dividend is a sum of money paid regularly by a company to its shareholders out of its profits. Dividends vary broadly in their amount and frequency, often determined by factors like a company’s profitability and board decisions.
Companies may issue dividends in different forms. For example, there can be cash dividends, property dividends and special one-time dividends. Dividends are a significant part of investing as they provide an income stream that’s separate from an asset’s capital appreciation. Therefore, they can be especially attractive to income-focused investors.
These payments are classified either as ordinary dividends or qualified dividends, each with different tax treatment. Ordinary dividends are considered income, so they’re subject to regular income tax rates. Qualified dividends, on the other hand, are taxed at the more favorable long-term capital gains rates.
What Is Dividend Growth Investing?
Dividend growth investing is a long-term investment strategy that focuses on buying shares in companies known for regularly increasing their dividends. The main appeal of this strategy is the potential for a consistent and growing income stream, which can be particularly beneficial for investors seeking to supplement their income during retirement.
For example, Procter & Gamble has a long history of dividend growth. When the household product manufacturer raised its dividend in April 2023, it marked the 67th consecutive year that it’s increased its dividend. This consistent growth can result in a substantial income stream over time, often outperforming many high yield stocks.
However, like any investment strategy, dividend growth investing is not without its intricacies. It requires an understanding of dividends, the difference between dividend growth and dividend yield and how to calculate the dividend growth rate.
Dividend Growth vs. Dividend Yield
Dividend yield and dividend growth are two key concepts in income investing. Dividend yield is the annual dividend income per share divided by the market price per share. It gives you an idea of the income generated by every dollar invested in a company.
On the other hand, dividend growth refers to the annual rate at which the dividend amount increases. While a high yield can be attractive, a growing dividend can lead to a higher income stream in the long run. For instance, companies with a high dividend yield may not sustain it, while companies with a history of growing dividends can provide increasing income over time.
How to Calculate the Dividend Growth Rate
Calculating the dividend growth rate is essential for this strategy. Simply divide the dividend that’s declared in the current year by the dividend declared in the previous year.
Suppose a company’s dividend was $1 last year and it’s $1.05 this year. In this case, you’d calculate the growth rate by subtracting 1.00 from 1.05 to get 0.05. Then, to express it as a percentage, you’d say that the dividend growth rate was 5%.
The rate gives investors an idea of how rapidly the company’s dividends are increasing. A high growth rate could indicate a company with a strong financial health and the potential for higher returns in the future.
Strategies for Dividend Growth Investing
There are several strategies for dividend growth investing. One is investing in what are known as dividend aristocrats, companies that have increased their dividend payouts for at least 25 consecutive years. This strategy can provide a reliable income stream as these companies are often industry leaders with stable earnings.
You could also focus on sectors known for strong dividend growth, including utilities and consumer staples. These sectors are often impacted less by economic downturns, providing stability for your investment portfolio.
It’s important to note that these strategies are not definitive and the best strategy varies depending on individual financial goals and risk tolerance.
Risks of Dividend Growth Investing
Like any investment strategy, dividend growth investing comes with risks. The most significant risk is the potential for companies to cut or eliminate their dividends. Intel, a tech company that produces semiconductor chips, cut its dividend by nearly 66% in early 2023. Shareholders who had been receiving a dividend of $1.46 per share saw their payments fall to just 50 cents per share.
However, this risk can be mitigated by diversifying your portfolio across various sectors and companies. A diversified portfolio can help cushion the impact of a single company’s dividend cut on your overall income stream.
Bottom Line
Dividend growth investing is a strategy focused on buying companies that regularly increase their dividends, providing a reliable income stream for years. This strategy requires an understanding of dividends, the difference between dividend growth and dividend yield, the ability to calculate the dividend growth rate, as well as an awareness of the associated risks.
Dividend Tips
- Stocks aren’t the only assets that generate dividends. Some whole life insurance policies can also pay out dividends. Whole life policyholders can either receive these payments in cash, put them toward their premiums, use them to buy additional coverage or leave them within their policy to accrue interest.
- A financial advisor can help you identify dividend stocks and make the most of the income they produce. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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