Advantages of dividend stocks
High quality dividend stocks have a lower price volatility
As dividends fluctuate much less than profits, they act to cushion any downward trends on the stock market.
Dividend payers invest more efficiently
Companies that pay out a portion of their profits or cash flow are automatically forced to use the retained funds as sensibly as possible. This generates added value in the long term.
Dividend stocks outperform the non-dividend payers in the long term
This has been confirmed by numerous studies, one of which was conducted by US research company Ned Davis. Using the S&P 500 as the basis, it shows that investing in all dividend stocks over the period from 1972 to 2010 would have generated an average annual yield of 8.8%, whereas the stocks that did not pay a dividend rose by just 1.7%. The overall index was up by 7.3% in the same period.
The dividend is the only balance sheet item that cannot be manipulated
Since the dividend cannot be manipulated, in contrast to all other earnings figures, the dividend history is a very reliable indicator of the company’s performance.
A consistent dividend policy sends out a strong message
Companies that regularly pay a dividend over a long period almost always have a tried-and-tested, well-conceived business model that earns more money than is needed. This generates considerable added value for the shareholders in the long term.
Dividends make you happy
The American oil billionaire John D. Rockefeller (1839-1937) knew this. One of his quotes speaks volumes: “Do you know the only thing that makes me happy? It’s to see my dividends coming in!”
Anyone who has ever received a dividend statement from their bank can confirm this. Unlike book profits, dividends constitute real money that flows into your account on a regular basis.
Reinvest your dividends
Even if you simply buy a wide selection of different dividend stocks, you will still outperform the market over the long term.
But if you regularly reinvest the dividends, you can earn more than with any other investment over an extended period. Investors who choose the right stocks and reinvest the dividends in a disciplined way will generate fantastic returns.
This is explained in the Global Investment Returns Yearbook 2009 (London Business School, February 2009).
A well-conceived strategy
In an article in the yearbook “Keeping faith with stocks”, the researchers ask what we should expect from stocks. To answer this question, they studied data from 18 countries over the period from 1900 to 2008 and compared the real returns on equities, bonds and money market instruments.
The results were clear: Those who regularly reinvested the dividends beat all other types of investment by a considerable distance.
Example US stock market: - One US dollar invested in 1900 would have developed as follows by 2009 (in real terms):
Results in USD
Equities (dividend reinvested)
Equities (without dividends)
Money market instruments
Big returns for little effort
How this applies in practice – and in a realistic time-frame for investors – can be seen in the following specific examples.
Example 1: BASF – EUR 10,000 invested at the end of 2003 (dividend yields reinvested on 31 December each year, 25% tax deducted from the gross dividend). This stock position would have developed as follows between then and today:
- The net dividend yield would have risen from 2.3% to 13.0%
- The number of stocks in the portfolio would have increased from 447 to 618
- The purchase price would have fallen from 22.37 to 16.20
- Net dividend income would have increased from EUR 232 to EUR 1,376
Example 2: Nestlé – CHF 10,000 invested at the end of 2003 (dividend yields reinvested on 31 December each year, 35% tax deducted from the gross dividend). This stock position would have developed as follows between then and today:
- The net dividend yield would have risen from 1.5% to 6.1%
- The number of stocks in the portfolio would have increased from 324 to 412
- The purchase price would have fallen from 30.90 to 24.27
- Net dividend income would have increased from CHF 150 to CHF 610
Example 3: British American Tobacco – GBP 10,000 invested at the end of 2003 (dividend yields reinvested on 31 December each year, 0% tax deducted from the gross dividend). This stock position would have developed as follows between then and today:
- The net dividend yield would have risen from 5.0% to 35.0%
- The number of stocks in the portfolio would have increased from 1,299 to 2,087
- The purchase price would have fallen from GBP 770 to GBP 479
- The net dividend income would have increased from GBP 498 to GBP 3,500
The compound interest effect
These dramatic improvements would not cost you a cent, just a few hours’ work each year.
This is because the companies have paid out an attractive dividend every year and increased it over the years – all you have done is regularly reinvest the dividends.
The more additional stocks you purchase, the higher your dividend income will be. At the beginning, there is little change, but with time the compound interest effect kicks in and your income increases disproportionately. According to Albert Einstein, compound interest is “the most powerful force in the universe”.
Price drops as an opportunity
You wouldn’t have to do much, since most of the work is done by the companies themselves. Nestlé sells its food worldwide, British American Tobacco produces billions of cigarettes a day, and BASF supplies the global economy with chemicals. All this goes on while you’re sleeping, watching TV or relaxing on vacation.
And the best thing about it: Price developments are completely irrelevant! You no longer have to worry about price drops. In fact, quite the opposite: low prices are a great opportunity to expand your portfolio and thus lay the foundation for an even higher income.
Let dividendpearls help
In addition to the necessary discipline, it is also essential to choose the right stocks, of course. You can expect to achieve these kinds of figures only if you invest in really good companies.
With its wealth of important information, dividendpearls.com can help you find the right dividend stocks.
How to find the best dividend stocks
Looking for good dividend stocks? Congratulations, you’ve made a smart choice! But what actually constitutes a good dividend stock? We define it as follows:
Stocks with high, safe and growing dividends.
If you put together a portfolio of such stocks, you will increase your wealth considerably in the long term and earn a steadily rising income from dividends.
At dividendpearls, our mission is to help you find such stocks.
Almost all really good dividend stocks have similar characteristics and features; for instance, they have positive track records. Although no one can accurately predict the future, past performance is often a good indicator.
We advise you to look for dividend stocks with the following characteristics:
- As many dividend increases as possible over the past 10 years
- Few to no dividend cuts in the past 10 years
- The last dividend was not reduced
- Unremarkable price performance compared with the index
dividendpearls.com provides you with precisely this information.
Compose a list of stocks that meet these criteria. This will allow you to separate the dividend pearls from the bad eggs.
We recommend that you analyze these promising dividend stocks in more detail.
In particular, you should investigate the company’s cash flow and financial strength. Good companies can always pay their dividends from their free cash flow, and they usually have healthy balance sheets.
Avoid dividend hazards!
A high dividend yield combined with a huge price slide is usually an indicator of an impending dividend cut. Avoid such stocks at all costs!
We’re not talking about normal corrections of 10%, 15% or 20%. Instead, we mean massive price slumps to the tune of 40%, 50% or more.
(At dividendpearls, we also measure the percentage price loss against the three-year high.)
Plunging prices in an unremarkable overall market are clear signs that a company or a whole sector is having major issues.
Thus, stocks with unusually weak price trends should not be seen as bargains but as potential problems. And who wants to invest in problems?
In order to achieve long-term significant capital growth with equities, you should apply the following five timeless investment principles.
- Do not buy expensive stocks
- Invest only in high quality companies
- Diversify your portfolio
- Never buy stocks on credit
- Be patient – falling prices alone are no reason to sell
Successful investment in stocks is not about predicting the future, but rather about not making common mistakes. If you design your portfolio according to these principles, you will avoid the biggest mistakes – and become a successful investor.
The key to successful investment in stocks is not how good you are at finding undervalued stocks or identifying high quality companies – neither is that difficult to do in today’s information age.
Instead, the key is to apply the investment principles consistently. This will decide who is successful and who is not. If there’s one thing that all fairly successful investors have in common, it’s consistency. They stay true to their principles.
Dividend Research Papers
Global Dividend Strategy, Credit Suisse/London School of Economics, 2009
The Future for Investors (excerpt), Jeremy Siegel, 2005
Do Dividends Matter More in Declining Markets?, Kathleen Fuller und Michael Goldstein, 2005.
The Effect of Dividend Initations on Stock Returns, Yanli Wang, 2005.
»free download (PDF)
Dividends and the three Dwarfs, Robert Arnott, 2003.
»free download (PDF)
The High Dividend Yield Return Advantage, Tweedy Browne LLC, 2007
»free download (PDF)