Many investors are tempted to ignore companies that pay dividends when investing in the stock market, simply because the idea of earning pennies per share four times a year doesn’t seem like an investment vehicle that’s worth getting very excited about.
But this is misguided thinking…
The truth of the matter is that learning how to invest in dividend stocks effectively can play a significant role in expanding your wealth through a stream of passive income that holds real potential for steady and exponential growth over the long-term.
1. Dividends Provide a Steady Income Flow
The most fundamental benefit of dividend investing is the ability to earn money with very little ongoing work.
Once you’ve done the initial research and analysis that’s required to identify the best companies to buy shares in, it becomes a matter of simply keeping an eye on those companies, to ensure the stocks you own remain profitable.
The beauty of dividends is that they are paid out regularly, regardless of how the stock market performs on a day-to-day basis. Dividends are not dependent on market activity, but rather on the overall performance of the company paying them out.
As long as you look for mature, financially experienced, and growing businesses to invest in, your steady flow of dividend income should continue uninterrupted for as long as you own your shares. And the return on investment you can expect for most dividends will easily beat anything you might expect to earn by keeping your money in the bank.
When your portfolio generates passive income, it allows you to spend more time on other endeavors while your money goes to work for you.
In this way, passive income through dividend investing represents the true key to financial independence.
2. Dividends Never Lie
Examining dividends offers an effective way to determine which company stocks are the most valuable in terms of their long-term income potential.
In fact, evaluating a business based on its dividend history, and its potential for future earnings, is often a far more reliable method for discovering the truth behind the numbers, than perusing a company’s financial statements.
The use of creative accounting practices means that business financial statements can, and sometimes do, get presented in ways that make a company’s profits appear healthier than they are.
Whether it’s reporting the sale of an asset as regular business income, or “hiding” a liability in layers of amortization, the better a company’s earnings picture looks in a given year, the stronger the support for its stock price will be, and the more its shares will appeal to investors.
Stock dividends, on the other hand, never hide the truth.
A company’s dividend payments will always give an accurate picture of its financial status, regardless of what may be printed in its earnings reports, simply because it takes real earnings to fund those payments.
Dividends are not just payments on paper, they are actual cash payouts made to shareholders on a regular basis, and they require a strong earnings profile to support them.
If dividend investing is a game of show and tell, you should always consider what a company’s dividends show you, rather than just relying on what its financial reports may tell you.
3. Dividend Investing Lets You Profit Twice
Dividend stocks allow you to purchase shares in financially sound businesses that share the profits from their annual earnings with their stockholders, in the form of regularly increasing dividend payments.
Dividends have a tendency to grow over time when you buy shares in solid, mature and proven companies because these businesses work hard to constantly grow their earnings, and to reward their investors with increasing dividend amounts.
Growing dividends provide the framework for an increasing dividend yield, since the higher the payout gets, the greater the return on your investment becomes.
For example, if you originally buy shares of a stock for $100 with an annual dividend of $2, and that dividend increases over time to $4, your dividend yield will have grown from 2% to 4%.
But dividend investing rewards you in another way as well.
While you enjoy your steadily growing flow of passive income from the stock you own, the value of that stock is very likely growing as well.
The capital gains resulting from this type of share appreciation is particularly common with dividend-paying companies that are financially strong and that have a unique market edge, a high performance financial strategy, or a seasoned management team.
And with dividend stocks, even if share prices do drop, dividends continue to be paid, and their yield only increases as a result.
4. Dividend Reinvestment Plans (DRIPs) Help You Maximize Your Return
One of the wonderful features of dividend investing is that it conveniently lends itself to reinvesting your earnings in order to generate even greater returns.
This is known as the power of compounding, since the more shares of a company you purchase, the more dividends you will earn, and the more of those earnings you reinvest in additional shares, the higher your returns will grow as a result.
In this way, dividend reinvestment can lead to exponential growth that requires no additional investment of new capital. And if you take advantage of an automatic Dividend Reinvestment Plan (DRIP), it can all happen with no effort whatsoever on your part.
DRIPs are the best way to benefit from the frequent reinvesting that leads to higher returns.
These programs are often offered by the dividend-paying company itself, in order to allow shareholders to automatically purchase additional shares of stock on each dividend payment date.
Instead of receiving your dividend in cash, the issuing company, or an outside brokerage firm or agent, will take that cash and buy more shares on your behalf. And in many cases, these shares can be purchased without incurring a commission charge.
The Bottom Line
From the steady flow of passive income, to the continued growth and reinvestment potential of dividends, to the thrill of experiencing capital gains when stock prices rise, dividend investing has a lot to offer.
While the stock market never comes with a guarantee, and you should always take the time to familiarize yourself with potential risks, buying dividend stocks can serve as an integral part of your overall ability to build long-term wealth into your investment portfolio.