Dividend investing has long been considered a sensible way for people to build their capital over a long period. The impact of compound investing is truly staggering, and it can make fortunes from relatively small, but regular, contributions. However, the trick lies in starting as early as possible, as dividend investing is a long game.
Why do companies pay dividends?
When a company first goes public, they’re usually young and looking to grow their business. Whereas, once a company has been listed for many years it’s less likely to grow, so it rewards loyal investors with dividends. Established companies such as these are attractive for having a less volatile share price, and the dividend is a bonus.
4 popular dividend stocks
Here are four popular US dividend payers:
Johnson & Johnson
Johnson & Johnson (NYSE:JNJ) is a company name almost everyone will recognise. It manufactures many consumer goods but is probably best known for its extensive range of baby products. As well as those brands under its own name, its portfolio contains Neutrogena, Band-Aid, Benadryl and Tylenol. But along with the healthcare products, it makes medical devices, such as diabetes testing kits.
Johnson & Johnson has been paying an increasing dividend for an incredible 58 years steady. Its current dividend yield is 2.5%. The company’s Q1 2021 earnings call and webcast will take place on Apr 20, 2021.
Coca-Cola (NYSE:KO) is another US stock with a lengthy dividend record. And it beats Johnson & Johnson by one year, having consistently raised its dividend for 59 years. Fast moving consumer goods have continued to fare rather well during the pandemic so there’s confidence this dividend raise will continue.
Coca-Cola continues to dominate through its strategic diversification into areas rising in popularity such as bottled water, tea and juices. Its dividend yield is 3.4%.
Verizon Communications (NYSE:VZ) is an American multinational telecommunications conglomerate and is the second-largest wireless carrier in the United States. It provides high-speed internet services and is gearing up to reap the rewards of a widespread transition to 5G. Verizon’s dividend yield is 4.5%.
Bill Gates’ Microsoft (NASDAQ: MSFT) needs no introduction. It’s success through Windows and Xbox has helped its share price steadily rise for the past seven years. It also owns LinkedIn and Minecraft developer Mojang. Its revenues have increased through the introduction of subscription style payment models. With the Microsoft share price being pretty high, its dividend yield is currently under 1%.
Benefit of compound investing
The trick to making money from dividend investing, is in how long you can leave your investment to compound. A little-known statistic shows that very young people investing for a few years, then stopping, actually end up with a larger capital sum decades later than someone who started at a later age but invested for longer.
Billionaire hedge fund manager Joel Greenblatt uses this lesson to teach his students. In his book Common Sense, he said:
“this person who started investing at 19 and only putting seven payments of $2,000 ends up earning more money just with seven payments by the time they’re 65 than the person who started seven years later at age 26 and put in 40 payments.”
A powerful wealth-building technique
Here’s another example:
If you save $100 a month for 40 years with a 5% dividend yield, you’ll end up with over $148k. But if you could achieve an effective annual interest rate of 12%, then your final sum would be a whopping $970k.
Alternatively, if you can contribute a lot more each month, such as $500 a month. Then, with an effective annual interest rate of 5%, you’ll end up with $741k.
These examples go to show that either a high interest rate or high regular contribution can build up to an impressive final sum.
When you look at the rate of compounding, it exponentially increases after a long period of time.
In this Covid-19 ravaged time, dividend investing may not be seen as attractive as an ARK Invest ETF or a cannabis ETF. But it can be a strategic, long-term way to gradually build wealth and protect your capital.
Of course, like every investment, there are risks to be aware of.
Risks to dividend investing
General Electric Company (NYSE: GE) was a dividend darling but after a series of bad acquisitions investor sentiment plummeted. In just 12 months it had to cut its dividend by 96%. Today it pays a fiscal dividend per share of $0.04. While anything is better than nothing, you must consider the long-term outlook of a company before opting to invest for the dividend benefits.
Today GE is trading at $12.50 a share, but JP Morgan thinks it’s probably not worth more than $5 a share. That’s its conclusion after accounting for future free cash flow and its massive debt burden.
The pandemic struck, with a sweeping halt to dividends globally. In the UK it led to cut, cancelled, or suspended dividend payments on 505 companies listed on The London Stock Exchange in 2020 (according to GraniteShares research).
Investing for the future
Warren Buffett is another Billionaire investor who advocates for this style of investing. Choosing the best dividend stocks for your portfolio can be made simpler by considering a few factors:
While a high yield seems the most obvious place to start, it’s not necessarily the best. Sometimes a very high yielding company will actually be a warning that all is not right with the business. The Johnson & Johnson dividend yield may seem low, but the company appears to be strong and has consistently paid for decades.
Dedicated management team
Has the management team been in place a long-time? Are they committed to the company and its future vision? It’s not always easy to tell how dedicated the management team is, but by reading shareholder reports and watching corporate videos you can get an idea.
History of dividend raises
This can be a very good guide to how established the company is and how reliable its dividend payments will be. Of course, no company is immune to downturns. The pandemic led many previously strong paying companies to have to cut their dividends. Those that were able to carry on regardless are worth paying attention to.
If a company has a competitive advantage over its peers then it’s immediately got more staying power. Well-loved brands, exclusive technology or something in high demand are all worth looking out for.
By ensuring your investment meets certain criteria before buying shares, it gives you peace of mind. Rather than worrying over share price movements, you’ll have the confidence that your stock pick is for the long-term. Therefore, intermittent fluctuations shouldn’t matter. Every stock is subject to ups and downs, it’s the nature of the markets as external and internal forces are at work.
But investing in a strong company, with a track record of paying dividends and generating free cash flow, should have staying power. And feeling good about your stock picks will give you confidence to leave them alone to compound.