Purchasing shares is something a lot of investors do. But have you considered dividend stocks? This type of investment can prove lucrative in some circumstances, as not only do they present the opportunity for making a profit if the share price in the company goes up, they also allow you to make additional income by way of dividends. Here we look at why dividends matter in the world of investment, how they work and why you may want to ask your investment planner about whether they’d be right for you.
Why invest in dividend stocks?
Dividend stocks are shares in companies that regularly pay dividends to their shareholders. It is true that many companies pay dividends, but they can be sporadic. Dividend stocks, however, have a reputation for paying regular, predictable dividends. Also, they will usually have what is known as a progressive dividend policy, which means their dividends grow progressively over time.
When you invest in dividend stocks, you become a shareholder in that company. As well as potentially becoming eligible for an additional income courtesy of dividends, you also get bonus privileges, such as voting rights.
Do dividends matter, and how do they work?
When a company is in profit, it will usually distribute dividends to its shareholders. The more shares owned, the more dividends received.
Some companies will only pay dividends during times of particularly high profitability, making payments out of the profit overflow. However, dividend stock companies will pay dividends from their retained earnings, even if they have not been as profitable.
Buying into dividend stocks means you get to share in the success of the company. However, it is important to bear in mind that companies are under no obligation to pay dividends, so as an investor, you should always consider a dividend as a bonus, rather than an expected regular payment.
Why do companies pay dividends if they’re not compulsory?
Dividends reward shareholders, and companies that pay them regularly tend to attract more investment. They will also have the effect of keeping an existing shareholder base loyal. Companies that pay generous dividends tend to be particularly attractive to new investors.
As new investment comes in, the increased input can often have the effect of increasing the share price, which is good news for the company, and of course its dividend receiving shareholders.
Why do dividends matter to companies? Dividends also have a positive effect on a company’s balance sheet. One of the most important entries that investors and analysts assess when deciding whether a stock has good potential is ‘return on equity’ (ROE). This is calculated based on profits after tax, but with dividends paid directly from these profits, analysts will take this into account. So if a company pays dividends, they will divide leftover profits for ROE by a smaller number, which results in a higher ROE.
What are examples of dividend stocks?
Companies that offer dividend stocks are generally large, blue chip organisations that have been profitable long term and are listed on the likes of the FTSE 100 or the Dow Jones. It’s important to bear in mind however that not all companies pay dividends. Just because a company has a worldwide, household reputation, doesn’t mean it is a dividend stock.
Some examples of renowned UK dividend stocks are GlaxoSmithKline, Imperial Brands, Sage Group and Phoenix Group Holdings.
You should be on the lookout for ‘dividend aristocrats’, which are companies that have paid dividends on a regular basis, as well as increasing their dividend payouts for 25 years or more.
Do dividends matter and why should you invest?
If you are investing with the objective of generating a regular, predictable income, dividends will matter to you. This is because they can offer frequent payments at known intervals. They also represent a passive income, in other words, one you don’t have to actively pursue.
You can also reinvest your dividends if you wish. If you don’t need to bank the income, you can instead put it back into the company to attain more shares. This will have the effect of compounding your investment over time, which can be a good way of growing wealth.
Looking for investment advice? Talk to the experts at Partridge Muir & Warren.
As chartered financial planners, PMW has been serving the people of Surrey and beyond with independent, professional advice since 1969.
Our investment advisers are highly experienced specialists in investment management and portfolio management. Also on our team we have experts in wealth management and retirement planning. In other words, all the expertise you need to choose the right investments to meet your goals and fit with your individual circumstances as well as attitude to risk.
To learn more about how we can assist you, please get in touch.