What Is Dividend Growth Investment and How Does it Work?

When it comes to investing in stocks, the companies with rapid growth and share price appreciation often steal the headlines. Of course, there’s a good reason for this – who doesn’t want to own the hottest stocks with rapidly increasing share prices? The problem with this type of investing is you need to become a good market timer because today’s hot stocks often turn into tomorrow’s laggards. Anyone who bought GameStop shares in 2021 can tell you that meteoric share price appreciation cannot last forever.

Another (less glamorous) way to profit from stock investing is through dividends. So, what is dividend growth investment and how does it work? Read on to learn more. And if you have any additional questions, contact our team today.

What Are Dividends?

Dividends are company profits that are returned to shareholders on a quarterly, biannual, or annual basis. Publicly traded companies often have decisions to make when it comes to excess profits. They can reinvest in the firm through research, development, or other projects or return the profits to their shareholders through a dividend payment. Dividends usually come in the form of a cash payment per share but can also be in the form of additional shares.

To be eligible to receive a dividend, an investor must be in possession of shares before what’s called the Ex-Dividend Date. This is the date where the company makes a record of who owns what shares and assigns dividend payouts accordingly. An investor can sell shares after this date and still be eligible for the dividend. For example, if an investor buys Company ABC stock on July 28th and the stock’s ex-dividend date is July 29th, they will be eligible for the dividend payment even if they sell the shares on July 30th. Think of it like a cutoff – you’ll get the dividend if you own XYZ shares before the cutoff date.

Dividends are treated differently than capital gains from a tax perspective. A qualified dividend will be treated as a long-term capital gain, which means a 0%, 15%, or 20% rate depending on your annual income. Most US stocks will pay qualified dividends. However, non-qualified or ordinary dividends (like those received from REITs) will be taxed at the regular income rate, which could be as high as 37% depending on your modified adjusted gross income (MAGI).

Dividend Yield and Dividend Growth

Dividend growth investing is thought of as a more conservative investment strategy since high dividends often come from well-established blue chip companies. High-flying growth companies are usually more concerned with reinvesting profits back into the firm for more R&D or expansion. But growth isn’t necessarily the main goal for large companies like JPMorgan Chase, ExxonMobil, or Proctor and Gamble. Sure, these companies will often reinvest some profits back into the firm, but most of the time, they want to reward their shareholders with dividend payments.

The dividend payout is determined by the dividend yield. The dividend yield is the percentage of the share price to which the dividend payment will amount. For example, if ABC company has a share price of $50 and a dividend yield of 3%, the annual dividend payout per share will be $1.50. If you own 100 shares of ABC stock, you’ll get $1.50 annually for each of those 100 shares ($150 total). If the dividend is paid quarterly, that would be 38 cents per share paid out four times per year.

Dividend yield should not be confused with dividend growth, although the two are related. Dividend growth is something dividend stock investors look for, especially in well-established companies. Dividend growth means a company increases its dividend payout consistently, returning more and more capital to shareholders over time. Since share prices fluctuate, dividend growth and dividend yield don’t always move in the same manner. It’s an increase in payot that matter here, not necessarily the yield which depends on the share price.

How Does Dividend Growth Investing Work?

A company that maintains or increases dividend payments each year is one that dividend investors should keep an eye on. A consistently increasing dividend payment means that the firm’s profits are growing and cash flow is strong. By returning an ever-increasing amount of capital to shareholders, the firm entices those shareholders to hold on to the stock long-term. And long-term shareholders will be happy to keep buying more stock as the dividend payouts increase. These companies are often called ‘Dividend Aristocrats.

Investing for dividend growth simply means buying these company stocks that have a history of increasing their dividends. This can be done in two ways: through direct ownership of the shares of these firms or through an ETF or mutual fund that holds a portfolio of so-called Dividend Aristocrats. If you want to build a dividend growth portfolio, contact your advisor and discuss where owning shares directly or investing through an ETF or mutual fund is the best course of action.

Disclosures

• Stock investing includes risks, like fluctuating prices and loss of principal.
• Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.
• ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF’s net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.
• Investing in mutual funds involves risks, including possible loss of principal. Fund value will fluctuate with market conditions and it may not achieve its investment objective.

Work Towards Your Goals with GLMP

We hope you found this guide helpful! If you have any other questions about dividend growth investment, contact our team at Good Life Financial Advisors of Mt. Pleasant. We can’t wait to help you work towards your financial goals!

The opinions voiced are for general information only and are not intended to provide specific advice or recommendations for any individual.