There are three ways for companies to utilize their earnings. They can reinvest into their business through higher wages, expansion, or other realms of development; they can execute a stock buyback that will lead to higher dividends for investors or issue dividends. A dividend is a reward given to company shareholders, often in regular cash payments. This reward is typically a portion of the company’s profits, and corporations provide it as an incentive for investors to keep holding on to their shares. In this article, we provide some key reasons investors should specifically seek out dividend stocks and how they compare to their non-dividend-bearing counterparts.
Share Buyback Taxation
Companies give their shareholders a return on their investment through share buybacks and dividend payments. Share buybacks are more versatile than dividends since companies can alter how much stock they repurchase as they deem necessary. By contrast, dividends are difficult to adjust due to the negative message corporations put out when they reduce the payout. The lack of confidence fallout from lower dividends typically leads companies to remain consistent in their dividend payments rather than altering them. Therefore, they prefer to utilize share buyback strategies instead.
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The Inflation Reduction Act, recently signed into law, may incentivize companies to pay dividends rather than engage in share buybacks due to a 1% tax on buybacks. According to the Tax Policy Center, this buyback tax, which doesn’t apply to dividends, could lead to an approximate 1.5 percent increase in corporate dividend payments. Opting for dividends could save money for businesses facing declining earnings or worsening business conditions.
Dividend Stocks Perform Better in Bear Markets
Dividend-paying stocks are generally less prone to volatile swings than the overall market. Over 20 years, from 2000 – 2020, analysts found that dividend stocks from three categories, namely those with growing dividends, yield/quality blended, and high yield, all had less volatility than the S&P 500 stock index
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Over the past two decades, three significant recessions have occurred — caused by the tech bubble bursting in March of 2003, the global financial crisis of 2008, and the COVID-19 pandemic. A study on high-quality dividend indices revealed that they outperformed the S&P 500 in all but the COVID-19 recession. Merril Lynch research showed that from 1990 through 2018, persistent dividend growers delivered less volatility while simultaneously yielding loftier returns than non-dividend-paying stocks.
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Investing in companies that pay dividend yields can be beneficial as these tend to have higher relative profitability and lower debt. Strong corporate finances indicate a company’s ability to sustain its dividend, demonstrating the predictability of its income. Quality companies have growing markets, competitive advantages, and intelligent capital allocation – all of which help to contribute to overall positive performance for investors.
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Dividend investing leads to compound gains
Compound dividend investing is an investment strategy that enables investors to make passive income from the dividends paid by stocks, ETFs, and other securities. With this technique, you can reinvest your dividend payments in order to receive even higher payouts over time – it’s what makes compounding so powerful! As your account grows, each of your reinvested dividends will yield more per share than before due to compounding.
You will still receive dividends if the stock market is flat or even down. Using a dollar-cost averaging strategy, you can purchase stocks at a ‘discounted’ price and lower the average cost per share in your portfolio, providing stability and a cushion against volatility, as shown in the above video.
By looking at S&P 500 returns, we can see that reinvesting dividends makes a world of difference. If you invested $10,000 into the S&P 500 in January 2000 and didn’t reinvest, you would have a total return of 55.304% (adjusted for inflation). By reinvesting, however, you would have a 136.461% return!
In Conclusion
The case is clear. We should nearly always seek assets that provide dividends if we want to grow our savings. Other popular investments, such as gold, may rise in value, but they will never provide the compounding interest opportunities of dividend-bearing assets.
Reach out to us today to discover what dividend stocks, ETFs, or Mutual Funds are a good fit for your investment portfolio and overall retirement strategy!
