“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” John Rockefeller, founder of the Standard Oil Company

For retirees, dividends are a source for cash flow and a great form of income security in their post work years. For smart investors, dividend investments represent one of the closest things they can find to guaranteed income and possible capital appreciation.

John D. Rockefeller, founder of the Standard Oil Company and the world’s first billionaire, was a vocal advocate of dividends. He once commented that, “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.”

Dividend investing provides a steady income stream from the distributions of a company’s earnings to its shareholders. It works well for investors looking for long-term growth and for individuals preparing for or living in retirements who have a lower risk tolerance.

Dividend stocks are companies that pay shareholders a portion of earnings, or dividend, on a regular basis. These payments are funded by profits that a company generates but doesn’t need to retain to reinvest in the business. Dividend stocks are a major factor in the total return of the stock market. About 3,000 U.S. stocks pay a dividend at any given time.

Divdend income investor.

Dividend paying stocks are major sources of consistent income for investors. They can create income and wealth when returns from the equity market are highly volatile or at risk. Essentially, dividend–paying stocks have become an attractive alternative to bonds for investors looking for a reliable stream of investment income.

Companies that pay dividends generally act as a hedge against economic uncertainty and provide downside protection by providing payouts or sizable yields on a regular basis. If you’re looking to build wealth or generate income, dividend stocks are pretty hard to beat.

Dividend-focused stocks do not offer much price appreciation in strong bull markets. However, they do offer a steady stream of income along with the potential of capital gains. These are the major sources of consistent income for investors to create wealth when returns from the equity market are at risk.

Companies that pay out dividends generally act as a hedge against economic uncertainty or downturns. They tend to provide downside protection by offering payouts or sizable yields on a regular basis.

Dividend stocks offer solid returns in an era of ultralow bond yields and also hold the promise of price appreciation. The S&P 500 index’s yield was recently around 1.9%, about even with that of the 10-year U.S. Treasury note.

Dividends also offer a number of advantages beyond income, one being that qualified dividend income is taxed as a capital gain and at a lower rate than ordinary income receives. The top federal capital-gains tax rate is 23.8%. Payouts can also help buffer volatility in tumultuous markets, providing returns even during a market decline.

Dividend stocks can reduce the amount of volatility or beta in a portfolio. Essentially, dividend investing is boring, and lacks the thrill of a small cap tech stock with exponential revenue growth and avoids the volatility of small caps.

Dividend Payout Date

Getting a regular income from the companies investors own are a testament to their discipline, the health of their business, and their confidence in its future. Companies will announce when their dividend will be paid, the amount of the dividend, and the ex-dividend date. Investors must own the stock by the ex-dividend date to receive the dividend.

The ex-dividend date is extremely important to investors: Investors must own the stock by that date to receive the dividend. Investors who purchase the stock after the ex-dividend date will not be eligible to receive the dividend. Investors who sell the stock after the ex-dividend date are still entitled to receive the dividend, because they owned the shares as of the ex-dividend date.

Dividend Payout Ratio

Dividends are typically paid from company earnings, but not all dividends are created equally. If a company pays more in dividends than it earned, then the dividend might become unsustainable. Comparing dividend payments to a company’s net profit after tax is a simple way of reality-checking whether a dividend is sustainable.

Unless there are extenuating circumstances, from the perspective of an investor who hopes to own the company for many years, a dividend payout ratio of above 100% is definitely a concern.

Another important check is to see if the free cash flow generated is sufficient to pay the dividend, which suggests dividends will be well covered by cash generated by the business and affordable from a cash perspective.

Still, if the company repeatedly paid a dividend greater than its profits and cash flow, investors should be concerned. Extraordinarily few companies are capable of persistently paying a dividend that is greater than their profits.

High Dividend Yield

A high dividend yield strategy does have several drawbacks. Those disadvantages include vulnerability to rising interest rates and the potential exposure to financially challenged companies that may have trouble maintaining and growing dividends. Since the stock prices of firms with stable cash flows tend to be more sensitive to fluctuations in interest rates than those with more-volatile cash flow streams.

With lower interest rates and the stock market trading at near all-time highs, the high dividend paying stocks and ETFs could be excellent picks at present. Dividend ETFs provide investors with a diversified portfolio of dividend-paying stocks that allows you to invest and collect income without having to do nearly the amount of research you’d need before buying a large number of the individual components.

Another source of income are preferred stocks. Preferred stocks are known for offering higher dividends than their common stock counterparts. In fact, they can be viewed as a safe haven in case of a market pullback as the S&P 500 is up nearly 24% so far this year.

Stocks with a history of above-average dividend yields typically can be a sign of companies with deteriorating business fundamentals. While that can be the case in certain situations, there are many companies with strong underlying fundamentals that are some of America’s largest and most stable companies.

Bottom line, don’t fall for a high dividend yield in a vacuum. It may not paint an accurate picture of the stock’s potential. Instead, look at the company’s fundamentals and determine how dividend payouts change over time. That may indicate a company’s financially stability. Also, it may illustrate long-term dividend potential.

Dividend-Growth Strategies

An investor should not buy dividend stocks just for the sake of dividends to generate income…they should also be seeking capital appreciation to keep up with inflation and mitigate the risk of the long term loss of buying power of the dollar, as well. The most successful dividend investors seek dividend paying stocks that have the potential to grow their dividend each year.

Dividend payers with a history of dividend growth over a prolonged stretch (10 years’ worth of dividend hikes) tend to be highly profitable, financially healthy businesses. While dividend growers prioritize delivering cash to their shareholders, they’re balancing that against investing in their own businesses. Such firms have often held up better than the broad market, as well as the universe of high-yielding stocks, in periods of economic and market weakness.

During the market downturn from early October 2007 through early March 2009, dividend appreciation stocks, such as Dividend Aristocrats, held up better as a category versus the broad market and versus high dividend yield benchmark.

Dividend-growth strategies also look appealing from the standpoint of inflation protection, in that income-focused investors receive a little “raise” when a company increases its dividend. Dividend-growth stocks will tend to hold up better in a period of rising bond yields than high-yielding stocks. That’s because dividend-growth stocks’ yields are more modest to begin with, so they’re less vulnerable to being swapped out when higher-yielding bonds come online.

The dependability of dividends is a big reason to consider dividends when buying stocks. Not every stock pay a dividend, but a steady, dependable dividend stream can provide a nice boost to a portfolio’s return.

Sources:

1. https://finance.yahoo.com/news/dividends-capital-gains-differ-195903726.html
2. https://www.fidelity.com/learning-center/investment-products/stocks/all-about-dividends/why-dividends-matter