One of my favourite Aesop fables is the tale of “The Tortoise and The Hare”. This famous story tells of how the valiant and enduring tortoise beats the over-confident hare, despite of his physical limitations. The moral of the story is “slow and steady wins the race”, this lesson can equally be applied to dividend investing.
2. Capital gains
3. Shareholder perks
It is the second benefit to which investors place too greater emphasis, but it is dividends which account for the biggest proportion of investment returns. The distribution of company profits to the shareholders goes to the essence of investing. That is you are the part-owner of the company, and therefore entitled to a share in the profits and growth of good companies through capital appreciation and dividend payments. Studies have consistently shown dividends when reinvested to be responsible for more than 60% of stock market performance. In the US, asset management company Eaton Vance says that as much as 65% of stock market gains have come from reinvested dividends. The historical and academic research today continues to support the view that a dividend-based investment strategy delivers superior returns over the long run.
What is dividend investing?
An income investor will search for companies paying high and reliable dividends. These companies provide essential goods and services, such as food and medicine. These ‘blue-chips’ companies are mature and stable, and therefore resilient enough to thrive in the challenging economic climate. They usually have an unparalleled record of earnings and dividend growth stretching back decades. They are typically global, established businesses like GlaxoSmithKline, Unilever and Vodafone. Blue-chips are often characterised as having excess cash flow and strong financial positions, which enables them to continually distribute income to their shareholders. Income stocks are an ideal investment for the conservative investor looking for a steady stream of cash. Alternatively investors can secure a steady income through an equity income fund run by a professional fund manager. A list of the top investment funds can be found at Hargreaves Lansdown and Citywire.
Back to basics
The beauty of dividend investing is the simplicity and the information it communicates about the companies’ financial strength. A well run business will be able to grow their profits year-on-year and therefore be able to pay a progressively higher dividends. Dividends are reality, they cannot be fudged by clever accountants and so rising dividends reflect the company’s long term strength and success. A progressive dividend policy and a strong financial position will attract new investors leading to capital appreciation; an income investor therefore has the potential to benefit from capital appreciation as well.
Peter Hargreaves, co- founder of the investment broker Hargreaves Lansdown, is a loyal exponent of equity income investing. He believes income investments should form the cornerstone of your portfolio, and then once you have achieved an income to meet your immediate needs you can start looking for racier growth shares. This approach is a boring ‘get rich slow scheme’ for the patient investor.