Dividend investing is a strategy that allows investors to potentially receive two sources of profit in the form of capital appreciation if share price goes up, and dividend income when a company shares a portion of profits with shareholders. Dividends form a vital component of an investors long term portfolio and the reason is that dividends provide real income. Capital gains can disappear before selling a share, but dividends are physically received by an investor throughout the year. Dividends tax is also lower than other forms of taxation in SA and is levied at 20% of the dividend declared.
Investing in companies with a track record of paying dividends is done by investors looking to achieve reliable, consistent passive returns. These dividends can be withdrawn or reinvested in a portfolio to allow compounding to take place. Investing in high yielding dividend stocks is seen as lower in risk, as these companies are mature and established. The global pandemic has however increased risk for investors looking for income in the form of dividends.
What is a dividend? Dividends are a share of company profits paid out to shareholders. The board of directors approve the percentage of profits declared as a dividend while the remainder of profits are retained within the company for future use. Investors looking for stable, consistent income in the form of dividends will be interested in analysing a company's life cycle.
Company lifecycles
Growth stage: This is a young company, recently established and still looking to grow. All profits will be reinvested back into the company for further growth, either organically or through acquisition. These types of shares are acquired by investors looking for high capital growth and for minimal dividends to be declared from this investment until the company starts to mature. Growth stage companies are viewed as riskier investments and are not suited for investors looking for stable consistent returns in the form of dividend income.
Mature stage: These are blue chip companies that form the Top 40 index on the JSE. They are mature, established companies with a track record of paying dividends. As these companies are not looking for aggressive growth, profits can be distributed to shareholders in the form of dividends. Investors looking for returns in the form of dividends must look at the lifecycle of the company then analyse historic and potential future dividends through the dividend yield.
Dividend yield: The dividend yield, expressed as a percentage, is a financial ratio that shows how much a company pays out in dividends each year relative to its share price. This ratio is calculated by dividing the company dividend per share by the price of the share and shows the investor the gross dividend return. This ratio can be utilised to analyse the company's previous dividends declared or predict future dividends to come.
Trailing dividend yield: The trailing yield shows a company's dividend yield over the last 12 months. The trailing dividend yield calculation is used to analyse past dividends declared before investing. This is useful when looking for dividend income as an investor. Dividends are a very powerful performance indicator and mature companies with proven dividend track record will do everything possible to avoid not maintaining that level of dividend yield going forward, as anything lower will be seen as negative by the market and impact the share price.
Forward dividend yield: The forward dividend yield, is calculated by estimating a company's next 12 months' worth of dividends and dividing by the current company share price. The more stable the dividend history, the easier the projection for the following 12 months. Investing in dividend stocks, should not be ignored by investors, as these returns add up over a period and make for easy budgeting of returns. When investing for the long term, allowing dividends to compound, by reinvesting can increase returns dramatically assisting investors achieve long term goals faster. Investors should look into companies with solid dividend pay-out history and consider adding these to their 2021 strategy.
