Dividends don’t always get the respect they deserve, especially from beginning investors. A dividend stock’s yearly 2% or 3% or 5% yield barely seems worth mentioning alongside yearly capital gains of 10%, 20% or 30% or more. Yet dividends are far more reliable than capital gains. A stock that pays a dividend of $1 this year will probably do the same next year. It may even rise to $1.05. So with today’s low interest rates, investors are paying more attention to dividend yields (a company’s total annual dividends paid per share divided by the current stock price). The best dividend stocks respond by doing their best to maintain, or even increase, their payouts. A couple of decades ago, you could assume that dividends would contribute up to a third of your long-term investment returns, even without the tax-cutting effects of the dividend tax credit. [ofie_ad] In the early years of the past decade, dividend yields were generally too low to provide a third of investment returns. But many yields have moved up since then and interest rates remain low. That means it’s realistic to assume they will again contribute as much as a third of your total return. You should also keep these two key points in mind:
- Dividends can grow. Stock prices rise and fall. That means capital losses often follow capital gains, at least temporarily. Interest on a bond or GIC holds steady, at best. But strong dividend stocks like to ratchet their dividends upward — hold them steady in a bad year, and raise them in a good one. That can also give you a hedge against inflation.
- Dividends are a sign of investment quality. Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks.
For a true measure of stability, focus on companies that have maintained or raised their dividends during recessions and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.
Choosing the dividend stocks you’re comfortable with
While we recommend that you spread your investments out across the five main economic sectors, the proportion you devote to each sector depends on your temperament and financial goals. If you’re an income investor, you may wish to place more emphasis on utilities and Canadian banks. That’s because these firms generally pay high, secure dividends. However, you’ll still want to make sure your portfolio is well-diversified within each sector. You can certainly find Canadian dividend stocks with attractive yields in companies in the Consumer, Manufacturing and Resource sectors as well. Currently, our Safety-Conscious Portfolio in Canadian Wealth Advisor contains 3 Consumer stocks, 3 Resource stocks and 2 Manufacturing stocks among a total of 18 dividend-paying stocks. COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members If a fellow investor told you that dividend stocks just don’t generate big enough returns to bother with, what would you reply? Let us know what you think in the comments section below. Click here.
