Dividend Investing Explained
By Mindaugas Vaičiulis
At Bankera, we aim to empower our users not only by providing them with financial services but also financial knowledge. Hence, when we have a chance, we are sharing our insights on the principles of banking, finance, and investment in our blog. This week, we have decided to cover the topic of dividend investing, an investment strategy focused on dividends as an important source of expected return.
What are high-dividend paying companies?
High-dividend paying companies are well-established businesses with more or less stable revenue streams, usually having a significant market share or even a natural monopoly, such as utilities, telecoms, etc. Such companies hardly have any potential for speedy market growth, which limits their price-rocketing potential. You have to choose either having a high dividend pay-out or sharing the hope of a rocketing price. Not both, unfortunately.
On the contrary, fast-growing "hot" companies usually need additional financing. They issue new shares and bonds, and do not pay dividends during their exponential growth phase.
Dividend policy creates some certainty for investors. It declares the intentions of the management and controlling shareholders regarding dividends. The policies can define stable dividends, speed of dividend growth, or a certain percentage of profit paid as dividends.
Risks are still there
Dividend policy is not a promise but rather an intention letter that can be changed or ruined by factors such as mismanagement or bad luck. In any case, dividends can only be paid when the company is profitable – investors should prepare for dry years, even while owning high-dividend stocks.
While more established companies might demonstrate lower share price fluctuation, equity investing is always exposed to high risk. Even five-year accumulation of dividend income can easily be teared-off by a negative swing of share price within a few quarters when the company or the economy in general get hit.
Dividend yield is the primary ratio for such investors. It compares the last dividend paid per share with the current share price. In other words, it shows what annual return you may expect to earn from dividends if you buy a stock at the current market price, assuming that the dividends remain the same. Dividend yield is always expressed as a percentage per annum, despite the dividends being paid annually, semi-annually, or quarterly.
The next ratio worth looking at is the dividend growth rate.
Who should invest?
More risk-averse investors could choose higher dividend-paying stocks. That is because such stocks might create more comfort while seeing the loss of the investors' stock portfolio. Hopefully, that approach can help avoid emotional trading during the nasty days.
The beginners could try such stocks first to test their own psychological reactions to stock fluctuations.
My own story
The inspiration to write this article is the Lithuanian Ignitis Group initial public offering (IPO), whose subscription period will end this week, on the 1st of October. The IPO should be the largest in the Baltics, with a 4-5% expected dividend yield. In such cases, dividend lovers, including myself, can be better assured that management will share the company's profit with the minority shareholders.
I have added dividend stocks and funds to my portfolio after the global financial crisis of 2007-2009 because I was hesitant to buy the whole market at the early moment of recovery. The portfolio consisted of energy and water utility stocks from my native Baltic stock market when their dividend yield was up to 10 per cent. I also bought a dividend-focused exchange traded fund (ETF), namely, the German DivDAX, because its dividend yield exceeded my mortgage rate. Creating your own rationale helps!
Mindaugas Vaičiulis is the external CFO of UAB Pervesk, a partner and electronic money license sponsor of Bankera. Before joining our team, he was an Executive Director of the Banking Service at the Central Bank of Lithuania in 2012-2019.
28 September, 2020