Why are Australians so fond of dividend investing?
Depending on your financial objectives, dividend investing can be a useful investment strategy. If you’re early on your investment journey, receiving a dividend payment every month, quarter or biannually can be a useful supplement to your existing income.
The traditional investing approach of “buy low, sell high” may take a while to produce capital gains, and the prospect of waiting years to benefit from a purchase made at the wrong moment turns off some prospective investors.
Even in times of market uncertainty, some dividend-paying companies provide shareholders a reliable source of income, but you have to choose them wisely, and there is obviously no assurance, especially in industries that may be subject to external shocks such as consumer finance.
What are dividend stocks?
Dividend stocks are companies that typically pay out a tiny fraction of the stock’s value, anywhere from 0.5% to 8% per year, however some pay out more than 20%. Just be careful to ensure these payouts would be sustainable over the long term. There are a wide variety of corporations that make dividend payments on occasion, but dividend stocks are distinguished by their reliability in delivering dividends on a recurring basis. When you buy a stock listed on the Australian Securities Exchange (ASX), you become a shareholder in the business and are eligible to receive dividend payments from the firm if they are applicable. Dividends are paid out of annual earnings and the company’s long-term cash flow. Semi-annual (every six months) dividend payments in the form of cash are the most popular in Australia, but can usually be made to shareholders at a regular interval decided by the company. Monthly, quarterly, and yearly dividends are the most common, although special dividends may be distributed at any time.
By compounding your dividends into further investment, you may achieve your goals earlier. At Unhedged we often invest in dividend paying stocks however we reinvest your dividends back in the fund and they’re accounted for within your performance figures.
Some dividend payers often don’t experience capital appreciation in their share price, which can be the tradeoff between a company that has ambitious growth aspirations and one that is mature and simply pays a large ratio of its earnings. In Australia, Telstra fits into the latter category, for example… It’s worth remembering that this kind of investing strategy is not suitable for everyone.
Types of Dividends
While cash dividends are the most well-known, you may be surprised to learn that firms can use stock, property, and other assets to distribute their dividends.
Stock dividends are paid out in the form of additional shares of stock in the firm without affecting the value of the shareholder’s existing holdings. There isn’t much use for them, therefore they’ve fallen out of favour. A stock dividend of 10%, for instance, would result in the issuance of an additional 10 shares to a shareholder who already owned 100 shares at $1,000 each. A “Hybrid Dividend” combines a cash dividend with a stock dividend.
If a company lacks the capital to pay a cash dividend, it may instead pay a Property Dividend, equal to the value the company wishes to distribute. A corporation in the electronics industry, for instance, may decide to deliver each investor a product with a specified market value.
Should you put your money into dividend investment?
Paying dividends may be quite rewarding for certain types of investors. At the same time they may dissuade some investors who would prefer the capital to be reinvested. Your financial strategy and personality will ultimately determine the outcome. Some shareholders, for instance, utilise dividends either as a sole source of retirement income or as a complement to an existing pension for the elderly.
There are many considerations to determine whether dividend investment is suitable for your portfolio. Dividends paying investments can be a valuable asset for increasing portfolio returns in both good and poor economic situations. Dividends are considered taxable income, so some investors may choose not to receive them while they are trying to minimise their tax liability or save for retirement. It’s worth noting that some Australian dividends are franked so there may be a benefit for some investors.
Long-term investors might hope that a company reinvests surplus funds back into the company in order to increase growth and profitability. Why? Dividends reduce capital that would otherwise be used for investment and expansion of the company. Each dollar distributed in one year could represent $1.15 tax-free inside the business if it were reinvested, assuming a return on invested capital of 15%. After another year of compounding, it would be worth $1.32. You still have a claim to these profits as a shareholder, but they will be reinvested (perhaps at a better rate of return than you might obtain) rather than being distributed to you as dividends. Growth stocks are often used to describe investments in firms like these and the benefits to you as an investor are in the form of capital growth of your investment in the company.
Some shareholders may rather see a company repurchase shares with surplus cash (ie. buybacks) rather than receive dividend payments. In addition to delivering (taxable) dividends, buying back shares is another means for firms to repay capital to shareholders. A company’s ownership is proportional to the number of shares on issue by the company. By lowering the number of shares outstanding, the firm may redistribute the proceeds from its operations across a smaller number of shareholders. Consequently, the earnings per share of the firm will rise since each outstanding share will get a proportionally higher part of the profits (EPS). Investors place a high value on profits as an indication of a company’s health, therefore more profits usually result in a higher stock price. There is no legal need for a company to carry out a share repurchase programme, hence some utilise them even if they don’t need to. This allows for more adaptability in the face of unforeseen market conditions or changes in the value of a company’s stock.
Dividend investing is a viable investment choice worthy of consideration
Investing in dividends is a popular strategy to build a passive income stream over time. Nonetheless, you should talk to an expert to make sure it’s a good fit for your financial situation, as all investments carry risk.
If you’re looking to diversify your portfolio and take advantage of an automated investment approach you should consider Unhedged. We are a long term investing platform that is looking to make investing super simple.
*Past performance is not indicative of future performance. If we assumed a 5% return it would be $178k in total assets using the other inputs.
The information in this post is general information only and does not take into account your personal circumstances, financial situation or needs