Dividends are a polarizing topic on financial blogs these days.  There are arguments that investors should steer clear of stock picking altogether and adopt an indexing strategy.  Others caution that focusing entirely on dividends ignores the fact that there are other ways to return cash to shareholders.

Yet the allure of dividend growth investing is hard to ignore.  A recent study by RBC Capital Markets showed that from 1986 to February 2010, dividend growth stocks were up 12% annually.  In comparison, the S&P Composite Index was up 6.1% per year and stocks that did not pay a dividend were only up 0.1% per year.

According to Myles Zyblock, chief institutional strategist and director of capital markets research at RBC, “dividend growth is probably the cleanest and strongest signal about the fundamental health.  Paying dividends also imposes capital discipline on management, meaning companies with an obligation to pay a dividend will be less likely to blow their shareholders’ capital on risky ventures or acquisitions that may not pan out.

Here are 5 more reasons to hold dividend growth stocks for the long term:

1.  Not only do dividend growth stocks deliver above average returns compared to non-dividend payers, they do so with below average risk.  According to this study, absolute returns and risk-adjusted returns are superior for stocks that pay dividends.

2.  Dividend investors continue to receive steady income from their portfolio without having to sell their shares.  This is particularly comforting during bear markets.

3.  Most fixed income strategies for retirees will likely ensure that they lose purchasing power to inflation over time.  Income from dividend growth stocks, on the other hand, can help offset inflation.

4.  Because of the dividend tax credit, dividends withdrawn from your non-registered portfolio are taxed at much more favourable rates than other income.  Depending on the province, tax on dividend income can be as low as 7% if your income is between $30,000 and $60,000 a year.

5.  With share purchase plans, investors can buy shares directly from the company without paying brokerage fees.  With a dividend re-investment plan, all dividends are re-invested in new stock, which can include fractional shares, at a significant discount and with no trading commissions.

As we saw with the recent Yellow Media debacle, dividend stocks are hardly a sure thing.  But rather than chasing yield, investors can do well by purchasing dividend growth stocks when they are value priced and holding them for the long term.

Dividends may not be the only way to return cash to shareholders, but it’s hard to ignore the significant part they play in overall market returns.


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