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6 Reasons To Invest In Dividend Growth Stocks

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  Because of the dividend tax credit, dividends withdrawn from your non-registered portfolio are taxed at much more favourable rates than other income.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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12 Comments

  1. My Own Advisor on November 7, 2011 at 5:54 am

    Nice post!

    In support of #2, I love the fact you get staying power during market volatility.

    If your entire reason for holding a stock is the prospect of selling it at a higher price in the future, good luck, because who knows what stocks those are and when that will happen. Falling prices are the exact opposite result you’re going for and the market is going to have them from time to time.

    However, if your stock pays a dividend, if it is an established company, you may be earning a return comparable to or even better than what you can get on fixed income investments; as you sit and wait for the market to rebound. You’re getting a solid return on your investment even as the price of the underlying stock gyrates with the market; but the company is still making cash from its earnings.

    What’s not to love? 🙂

    • Echo on November 7, 2011 at 10:22 am

      @My Own Advisor – I love getting paid to wait, and with a growing dividend it’s that much sweeter.

  2. PKamp3 on November 7, 2011 at 9:01 am

    The problem with dividends (in the United States) is the huge advantage a stock buyback presents, tax-wise. The profits earned to pay dividends are taxed, then the dividends themselves are taxed again when they are paid out (Taking it further, they can be taxed again at death, but I’m being facetious).

    Dividends are great if you are receiving them, however. They’re incredibly sticky – it’s hard for a company to cut a quarterly dividend because dividends have tradition built into them. Dividend cuts also cause a huge number of income investors to flee a stock.

    • Echo on November 7, 2011 at 10:24 am

      @PKamp3 – Dividends are taxed quite favourably in Canada (outside of a registered account). I agree that dividends are sticky, there is an expectation to continue to pay them, and grow them if the company has a tradition of doing so.

  3. Kevin on November 7, 2011 at 10:16 am

    Great article. Unfortunately, there is an error in your header when I try posting to Facebook… the word Growth is misspelled. Thanks… I will post to Facebook when this is corrected !

    Dividend Growrh Stocks: 6 Reasons To Invest

  4. krantcents on November 7, 2011 at 2:18 pm

    Good points, I am starting to shift some of my investments to dividend funds over the next year because I am 5.5 years away from retirement.

  5. cashflowmantra on November 7, 2011 at 2:57 pm

    I too am thinking more and more about dividends. I think the stocks do well because they don’t tend to lose as much during bear markets so don’t have to recover as much. Dividend stocks seem defensive in nature

  6. Addicted2dividends on November 7, 2011 at 6:41 pm

    Did someone mention dividends?!

    I love how dividend paying stocks rebound so quickly when the markets drop compared to non-dividend paying stocks.

  7. the Paperboy on November 9, 2011 at 8:42 pm

    Dividends are amazing, not only due to the fact that they can help smooth out the market ride but because they are so versatile. In the early stages of the game they can be used to purchase more equities through DRIPs (or manually) and then later on the funds can be diverted when necessary, all while holding the shares of the company and sharing in the capital growth.

  8. Richard on April 18, 2013 at 12:34 am

    Dividends are attractive for various reasons like you pointed out. I like to invest in stocks that pay dividends because they are generally safe investments. Dividends can indicate that the company is financially healthy.

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