Being a dividend investor is among the easier ways to invest in stocks.
When people are young, goals like beating the market and becoming rich tend to dominate their thinking.
But later in life, goals like having plenty of income for retirement and never running out of money move up in importance. Stocks that pay dividends move up the list of “best stocks.”
Many investors, including myself, have found that investing in companies that pay regular, reliable, and growing dividends is the easiest way to meet the basic test of investing as laid out by Warren Buffet and others:
How much cash are you going to get, when are you going to get it, and how sure are you?
Dividends Provide Regular Income
It may seem obvious, but because dividends are direct payments, they completely bypass the stock market. They are transactions between a company and its shareholders that the market is not involved in.
The absence of the market from dividend distributions is one fact that makes dividend investing easier.
Dividend payments are completely uncoupled from the stock’s price. Prices go up and down all the time at the whim of traders, but dividend companies declare and increase dividends on their own schedules.
Dividends and prices do have a common source, namely corporate earnings and cashflows.
Unfortunately, however, the way the stock market works is that Mr. Market sometimes spins his Hot and Cold dials, taking stock prices through irrational swings that have nothing to do with the actual business success of the companies being traded.
Let’s look at an example. PepsiCo (PEP) is an iconic dividend-growth (DG) stock. It has an extraordinary record of not only paying, but also raising, its dividend every year for decades, as shown on this display.
In fact, for a dividend-focused investor, the term “stock market” takes on a different meaning. The market isn’t a scary, mysterious place. It is simply a store where you can buy, and occasionally sell, stocks.
You do not go there to engage in trading battles.
Dividends Help Relieve Obsession over Market Volatility
Dividend stocks help alleviate this self-defeating impulse by providing real dollar returns that arrive in cash.
On the following 20-year chart, Pepsi’s dividend payments are shown in orange, while its price is blue.
Here is the largest circled area expanded so you can compare Pepsi’s price action (controlled by Mr. Market) to its dividend returns (sent directly by the company).
But its dividend rose 20%. The negative market action had no impact on Pepsi’s decisions to raise its dividend twice while its price was crashing.
I held Pepsi during that period, and I can say from personal experience that those two dividend increases made it easier to continue holding it. In fact, I still hold those same shares today.
Dividend investors are, to a degree, set free from constant concern about stock prices. They are insulated from the fear of falling prices by the cash that the company sends their way every quarter.
If you sell a stock when its price is falling, then wait too long to get back in when the market reverses, you will underperform the stock itself. That’s the way the market works.
The net result of that behavior is to be in cash too much. Being in cash instead of the stock means that overall performance lags what it would have been had the investor simply held onto the stock.
Refer back to the PepsiCo graphs above. The ride on the orange line is smooth and positive. It generates no fear. The only real unknown is how much Pepsi will raise its dividend next year. It is a near certainty that they will raise it.
With a great dividend stock like Pepsi, there is little temptation to sell when its price drops. I barely know what Pepsi’s price is on a monthly (let alone daily) basis.
What I do know is that my income from Pepsi goes up every year, and its capital value (based on its price) goes up over time too.
Dividend Investing Allows You to Set Realistic Goals that Can be Tracked
There is risk, of course, in every investment. Corporate dividend policies are not contracts, nor are dividends guaranteed.
Nevertheless, compared to stock prices, dividends are far more reliable and predictable.
Hundreds of companies have a long history of increasing their dividend regularly. I have put four of the best dividend stocks on this display to show what they all have in common: Annual dividend growth.
You Do Not Have to Sell the Stock to Get the Dividend
As we saw earlier, this helps you bypass the irrational intermediary – Mr. Market – that stands between you and your stock’s price. You do not have to worry about what he is up to. You will get your dividends no matter what.
In contrast, if a stock pays no dividends, you can only realize returns if you sell the stock. Combined with media hype about what the stock market is doing minute-by-minute, that leads many investors to be deeply concerned about stock prices.
That concern makes investing harder, because prices go down almost as much as they go up.
Dividend investors, however, often see stock shares not as lottery tickets, but rather as proof of ownership in cash machines that generate streams of income.
You do not have to dispose of shares to realize that income. That is important, because receiving dividends does not deplete the number of shares that you own.
All of your shares remain in your portfolio after you receive each dividend payment. In contrast, a sold share is gone, and it can no longer benefit you.
Dividend Growth Companies Are Usually Outstanding Businesses
Dividends cannot be faked. A company must have cash to pay them.
Dividend-growth companies are typically strong enterprises with:
- Proven, time-tested business models.
- Steady growth in revenue and profits.
- Sustainable competitive advantages (called moats).
- Reliable generation of excess cash above and beyond what the company needs to thrive and to grow.
Whether my stocks’ prices go up or down, I know I will receive some of their earnings every year directly from them.
If you build a strong portfolio of great dividend-paying stocks that regularly increase their dividends, you can arrive at retirement with a significant income stream paying an enormous yield on your original investment.
You may be able to switch over from a salary paycheck to a "dividend paycheck" seamlessly. And you may be able to finance a comfortable retirement without needing to sell any of your assets.