One important lesson I’ve learnt after investing for 16 years now is this: Dividend investing is not what you think it is.
The thing is, many people believe the way to invest in dividends is simply owning a portfolio of “high dividend yielding” stocks.
But this is a paradox of investing that few people realize. And I find this very dangerous.
After I gave a seminar on investing one evening, a very senior man walked up to me.
He owned just five stocks in his portfolio. All five had high dividend yield. He thought he could retire on them. Yet, he told me all his stocks in his portfolio were losing money.
I asked: “How come?”
He said all of his stocks paid him high dividends. But every year, his money kept dropping.
When I dug further, I realized the companies he bought weren’t doing well in the first place — falling revenues, declining earnings and shrinking free cash flow. Yet the companies somehow could still pay him dividends.
For example, you buy a stock called Hutchison Port Trust at US$0.50 in 2016. Back then. It had a solid, high dividend yield of 12%.
But what comes next is this. As you collect your 12% dividend yield every year, Hutchison Port Trust shares kept falling year after year.
Today, Hutchison Port Trust shares are only worth US$0.22. That’s a 56% drop. All the fat dividends you’ve collected were simply compensated for the capital losses. That was what happened to that man.
I see many people making this same mistake — owning companies like Hutchison Port Trust.
The Power of Double Compounding
Now, this isn’t a new concept coined by me. It’s a long-forgotten strategy that is the bedrock of my financial blog.
Instead of looking ONLY at “dividend yield”, I’d focus on the modern way of dividend investing – a dividend growth investing strategy.
I was inspired by a lady called Geraldine Weiss, who co-founded a financial newsletter called Investment Quality Trend in 1966.
She started to advocate about dividend growth investing. She was even nicknamed the “Grande Dame of Dividends” and “The Dividend Detective”. Some even called her the Queen of Blue Chip.
I learnt the true potential of a dividend growth investing strategy is considering total return, not just high dividend yield.
Total returns mean you consider dividend yield. But you also want to pay attention to capital gains and dividend growth.
Total Return = Capital Gains + Dividend Growth + Dividend Yield
And the growth potential of a total return portfolio is the only reason for investors to invest in stocks.
Why dividend growth is so powerful
It provides stability in the market.
When the market goes down, dividends become more and more important because it is the value investors hold when they own stocks. That’s why people say dividend stocks don’t fall as much as other stocks do. It’s true. I mean, look at our Singapore bank stocks and high-quality Singapore REITs – surprisingly resilient.
Another reason is because of the one thing that destroys the purchasing power of our money — inflation.
When your portfolio grows out of both capital gains and dividend growth, it beats inflation. Even in Asia, dividend stocks continue to compound and multiply your wealth.
Even in Asia, dividend stocks continue to compound and multiply your wealth.
This is important if your portfolio is going to provide you with a source of stable, safe and passive income.
Unlike Hutchison Port Trust, a solid dividend grower not only produces consistent profit margins, it generates enormous free cash flow.
This free cash flow allows companies to buy back its shares, but more importantly pay bags of dividends year after year. That’s how you achieve a high dividend yield.
For instance, If you’d buy JNJ stock at US$38 in the 2000s, you’d be getting a ~13% dividend yield on cost today – based on US$5.14 per share dividend paid over the past year.
Even after 30%-tax, your long-term yield is still 9% dividends.
Not too bad. Not too bad.
Your capital gains also grew from US$38 to US$237 today – 523% gains since early 2000.
Dividend investing isn’t just buying yield. What we should be doing is look at stocks which give both dividends AND capital gains.
So, don’t just buy stocks based on “high dividend yield”. I make sure my portfolio has a healthy dose of capital gains, dividend growth and dividend yield.
