I regularly get this question from readers.
And I want to share with you why I invest for dividends.
You see, if investing is all about finding companies that grow fast, then why not find companies that reinvest all their money (instead of paying dividends) into growing faster?
By looking at dividend growers, you can miss out on the next Amazon, or the next Facebook.
But here’s the thing, for every winner like Amazon, there are more than 10,000 failed companies. Think about this.
These companies tend to be very vulnerable to market disruptions early on.
If there’s no sustainable business models, it could fail very, very fast. Look at GoPro, BlackBerry and Nokia.
You see, most stocks don’t thrive for 70 years in the S&P 500 Index. These companies have either gone bust, fallen out of the index, or merged along the way.
In fact, the average lifespan of companies in the index fell from 30+ years (during 1970s) and is projected to be just less than 20 years (in the 2020s). That’s market disruption.
These “growth companies” grow very fast. But they just aren’t sustainable.
Many of these businesses fall from the top to the ground, flat.
Credit: Business Insider, CLSA/Innosight
Here’s the other thing.
More often, finding these growth stocks means you need to spend hours after hours reading pages of data.
It’s tough if you’ve a family, a full-time job or simply want to spend your retirement years playing golf or travelling.
And it’s highly unlikely you’ll be able to consistently spot these companies at the beginning. If these companies don’t turn profitable – the stock gets wiped out. You might get wiped out.
A fellow reader said this: “During 2020, I followed a guru who recommended Peloton, even at $108 per share, saying it has strong growth potential. I trusted his expertise, and I bought 100 shares. However, I got busy with work, and when tech stocks crashed in 2022, I lost almost 80% of my investment in the stock.
..I realize I want to focus on more stable, reliable investments that give me passive income. I read about dividend investing through Dr. Wealth and the Smart Investor, which led me to your blog.”
Credit: Google Finance
Peloton was all about growing fast (look at 2017-2020 revenue growth)…
But has never been profitable…
You can choose to invest in growth stocks. But you need to own a couple hundred of them to diversify your risk.
That’s what venture capitalists and early-stage investors do — They invest in a massive basket of stocks and start-up investments. Let’s face it. Most of these investments are going to fail.
Even professional investors who run hedge funds hire a team of analysts to surgically analyze each stock.
It’s hard for the average retail investor to do that.
Even then, these professional investors also struggle — often fail trying to bet the next big winner.
So… how would I invest for dividends?
Rising dividends – that’s a hallmark of financial excellence
Before a decision to raise dividends, management must believe there are prospects for higher earnings in the future. It takes layers of decision making before a dividend gets paid.
No manager will stick their heads out to raise dividends, if they feel poorly about its company’s future earnings.
By sending you a regular check in your letterbox, it shows you a business has sustainable earning power and strong financial health.
And sustainable earning power means large shareholder returns.
In the study shown, each stock is classified into 6 different categories. You’d notice that categories with Dividend Payers and Dividend Growers & Initiators produced the highest returns.
Simply, if you’d invested $100 in either category, you’d have made $8,756 or $14,118 respectively over the past 50 years, much more than stocks in the other categories (including dividend non-payers, cutters and eliminators).
Rising dividends boost share price over the long run. Because the stock market sees rising dividends as a form of potential value and a good predictor of future growth.
Even in Asia, excluding Japan, dividends (see green chart below) have been a big driver of stock market performance.
This means, we’re in the best location and time to compound our stocks for the long run.
I buy stocks for the long term. My ideal holding period is many, many years.
That’s why, I want to pick high-quality companies that pay dividends, that have a sustainable business model – Coca-Cola’s secret recipe, Costco’s unique membership, McDonald’s franchise model and so on.
This keeps their enormous profits gushing (hint: shares go up this way — not hype), monster dividends growing.
Meanwhile, I stay away from loss-makers, high growth “glamour” stocks, or companies that take on huge leverage.
Because the stock market sees rising dividends as a form of potential value and a good predictor of future growth.
This is why I do what I do — I invest for dividends.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan
