Harnessing the power of dividends

So a stock pays you less than a dollar a share. Are those pennies really all that important? Maybe more than you think. Long-time strategic investors look particularly for stocks that keep their dividend payout ratio constant. As the company grows, so will the dividend.

Dividends_StocksThere are lots and lots of ways to tell a beginning investor from a more experienced one. How they react to dividends is one. Sometimes it’s not the size of the dividend that matters so much as its very existence.

To give a simple example, Waste Connection Inc. (TSX—WCN) common shares pay a dividend of US$0.62 a share each quarter. “Sixty-two cents,” a novice investor might say. “What can you do with that?”

Seasoned investors, though, tend to give dividend payments more of the respect they deserve. Partly, that relates simply to the fact that the company pays a dividend at all, of whatever level, versus other companies that don’t. If you divide the common stock universe into two groups—those that pay dividends and those that don’t—you’ll find the stable, blue-chip high-quality stocks predominantly among the former.

Payout ratios matter, too. The dividend payout ratio is the amount of dividends a stock pays to shareholders compared to the amount of money a company makes. It’s calculated by dividing the dividend per share by earnings per share.

A company with a relatively low ratio, such as Waste Connections, which pays 38 per cent of its earnings out in dividends, should have the flexibility to pay out a higher percentage of its earnings as it matures. It’s just that the company is reinvesting most of its earnings in its business right now. This, in turn, should help it increase its profits, share price and dividends down the road.

More mature companies that pay out high levels of earnings in dividends and reinvest less in their business have less room to grow their dividends and share prices in the future.

Dividend growth investing strategy

Dividends, then, no matter how small, are attractive because they have the potential to increase over time. Often, they increase faster than the rate of inflation. Meanwhile, the adjusted cost base of the shares you purchase, of course, remains constant.

Take, for example, a purchase of Royal Bank shares in 2007. Back then, Royal traded as high as $61.10 a share, and as low as $48.60. So let’s suppose you bought shares at the mid-point of those two prices, or $54.85. Based on a then-dividend of $1.82 a share, your yield would have been 3.32 per cent.

However, Royal’s dividend has increased over time, to where today it’s $3.48 a share. If you still held your shares purchased in 2007 at a cost of $54.85, your yield today would be a very handsome 6.34 per cent on your original purchase price. This is why we advocate a buy and hold strategy for dividend-paying common shares. They should get more respect than they do.

This is an edited version of an article that was originally published for subscribers in the August 18, 2017, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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