Investing in stocks and shares represents an opportunity to put financial resources into companies willing to pay investors for the privilege of using their money. There are essentially two ways to look at stocks and shares: growth investing and dividend investing. Investors who choose dividends do so because they are looking to maintain a substantial cash flow not achievable with a growth strategy.
To make this easier to understand, consider two companies offering the same number of shares to investors. At the end of the year, Company A pays 50% of its profits to investors in the form of dividends and puts the remainder back into the company to generate growth. Dividend investors will be thrilled to put that cash into their bank accounts.
Company B's strategy is different. They pay no dividends, choosing instead to turn around and put all their profits back into the company. Dividend investors receive nothing in terms of cash flow while growth investors should see the value of their shares go up as growth is realised.
Making Money in Dividends
It is obviously possible to make very good money with both growth and dividend investing. But those who choose dividends pursue a specific strategy for generating wealth. The idea is to purchase the right stocks to start with, then use the yields from those stocks to partially fund new acquisitions.
The key here is annual cash flow. All other things being equal, the growth investor must liquidate some of his/her assets in order to put money into new stocks and shares. The dividend investor does not. He or she can hold on to well-performing stocks while using annual dividends to purchase new stocks. Dividend investors have an advantage in that they also benefit from growth. This allows them to compound their yields year after year.
Choosing Which Stocks to Buy
Getting rich by compounding dividend yields is a long-term strategy that must be undertaken with the understanding that companies paying significant dividends are not likely to see the same kind of growth as others that put all of their profits back into their own operations. So choosing the right stocks is key.
Investors need to consider why a company might be offering high dividends to shareholders. High dividends can mean:
- a company is currently undervalued
- attracting new investors is more important than growth
- a company does not expect a high return should they reinvest profits in growth.
A company offering high dividend yields as a result of being undervalued would be a good candidate for dividend investing. At some point, the undervalued stock will probably correct itself, thus adding to growth along with paying dividends. On the other hand, investors should be cautious about a company offering high dividend yields to attract new investors. They may have cash flow problems of their own.
In order to find attractive dividend stocks, start by looking at the top performers on the London Stock Exchange, Dow Jones, S&P 500, and Nikkei 225 Stock Average. You are looking for high performing stocks with a dividend yield of at least 150% of the average yield for the top performers.
Next, do some research on mutual funds with a heavy concentration on high-performing dividend stocks. Successful mutual fund operators offer free advice on dividend investing just by paying attention to where they put their money.
Finally, look for both dividend achievers and aristocrats. Achievers are companies whose dividends rise over extended periods of time. Yield increases can be gradual, but they historically go up. As for dividend aristocrats, they are companies with dividends that have consistently increased every year for the last 25 years. These are blue chip companies that have been around long enough to take a more modest approach to growth.
A Word of Caution
The title of this post is likely what caught your attention and invited you to read. To that end, it is possible to get rich by investing in a strategy relying heavily on dividend yields. But a word of caution is in order: dividend yields do not guarantee positive portfolio growth over time. No investment does.
Investing in dividend stocks is a strategy best pursued by investors looking for annual cash flow. Dividends can be used as regular income, as a means of purchasing new investments, or a combination of both. Investors who do not necessarily need annual cash flow might do better with a growth strategy instead.
Investing in stocks that pay stable, substantial dividends is one way to earn quite a bit in the stock market. Choose the right stocks and you could do very well for yourself over years of investing. Choose the wrong stocks and you may not do as well as someone else focused on growth.