ou might be familiar with the dividend investing strategy. It's about purchasing stocks from companies that consistently pay good dividends and holding onto those shares unless you decide to acquire more.
Now, how does a dividend growth strategy function? Well, companies that not only pay dividends but also show consistent year-over-year growth, cover their expenses, and generate increasing cash flow are ideal for dividend growth investing. These companies typically gradually raise the dividends they offer to shareholders because of their ongoing growth.
While methods can vary among practitioners, the core of the dividend growth strategy typically includes a mix of the following:
Consider Swiss food company Nestle as an example of a strong dividend growth stock. Over the past few decades, Nestle has consistently increased its cash dividend. An investor who only made an initial stock purchase and never bought more shares has received growing amounts of money from their share of Nestle's sales in various products worldwide, including coffee, tea, and chocolate.
Net present value is like adding up the future value of something, but in today's money. It works on the principle that money you have now is more valuable than the same amount in the future.
Now, picture this: You have to decide between two stocks for your investment. Which one would you pick?
If you're into the dividend growth investing strategy, you might lean towards choosing Stock B over Stock A, assuming everything else is equal. It might seem a bit surprising, but you could end up receiving larger total dividend payments by owning Stock B compared to Stock A. This is because Stock B's net present value is higher, allowing more money to work for you in the long term.
This remains true as long as the continuous growth can be sustained over a significant period. As the earnings rise and the dividend keeps pace with the profits, the yield-on-cost (dividend compared to the price paid) begins to surpass that of the slower-growing company.
Yield-on-cost is a ratio that helps you assess the dividends you receive in relation to the price you paid for a stock. It's a useful measure for individual investors, though not widely used by others.
At some point, a company may reach its full potential, and there's limited room for smart reinvestment of the surplus money it generates each year. In such cases, management that prioritizes shareholders will give back the extra funds through dividends or buying back company stock.
Look at companies like McDonald's and Walmart for examples. In their early expansion years, their dividend yields weren't very high. However, if you had bought their stock, you would have seen a decent dividend yield on your initial investment within 5-8 years, depending on the period.
Consider this scenario: Would you feel more secure owning a company that currently pays a smaller dividend but is consistently growing its sales and profits each year, or a company that pays a large dividend now but is experiencing a slow decline in its core business? If you believe there's added protection in the successful and growing enterprise, this investing strategy might be worth considering.
This approach holds some wisdom. In the United States, particularly, a board of directors is unlikely to increase the dividend if they anticipate having to cut it soon. Therefore, an increased dividend rate per share often signals confidence from those who closely monitor the company's income statement and balance sheet.
Earning passive income from growing dividend stocks can be more financially advantageous compared to other investments. This is because qualified dividends, often seen in these stocks, are taxed at a lower rate than ordinary dividends, which are taxed as regular income.
Equally important is the benefit for heirs when these stocks are held in taxable brokerage accounts. When you pass away and leave these stocks to your heirs, the cost basis is adjusted (stepped-up), making it advantageous for them. For example, if you bought $10,000 worth of Starbucks at its IPO and it grew to $750,000, your heirs can inherit it tax-free (assuming it falls within estate tax limits). When they sell it for $750,000, they won't owe any capital gains taxes, as they can consider the cost basis to be $750,000.
Earning passive income from growing dividend stocks can be more financially advantageous compared to other investments. This is because qualified dividends, often seen in these stocks, are taxed at a lower rate than ordinary dividends, which are taxed as regular income.
Equally important is the benefit for heirs when these stocks are held in taxable brokerage accounts. When you pass away and leave these stocks to your heirs, the cost basis is adjusted (stepped-up), making it advantageous for them. For example, if you bought $10,000 worth of Starbucks at its IPO and it grew to $750,000, your heirs can inherit it tax-free (assuming it falls within estate tax limits). When they sell it for $750,000, they won't owe any capital gains taxes, as they can consider the cost basis to be $750,000.
To estimate the potential return on your investment, you can check the yield of similar investments. If you're following a dividend growth strategy, it's helpful to compare companies to a dividend stock ETF. For example, if a dividend ETF has a yield of 2%, you might consider looking for individual companies with a dividend yield of at least 2%.