Dividend investing works at any age

Why the dividend investment is suitable for all age groups

Dividend investing is often described as an income strategy for retirees, but the potential to grow returns over a variety of years and investment styles is severely neglected. Also, this particular investment strategy can be critical to your efforts to build wealth in the stock market.

Below is a stock chart that shows the performance of a company you've probably heard of over the past 10 years.

It's obvious that this stock has done reasonably well, averaging 27% annualized return over the past decade, meaning that an investor's money would have more than tripled if they had held the stock during that period . We'll come back to this company and the lesson it teaches about dividend investing a little later.

IMAGE SOURCE: YCHARTS. AUTHOR'S NOTES.

Benefits of Investing Dividends: A Case Study

It's important to note that dividends are voluntary; the board of directors of a company is not legally obliged to make a recurring cash distribution to shareholders. In practice, however, companies that opt ​​for a regular dividend often also commit to increasing the payout whenever possible.

A large portion of the consistent dividend payers increase their payouts to shareholders annually. These increases increase the dividend yield an investor receives over time, based on a stock's original purchase price. Mastercard is a good example of the increasing "return on purchase price" phenomenon.

The card issuing and payment technology titan has increased its dividend payout by an average of 25% per year over the past five years. Mastercard's expansion in the European market, double-digit growth in cross-border payments, platform innovations and strategic acquisitions have increased cash flow and thus enabled the increases.

If an investor had bought Mastercard stock in 2014, they would have had an initial return of around 0.5% on the annual payout of $ 0.44 per share. The company has now tripled its quarterly dividend - it now stands at $ 1.32 per share per year. If the dividends had been reinvested, the same investor would now earn an annual return of 1.8% based on the original cost of the stock.

Mastercard should teach us wrong about the fallacy that dividend stocks are sluggish. They don't have to be. Despite a market cap of nearly $ 285 billion, Mastercard has behaved like most growth stocks since going public in 2006, generating a staggering total return of 1,750% in 13 years.

The current dividend is only 0.44% due to the enormous price increase. While a patient investor can turn the dividend into an income generator over time by steadily increasing payouts, many shareholders will reinvest the dividend simply because it represents some kind of bonus: stakes in a fast-growing company with no additional investment out of their pocket.

Calm in the storm

The power of increasing returns and reinvesting dividends is also enhanced by the ability for an investor to use dividend stocks to hedge against volatility. Dividend-paying stocks, even those with high growth potential, are often less volatile than their non-paying counterparts.

This is in part due to a valuation metric called the Dividend Discount Model (DDM). This model values ​​a stock using the sum of its future dividend cash flows, discounted to its present value. In simpler terms, it's a way of measuring the value of a company in terms of cold, hard money that is returned to shareholders.

While institutional investors are more likely to use DDM to value a stock, all other investors should understand that the model provides an alternate basis for measuring the value of a stock that complements traditional techniques such as pricing. B. Pricing models based on future earnings. This contributes to the relative stability of dividend stocks when trading in the open market.

In many cases, companies that promise shareholders increasing annual dividends naturally focus on keeping cash flow predictable in order to meet annual, quarterly, and - in some cases - monthly payout goals.

While today's markets are at historic highs, price gains are taking place amid trade disputes, geopolitical uncertainties, and the World Bank's recent downgrade of expected global GDP growth for 2019. So now might be a good time to see if you can add some relatively stable dividend payers to your portfolio before volatility rises again in the quarters ahead.

Economic transformation is fueling traditional dividend stocks

While the US continues to develop from a manufacturing economy to a service economy, dividend payers create opportunities for above-average returns in the face of technological change.

Intuit, for example, which, like Mastercard, is a well-capitalized, dominant industry player who behaves more like a growth stock than a phlegmatic company. Intuit has grown from a provider of desktop accounting and control modules to a cloud-based giant in recent years. With the introduction of subscription models for the popular accounting software QuickBooks Online, the company has achieved an average annual revenue growth of 13% over the past two fiscal years.

At the time of this writing, both Mastercard and Intuit have had a total return of 268% each for their shareholders over the past five years - nearly quadrupling their initial investments when we factor in dividends reinvested. Intuit's dividend yield, while only 0.7%, allows investors to buy more shares in the leading tech company each quarter.

Are you looking for a dividend candidate?

While the moderate growth of the US economy, which has now lasted for years, has continued since the financial crisis, the rail giant CSX has seized the opportunity and taken on more high-quality combined transports and significantly improved its operational efficiency. The stock is up an impressive 180% over the past three years - 193% considering reinvested dividends. CSX stock posted a return of around 1.2%, which is roughly half what it paid three years ago prior to the rapid rise in price.

A visual example of the effects of dividends and one final caveat

Let's go back briefly to the graphic at the beginning of this article. Did you find out which company we are talking about?

McDonalds is hard to imagine, but many investors may be ignorant of the fact that the fast food giant's surge has been linear over the past 10 years or that dividends have had such a noticeable impact on returns. The diagram at the beginning of the article only shows the price development, which is shown in blue below. If we break down the total return over the same period, which is shown here in orange, we can see what an investor could have got.

MCD DATA FROM YCHARTS.

McDonald’s has tripled its shareholders' money in the past 10 years, but with dividends reinvested, the result is five times that: $ 1,000 invested in July 2009 would be worth over $ 5,000 today. A generous, recurring payout to shareholders makes many such companies look like tech stocks over the longer term.

Dividends can be used for sustainable growth that investors of all ages can benefit from - the younger the investor and the longer the holding period, the better. But remember this caveat: No strategy is completely safe. Always do your homework before clicking "Buy". A regular dividend is a signal and not a guarantee that a company has good prospects for sustainable success.

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Asit Sharma has no position in any of the stocks mentioned. It has been translated so that our German readers can take part in the discussion.

The Motley Fool owns shares of and recommends Intuit and Mastercard.

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Photo: The Motley Fool.