Dividend investing is one way to accumulate wealth through the power of compounding. In this case, compounding can be explained simply as the on-going process of “earning from an investment, and putting back the earnings into the stock or reinvesting in other companies”.
When a company earns profits, there are a few ways to distribute their corporate earnings:
Fund the company’s R&D segment
Retain or save it for future use
Passed on to shareholders as dividends
Regarded an indicator of the company’s earnings, regular dividend payments tend to reflect positively on the company’s performance and its future prospects. This will in turn strengthen the trust of current shareholders as well as attract potential investors. In fact, one of the characteristics of a blue-chip stock is that it belongs to a company with long records of paying stable or rising dividends1.
Most dividend-paying companies tend to be well-established businesses with large market capitalisation, commonly found in sectors such as Telecommunications; Basic Materials; Financial; Healthcare/ Pharmaceuticals; Utilities and Consumer Staples2.
There is risk involved in every strategy, and dividend investing is no exception. One of the biggest risks in dividend investing is that dividend cuts may and can happen. In a worst-case scenario, companies can either stop paying out dividends or reduce the amount it pays out. During the pandemic, some of the most established stocks have done so, including prominent global names such as Goodyear Tire & Rubber, HSBC, Airbus and Rolls Royce3.
With this being said, I believe that portfolio diversification should always be top of mind for any investor. Anyone who only focuses on high-yielding dividend stocks will likely miss out on strong growth potential in regions and industries that are not paying out high dividends right now.
A company undergoing rapid expansion usually will not pay dividends because it would want to invest as much as possible to fund further growth. For example, young and fast-growing tech companies generally do not pay dividends.
With so much uncertainty in the markets, you will certainly need a well-diversified portfolio spread across different sectors and asset classes. Do connect with me to see how we can better adjust your current investment strategy.