As the stock market has taken investors on a roller coaster ride during the last few years, many people have begun to ask "what's the point?" Tired of the risks, many have shifted to more conservative investments like cash, bonds, and treasuries. Despite the ups and downs of the past 10 years, the stock market still offers the single greatest opportunity for passive income and capital appreciation available to the individual investor.
For more information on this investing style, one excellent read is a book entitled The Single Best Investment: Creating Wealth with Dividend Growth. It will demystify dividend investing in a way no other book you have read ever has.
Choosing dividend growth stocks is important for several reasons, which are outlined below:
- You can't fake a dividend. Recent history has proven that certain disreputable companies are capable of, and in certain circumstances have used "creative accounting" to mask serious cash flow and earnings issues. A dividend offers some fraud protection to the investor as the company cannot pay out profits that only exists on paper.
- Dividend payouts are very investor friendly. Certain corporate behaviors are seen as being highly favorable towards investors, such as stock buybacks (when the company purchases back shares, thereby increasing the price), and dividend payouts (in which the company pays out a percentage of earnings to shareholders). These types of activities indicate a corporate structure that favors investors.
- Reinvested dividends have accounted for approximately 40% of stock market index appreciation in the past century. Reinvesting dividends is a great long term strategy. As the dividends are paid out, the investor can use the money to purchase additional shares often without being charged a commission. The reinvested dividends then compound, resulting in an increasing number of shares during the next quarterly payout. This can result in huge earnings over time and offers the power of compounding during rising and falling markets.
- Dividend paying companies have an artificial stock price floor. If a healthy and profitable company pays a dividend to investors, and the stock falls out of favor in the markets, the dividend can often prevent the stock from dropping too far, unless the company reduces the dividend payout (which is rare in healthy dividend payers). In a dividend paying company, when the stock price drops, the dividend yield increases, which in turn attracts investors who are lured in by the larger payout per share.
- Dividends are a passive income stream. Investing in dividend paying stocks now, and reinvesting a consistently increasing payout offers the power of compounding dividends, share price appreciation, and the opportunity to shift from dividend reinvestment to a source of passive income in retirement.