Since the credit crisis of 2007, central banks around the world have pushed interest rates to historic lows in an attempt to stimulate economic growth. That has led investors to develop an appetite for dividend paying stocks.
So, what are dividend stocks and why should they should be a part of your portfolio?
To understand what dividend stocks are, you have to understand the difference between owning and loaning. If you buy a fixed-income investment, such as a bond or a GIC, you are making a loan to a borrower. The borrower typically agrees to repay you the capital and pay you interest over some set timeframe. However, the interest rate is typically fixed and you may find that over time inflation has eroded the value of your capital and income.
When you buy a stock, you are buying a part ownership in a business. Stocks represent a claim on the business’s assets and earnings. A dividend is a portion of a company’s earnings that is returned to shareholders. A well-managed business should grow over time. As earnings increase, management have the option of increasing the dividend.
Why do some businesses offer dividends while others don’t? Businesses that offer dividends are typically ones that have progressed beyond the high growth phase. When businesses no longer benefit sufficiently by reinvesting all of their profits, they usually choose to pay out a portion to their shareholders. Dividends make holding the stock more appealing to investors and can over time increase demand for the stock and therefore increase the stock’s price.
Consider the following example: In 2005 BCE Inc. (TSE:BCE) paid an annual dividend of $1.32. In 2015, the company paid its investors an annual dividend of $2.60. In the same period, BCE’s stock price has risen from around $25 to $58.
When monitoring their portfolios, investors should think about total returns. Total investment returns include both dividend income and capital gains. Some stocks pay no dividends, but may offer the potential of capital gains. On the other hand, high yielding dividend stocks may offer limited capital gains potential. A well-diversified portfolio should include both.
Traditionally, investors with modest portfolios have held dividend stocks inside mutual funds. Over the past decade, investors have moved billions of dollars out of mutual funds and into exchange traded funds. Why are ETFs popular? Low management fees are the main reason. ETF fees are in the 0.5% range, compared with 2% to 3% for many large Canadian mutual funds. However, ETFs can expose investors to unexpected risks.
We believe that investors can benefit from our three-part value investing strategy. In our view, it is the best way to reduce risk and volatility and earn consistent returns over time. Our diligent, patient and opportunistic approach has served our clients well, through good and bad markets:
- Appraise the intrinsic value of each company over a business cycle;
- Seek long-term growth of capital by investing in companies that we perceive to be mispriced;
- Utilize a margin of safety to promote return of capital…not just return on capital.
Why does our value investing approach work? The prices of well-established, high-quality stocks tend to rise over time as the companies create value for shareholders.
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The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.