When you invest in stocks, you have the potential to earn money when you sell your shares at a higher price than you paid for them. Dividend-paying stocks do something extra ─ they pay part of the company’s earnings to investors as dividend income.
Key takeaways:
- Dividends are a portion of a company’s profits that are paid to investors (i.e. shareholders) on a regular basis. This may provide a source of income.
- Dividend income can help offset declines in share prices.
- The growth potential of dividend income can help minimize the impact of inflation.
- Dividend-paying stocks have outperformed the wider market over the long term.1
- Some risks of investing in dividend-paying stocks include the discontinuation of dividend payments and the general risks associated with investing in stocks.
FAQ
What are dividends
Dividends are part of the profit a company pays to investors (i.e. shareholders). Dividend-paying stocks can provide a regular income stream as well as the opportunity to earn capital gains.
What kinds of companies pay dividends and why?
Dividend-paying companies are typically well-established companies with stable businesses that are able to share a portion of their profits with their shareholders. Conversely, more nascent or smaller companies may prefer to reinvest their earnings to grow their business rather than pay dividends.
How often do companies pay dividends?
The company’s board of directors sets the amount and timing of the dividends. Most often dividends are paid once, twice or four times a year.
How do dividend-paying stocks perform compared to the broader market?
Shares of dividend-payers have historically offered more stable performance than the broader market. Companies that are able to pay dividends to their shareholders are usually financially strong businesses with healthy cash flow. This can help make these stocks less susceptible to sharp price changes
As the charts below illustrate, the shares of companies that pay dividends have historically outperformed the index.
Dividend-paying stocks have outperformed over time*
Additionally, shares of companies that pay dividends have historically shown lower volatility.
Dividend-paying stocks have displayed lower volatility over time*
What role can dividend-paying stocks play in investors’ portfolios?
Dividends play a key role in long-term returns
Investors can take the dividend payments in cash or re-invest them. Reinvestment of dividends allows investors to accumulate shares without paying a commission. Also, investors can gain long-term benefits of the compounding. The chart below shows how reinvesting the dividends can significantly improve the total return of the investment over time.
Dividends have consistently and significantly contributed to total returns, year after year
Growth of $10,000 invested in S&P/TSX Composite Index
An investment cannot be made directly into an index. The graph does not reflect transaction costs, investment management fees or taxes. If such costs and fees were reflected, returns would be lower. Past performance is not a guarantee of future results.
Can dividends help protect investors from inflation?
Yes. Dividend yields are often higher than the inflation rate. In times of high inflation, some companies will even raise their dividend payments. But higher than average dividend yields may not always be a positive sign unless the company is in good financial health. Some companies may not be able to sustain the higher dividends and their stock price may become more volatile.
What are the risks of investing in dividend-paying stocks?
The payment of dividends is not guaranteed. Market conditions and company-specific activities can influence whether dividends will be paid, reduced or increased. In assessing the risks of the dividend-paying stock, due diligence on the company’s financial health and motivation for paying dividends can provide important insight on the level of risk of the stock. For example, if the company is paying a high dividend amount, close analysis can reveal if this is due to increasing profits or stock price weakness (i.e. when stock prices drop, dividend yield goes up and may be less sustainable).
How do I invest in dividend-paying stocks?
You can invest in individual dividend-paying stocks. Another option is to invest in mutual funds or exchange traded funds. These investments offer the advantages of a diversified portfolio of dividend-paying stocks in one ticket solution. They also provide ongoing professional money management.
Over the past 46 years, dividends have contributed an average of 3.2% per year to the S&P/TSX Composite Total Return Index, representing approximately thirty percent of the average annual total return.
While no one knows exactly when markets will move up or down, dividend income can help deliver consistent cash flow to investors. It can also provide exposure to the compelling growth opportunities that are emerging amid solid corporate earnings and improving global economic growth. Dividend paying equities can also offer a yield premium over Canadian government bonds and may offer more favourable tax treatment.
Dividends give your portfolio a head start