When it comes to investing and the stock market you will hear many different perspectives. It’s important for us, particularly those of us new to the market, to understand these different perspectives and what people mean when they say terms like growth investing, value investing and dividend investing. Today we will look at dividend investing so we can understand how it works and figure out whether this is the right investment approach or philosophy for us.
Dividend investing is a rewarding investment approach centred around purchasing stocks of companies that regularly distribute cash payments to their shareholders as a token of appreciation for owning their stock. These dividends not only offer a consistent income stream from your investments but also complement the potential growth of your portfolio as the stock value increases over time.
We can liken dividend investing to owning land for rental income. It is focused on the cash flow generated by the assets (shares) we own. The simple premise is to invest in shares that will pay out consistent amounts of cash which we can reinvest or use for other purposes.
Key Points about Dividend Investing
Cash Payouts
Dividends are payments made by corporations to their shareholders. When you own stocks that pay dividends, you receive a share of the company’s profits as income. In Zimbabwe, the best you can expect is semi-annual dividends (twice a year), though the Caledonia Zimbabwe Depositary Receipts listed on the Victoria Falls stock exchange and the Tigere Real Estate Investment Trust (REIT) payout quarterly dividends.
Frequency and Growth
An important distinction with dividends is that they are not mandatory, save for the Tigere REIT. Dividends are voluntary payments and some companies do not pay out dividends. Dividends can be paid from the company’s retained earnings or in the form of additional equity shares (dividend in specie).
Example
For instance, if you invest in a company offering a 3% dividend per share, owning 200 shares worth $100 each would grant you $600 in dividends. The calculation is: ($100 share price * 200 shares) * 3% = $600. This is before the dividend withholding tax.
Dividend Reinvestment Plans (DRIPs)
Some companies offer dividend reinvestment plans (DRIPs), allowing shareholders to reinvest their dividends to acquire more shares instead of receiving them as cash. This can be advantageous, especially when dividends are relatively small or if you own a limited number of shares.
Dividend Safety
One of my favourite things about dividend-paying companies is a sign of short-term health. Assessing dividend safety involves comparing a company’s earnings to its dividend payments and considering the stability of the industry it operates in. That said companies pay dividends out of abundance.
Dividend Investing Strategies
There are two primary dividend investing strategies: high dividend yield and high dividend growth rate.
High Dividend Yield
High dividend yield focuses on slow-growing companies with substantial cash flow, offering immediate income. The dividends are high as a percentage of the share price paid to access them. In Zimbabwe, dividend yields average around 1%.
High Dividend Growth
High dividend growth centres on rapidly growing companies with low current dividends but the potential for significant income growth over time. This is done through observation and extrapolation to estimate future dividends.
Tax Benefits
Dividends are taxed at 10% which is lower than income tax and corporate tax. If you are in the practice of buying shares for the short term to receive dividends you will need to be mindful of the capital gains tax on shares held for shorter than 270 days going up to 40% of the proceeds. This will impact the profitability of this strategy.
Dividend investing is a prudent approach for investors seeking both stable income and potential long-term growth from their stock portfolio. By carefully considering the safety of dividends and choosing the right strategy based on individual preferences and risk tolerance, investors can benefit from this rewarding investment method.
