Dividend investing has always been an attractive investment strategy to Singaporeans because it generates passive income for us. It is a popular way to earn additional income, or build your investment portfolio towards retirement. Especially during periods of market volatility, high dividend stocks have historically outperformed the market with less volatility.
Let’s explore how dividend investing can help you achieve your financial goals.
What is dividend investing?
Dividend investing refers to choosing stocks from companies that are able to pay out relatively high and consistent dividends. These corporations are usually established with a strong history of stable earnings.
Learn more about how REITs and stocks differ in dividend returns here.
How is a dividend payout calculated?
For example, company X pays a S$0.50 annual dividend per share of a stock.
If you own 1000 shares of company X for $10 each. Your total investment value would be $10,000. Over the course of a year, you would receive a dividend payout of $500 ($0.50 x 1000 shares). If the share price stays at $10, that would mean a yield of 5%. Dividend payouts can be paid at different times — typically quarterly, semi-annually, or annually.
How do you identify good dividend stocks?
There is no ideal number for a good dividend payout ratio as it is dependent on the sector that the company is in. Instead, look out for companies that give a consistent and stable payout ratio.
Again, there is no ideal number for a good dividend yield. More importantly, if you do find a company with high dividend yield, look further into the company’s underlying financial strength to determine its ability to generate consistent payouts in the future.
Dividend growth rate
This is a less common measurement but a good gauge of a company’s future dividend growth. If it has a strong history of dividend growth, it signals that the company is profitable in the long term and future dividend growth is likely.
Benefits of dividend investing
Generates passive income
Being able to secure investment returns from payments is one of the biggest benefits. This makes it more attractive than growth investing. Even though growth stocks may have larger capital appreciation, returns are not realised unless you sell your investment holdings. With this additional source of income, it can help you to meet your financial goals in the short term as well.
Less volatility and lower risk
During periods of economic instability, stable, dividend-paying companies tend to endure economic downturns better than other companies because of their strong financial foundation. This explains why they usually have a long record of reliable and stable growth, even if it is slower. With less volatility and lower risk, dividend stocks are hence great for capital preservation while earning passive income from dividend payments.
Dividends grow together with company’s profits
Some may be turned off by the idea that dividend stocks are boring. Still, if you invest in a dividend paying company with increasing profitability, your dividends grow steadily, giving you the freedom to use that growing passive income. Here are some examples of top dividend-yielding companies (including REITs) of the Straits Times Index (STI) in Singapore.
Dividend investing is no sure bet
To be clear, dividend payouts are a variable amount or percentage of the share price.
Companies may have a dividend policy that serves as a more assuring guide, but it is not guaranteed. That means dividends can be skipped or lowered.
Investors should also keep their eye out for companies that have been raising their regular dividend payouts and are running sustainable businesses that justify the payouts. If a company is not profitable, it will have less available funds to fund the dividend payouts. It is very important for investors to look closely at the financial status of the company. Some unprofitable companies may be seen to be giving a stable payout but that is artificially looking as such because the share price has been falling, thus boosting its yield figure.
Ensure that dividend growth is financed by increasing profits of the company instead of debt. A company may choose to take on a new debt in order to pay a special dividend to private investors or shareholders, also known as dividend recapitalisation. There may be a risk that the company is unable to withstand the additional debt.
When a company decides to reinvest their income, the money will be pumped back into the business to boost the company’s growth. Investors who want in with the sole intention of getting dividends back may be disappointed, unless they are convinced that the money should be reinvested to accelerate growth, which promises stronger dividends later.
Finally, when companies do not meet their expected earnings or are facing diminishing earnings, the stock price falls as investors dump the shares. That means lower capital gains.
Dividend investing strategies
Dividend investing can be a very powerful and sustainable investment strategy for passive income. To optimise your dividend investments and tackle the risks, here are some tips.
Invest in companies with stable payouts, rising dividend growth rate
Since dividends can face the risk of getting cut, there is no guarantee that you will receive a stable payout. However, you can lower this risk by focusing on a company’s ability to increase and consistently distribute dividends instead of its dividend yield.
One easy way is to study a company’s financial profile:
- Total revenue: tells us the ability of the company to sell its products
- Net income: tells us the ability of the company to make profit
- Cash flow from operating activities: tells us the ability of the firm to pay off its liabilities
This would be a signal that the company is profitable and has a healthy cash flow to keep a steady dividend payout.
Building your dividend investment portfolio with Endowus funds
Besides investing in single dividend stocks, you may consider investing in dividend yielding funds as well that give you a diversified exposure to various sectors or markets. Here are some of the higher yielding funds you can invest in with Endowus through our Fund Smart solutions. Find out more about these funds from our webinar.
For more income options, you may also explore our Income Portfolios.
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