The true investor will do better if he forgets about the stock market and pays attention to his dividend returns and to the operation results of his companies.’ – Father of value investing, Benjamin Graham
A well-known fact in the stock market is that dividend stocks provide stability to investors’ portfolios during the volatile periods.
The stability of these stocks in an investment portfolio has proven the importance of dividends to investors time and again.
During periods of economic uncertainty, when growth stocks are crashing, dividend stocks can provide investors with a steady income and a moderate return on investment.
Why is this the case?
In this editorial, we will look at the benefits of investing in dividend paying stocks.
#1 The Management’s Perspective
Paying dividends is beneficial for companies too. It provides an incentive for the management of companies to increase earnings, so they can pay an even higher dividend next year.
If they are successful, more investors will be attracted to the stock, which in turn, takes the company’s share price higher.
The interest of the management and shareholders are aligned. Both want higher dividends so the focus is always on higher profits to pay dividends from. This is positive for the stock price.
So, this is the reason why academic studies have shown dividend paying stocks provide higher returns than non-dividend paying stocks over long periods of time.
#2 Importance of Cold Hard Cash
While rising stock prices is important to all investors, as well as traders who are long on the market, the gains are ‘on paper’. One needs to sell to book profits.
Booking profits might feel rewarding but if the stock continues to rise, there will be a sense of having missed out.
Also, the ups and downs of the market provides only an abstract feeling of profit or loss to investors.
On the other hand, the cash flow provided by dividends is concrete. It’s cash directly transferred from the company’s account to the investor’s account. Shareholders who receive regular dividends never get a sense of missing out on the company’s profits.
Additionally, nothing can provide a better signal to the market that the company is doing well than a steadily rising dividend.
After all, if the company isn’t doing well, it wouldn’t be able to raise its dividend.
#3 Corporate Governance
It’s easy to understand the link between rising dividends and rising profits. The two go hand in hand.
But what is often not appreciated enough is the link between regular dividends and good corporate governance. The two also go hand in hand.
You see, a company may fudge its accounts but it cannot fudge the cash in the bank. In fact, it won’t be a stretch to say that the company’s cash position is the only thing that can’t be tampered with via creative accounting practices.
Thus, a company that regularly pays dividends and has a history of increasing the per share dividend amount, is less likely to tamper with the books.
Of course, this is not a rule set in stone. A fraudulent management determined to cook the books will do so no matter what. But in most cases, a steadily rising per share dividend is a positive check mark as far as corporate governance is concerned.
#4 Inflation Protection
Dividends are the lifeblood of many investors because they can help offset inflation and even provide an income during retirement.
Dividend stocks also have the potential for value appreciation. They can thus bring a dual benefit in the long run.
This provides an additional way to beat inflation. Not only does the stock provide income during inflation but the stock price appreciation can also help offset inflation.
Conclusion
It’s no wonder dividend paying stocks are also considered to be a good buffer for one’s portfolio during times of market volatility and economic uncertainty.
However, dividends are not the only way to assess a company’s fundamentals. Other factors like growth, industry dynamics, debt levels, government policies, etc, all play their part.
Investors should evaluate these companies’ fundamentals, corporate governance, and valuations of the stocks, as key factors when conducting due diligence before making investment decisions.
Having said that, you won’t go wrong by starting your search for good stocks by screening for dividend paying stocks.
If you want to dig deeper into dividend investing, use Equitymaster’s powerful stock screener to check high dividend yield stocks and dividend growth stocks in India.
Happy investing.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here…
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