Topic: Dividend Stocks

What are dividends? A guide to investing in the best (dividend) stocks around

February 2, 2017|by Pat McKeough

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What are dividends worth? Canadian dividend stocks can produce as much as a third of your total return over your investing lifetime.

Dividend stocks rarely get the respect they deserve, especially from beginning investors. That’s because a yearly 2% or 3% or 5% dividend barely seems worth mentioning alongside possible yearly capital gains of 10%, 20% or 30% or more.

But dividends are far more reliable than capital gains. A stock that pays a $1 dividend this year will probably do the same next year. (It may even raise the rate to $1.02).

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What are dividends? A look at stocks that pay dividends

Canadian taxpayers who hold Canadian dividend stocks get an additional bonus. Their dividends can be eligible for the dividend tax credit in Canada. This means that dividend income will be taxed at a lower rate than the same amount of interest income (investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income). Investors in the higher tax bracket pay tax on capital gains at a rate of 25%.

A couple of decades ago, you could assume that dividends would supply up to about one-third of the stock market’s total return. Due to the rise in stock prices since the 2008/2009 downturn, dividend yields are lower than they used to be. But it’s still safe to assume that dividends will supply perhaps a quarter of the market’s total return over the next few decades. That’s a major tax-deferral opportunity, even though taxes on dividends are lower than on interest.

When you add in the security of stocks that have dividend records going back many years or decades, and include the potential for tax-advantaged capital gains as well as dividend income, Canadian dividend stocks are an attractive way to increase profit with the least amount of time.

Ultimately, dividend stocks are good for cutting tax rates and making investors more money.

What are dividends: A sign of investment quality

Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks.

One of the best ways of picking a quality Canadian dividend stock is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. A history of dividend payments is one thing that all the best dividend stocks have in common.

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We look for Canadian dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation, industry trends, etc. to suit themselves. Minor firms can’t do that.

Canadian dividend stocks are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend-payers. That’s why the majority of your stocks should be dividend-payers at all times. As you get older and closer to retirement, you should raise the proportion of dividend-paying stocks in your portfolio, to cut risk and improve the stability of your investment results.

What are dividends with risk?

When looking for stocks with high dividend yields, you should avoid the temptation of seeking out stocks with the highest yield—simply because they have above-average yields.

That’s because a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend. Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have a high dividend yield that they have maintained or raised with their dividends during economic or stock-market downturns. That’s because these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

A track record of dividend payments is a strong sign of reliability and a strong indication that investing in the stock be profitable for you in the future.

Hopefully you are no longer asking what are dividends after reading this article. Do you have any further information to share about dividends? Please add it to the comments.