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3 Ways to Find Great Dividends

It is not uncommon to see investors being fixated on the capital gains of their investments and neglect the importance of dividends. However, that can be a mistake as there are some good benefits that come with dividends.

1. Thing is, dividends to capital appreciation are like bonuses to your normal salary. When you invest in high quality shares, your wealth can be enhanced further through dividend income besides capital appreciation.

2. While commissions and the relevant charges have to be paid when you buy/sell shares, dividends are tax-free in Singapore. Nothing beats a regular and steady inflow of cash that comes with minimal effort, apart from the initial study of a share’s business and the periodic act of keeping yourself updated on the share’s corporate progress.

3. Companies which consistently pay dividends through both good times and bad have some level stability in their businesses. Thus, they are generally viewed to be less risky and the dividends can provide a cushion against wild share price volatility.

The concept of total return

One important notion in investing in the share market is the total return. What it means is that the returns from a share come not only from capital gains, but also through dividends which are paid out over time. In fact, some research has shown that dividends have made up more than 40% of the US share market’s total returns since 1930.

So in short, don’t belittle the seemingly small annual dividend yield – especially if a company has the ability to grow its dividend quickly.

When you invest over the long run, the pace of growth in a company’s dividend can make a huge difference to the total returns you can achieve from your investment.

Consider this fact – when Warren Buffett first bought shares of Coca-Cola  starting in 1988, the company paid less than 8 US cents per share annually in dividends and was giving a modest yield of around 4%. But since then, the company’s dividend has grown by close to 1,300%, giving Buffett more than a 50% yield on his original investment today.

Finding dividend growth shares

Hopefully by now you’d have bought into the idea of the importance of dividends. The next step then comes: How should we find good shares with growing dividends? Here are three simple ways to give you a head-start, though it should also be noted that the pointers below are certainly not the only important things an investor has to look at when it comes to income investing.

1. Search for companies with a record of uninterrupted dividend payments over the past 10 years.  The rational is simple: Companies that have been paying solid dividends for a decade or so are likely to continue paying good dividends. One great example is Keppel Corporation Limited (SGX: BN4). The shipbuilder and property developer paid its first dividend of 2.5 Singapore cents in 1989 and over the next decade, it paid a dividend every single year. In 1999 (10 years after 1989), Keppel Corporation paid out 5.5 cents; some 14 years later, that dividend has ballooned by 630% to 40 cents in 2013.

2. Find companies which have a history of growing their dividends. In particular, look for shares which have consistently increased their dividends annually – or if you’d like to loosen the criteria, every two to three years.

3. The sustainability of the dividends paid is also essential when it comes to finding good dividend shares. In some cases, companies may declare a high one-off high dividend which isn’t sustainable over the long run. To get a better feel for that sustainability, look at a share’s payout ratio (dividends to net earnings) and make sure it does not exceed 100% too frequently.  A good example of a share with a relatively low payout ratio is Singapore Telecommunications Limited (SGX: Z74), or more popularly known as SingTel. The telecommunications giant has a dividend policy of paying out between 60% and 75% of its underlying net profit as dividend

Foolish Bottom-line

In summary, investors have to keep in mind that dividends play an important role in helping deliver superior investment returns from the share market. And, an effective way to harness the power of dividends would be to look for shares with safe and growing dividends – on that front, there are clues in a company’s finances which can help you find such shares, like I’ve shared earlier.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo doesn’t own shares in any companies mentioned.