People generally pick an investing style or philosophy they’re comfortable with, ranging from growth styles to value styles across a wide spectrum. Most investors readily admit that they invest in order to grow their wealth through capital gains. Fewer investors think of relying on a dividend strategy to grow their asset base, as dividend investing is often viewed more like a retirement strategy to obtain income during one’s golden years.
However, perhaps it may be time to look more closely at this assumption. A dividend investment strategy should not only be viewed as one of income, it should be recognised as one that could offer a good margin of safety and also help to grow your overall portfolio through compounding. Companies chosen for their dividends often display resilient characteristics, and the dividends received may be reinvested in order to organically grow the total portfolio value over time.
Let’s explore how this works and how investors can harness the power of a dividend investment strategy.
Choosing stronger companies
A strategy involving companies that pay dividends inherently means there’s a focus on choosing financially robust companies, as these usually have track records of paying good dividends over time. Such companies generally have strong balance sheets that are able to tide the company over through tough times, along with management who emphasize paying out a dividend to reward loyal shareholders. Thus, choosing companies with defensive balance sheets that are willing to pay dividends during good times and bad makes for an overall stronger portfolio.
A focus on the ability to pay out dividends
When focusing on a company’s ability to pay dividends, investors usually look at the free cash-flow-generation ability of the company, as well as the company’s debt levels. Companies able to pay dividends over a sustained period of time should be able to consistently generate good levels of free cash flow, and they should also be prudent in managing their debt levels. These aspects also act as a natural filter, screening out companies with overly-aggressive growth plans, or those that are debt-heavy.
The compounding effects of dividend reinvestment
Finally, the most powerful aspect of a dividend strategy is the ability to reinvest the dividends received back into the portfolio, thus growing it slowly but steadily. By funneling part of the received dividends back into the market by buying more shares of dividend-paying companies, the investor is effectively growing both his portfolio size and his future dividend income stream. By rinsing and repeating this process over the years, investors can then build their portfolios to a sizeable balance.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.