Dividends are quite important for investors and stocks alike. Here are some of the most important benefits that dividends may offer to investors.
Profits from Growth and Expansion
Perhaps one of the most obvious and biggest advantages of investing in companies that pay out consistent dividends is that dividends usually grow over time. Big, well-established companies usually increase their dividend payouts every year.
There are market risks or inherent risks associated with any equity investment. Stocks may go up and down, which means there’s no guarantee for profits. But dividends provide at least a partial return on investment that is essentially ensured.
Most investors don’t realize the large impact of dividends on the stock market profits. Dividends have accounted for nearly half of most investing profits in the companies that make up the S&P 500. What this implies is that the inclusion of dividend payments has almost doubled what stock investors have realized in returns on investment as compared on what their returns would have been barring dividend payment.
Important in Equity Valuation
Dividends also offer a useful point of analysis in terms of equity valuation and stock selection. Using dividends when valuing stocks is usually a more effective evaluation metric than other more commonly used items like price-to-earnings ratio.
Most of the metrics that investors and analysts use when valuing a stock come from the company’s financial statements. One potential problem from this is that companies can and sometimes will manipulate their financial statements via accounting practices to improve their image in the eyes of investors.
Dividends, on the other hand, provide a solid indication whether a company is doing well. In other words, a company needs to have real cash flow to make a dividend payment.
Lowering Risks and Volatility
When it comes to overall portfolio risk and volatility, dividends play a crucial role in that the payments mitigate the losses that take place from a decline in stock price. However, there are more risk reduction benefits than that.
Based on studies, dividend-paying stocks largely outperform non-paying stocks during bear market periods. Even if an overall downward drag pushes the stocks across the market, dividend-paying stocks typically suffer fewer declines in value than non-dividend-paying stocks.
When you own dividend-paying stocks, you also substantially decrease overall portfolio volatility. In a 2000-2010 comparison report of dividend-paying companies versus non-dividend-paying companies in the S&P 500 index proves a marked contrast in the degrees of volatility.
The beta of dividend-paying stocks during this period was 0.98, less than the overall market average. The beta of the other stocks during the same period was 1.48, indicating a much higher volatility rate than the overall market average.
Capital Purchasing Power
Dividends also help in terms of the effects of inflation on investment returns. Before an investor realizes any genuine net gains from an investment, that investment must initially provide enough return to offset and overcome the loss of purchasing power that is the result of inflation.
If you own a stock that hikes in price 3 percent over the course of a year, but inflation sits at 4 percent, then you actually suffered a 1 percent loss. On the flip side, if that same stock also offers 3 percent dividend yield, then the investment has actually returned a profit that outpaces inflation and gives an actual gain in buying power for the investor.
