A little theory

In this first commentary we take a look at the theory behind dividend investing. For numerous sources of information on dividend investing, see the sites DRIP Investing Resource and The Dividend Guy .

Some history

The idea of preferring shares that pay a dividend is not new. Dividends have always represented an important source of income for investors; see FinanceandInvestments.blogspot . Some of our readers may recall an investment concept in the 1960’s called the Nifty Fifty, which entailed investing in the stocks quoted on the NYSE which paid the best dividends;  see Wikipedia .

Investing for dividends is the new "new" thing. I do not remember seeing as much interest in dividend investing since it was hot in the early 1960s. At that time, this investment philosophy search resulted in the creation of the "Nifty Fifty," which was comprised of the 50 must-own stocks "because of their dividend yield. Source: Researchstock.com

An investment strategy

Dividend investing is an investment strategy (in general, see Wikipedia ) that is often similar to value investing ( see Wikipedia ), but the two have their differences:

Income investing and value investing are two methods of making money from stocks. One way attempts to buy stocks Undervalued sure to take off. The other method attempts to get into stocks that are paying out a monthly income to their stock holders. Which one of these two is the most profitable? Well each strategy has one big weakness and one big strength. Value investing Which Involves buying strong companies Whose Stocks are Undervalued has one major advantage. When you look at the long-term results of this strategy it really does work. Great companies with good fundamentals will almost always beat the average stock market return over the long term. This means that it can be worth your while to look at the company. Things like the PE ratio and the price to book ratio are very important ways of measuring how well a company will do in the long term. However there is one big disadvantage to value investing. Investing for value is a very long term approach, you may have to hold a stock for 20 years or more to see any real kind of return off of that equity. The real benefit of buying great dividend paying stocks is that you can start to see money as soon as you buy it, without waiting such a long time. Because stock will pay a consistent dividend buying good quality stocks dividend helps to produce an income Whether or not the stock goes up. However dividend investing has one big pitfall of its own, it takes a lot of money to make money. Combining these two strategies is probably a much better option then just doing one. As a stock appreciates over time so does the dividend Which means the income it produces also increases. In short each of these strategies is comes up short where the other is beneficial. It can take some time to get a plan like this to work. But it can be a very powerful long-term way of saving. Source: StockInvestingStrategies ( as PDF doc.1448).

Components of your total return

The return on equity investments consists of dividends and of capital gains; see Hussman( or as  PDF doc.1449 ) and Investorsfriend ( or as PDF doc.1450). Institutional investors are concerned about the total all-in return of an investment, and, subject to tax issues, are typically indifferent between receiving their return as cash dividends, capital gains or in the form of share repurchases. However it seems that institutional investors still often prefer shares that pay at least a nominal dividend. In the U.S. this behavior may be  due to legal constraints,  now repealed but which, through  inertia, continue to affect behavior; see Kristine Watson Hankins "The Effect of fiduciary standards on institutions' preference for dividend-paying stocks" ( or in PDF doc.1451 - page 1 only) .

Some investors are comfortable utilizing investment strategies that deliver small, positive, consistent returns. Dividend investing is one such strategy, where investors are frequently rewarded for holding a portfolio of the best dividend stocks, by receiving regular cash dividends. Source: SeekingAlpha ( or as PDF doc.1452 )

Bear markets

Unlike institutions, for many retail investors the composition of a stock’s total return is important. They often look for a small, stable, recurring cash return and worry less about  a decline in the current price of a security (as if  a price decline was not real loss until realized by disposing of the share, to wit the expression paper loss; see Investopedia and  MotleyFool or as PDF doc.1453 ). Therefore, dividend investing is particularly popular in bear markets:

Annual total returns are the sum of annual price appreciation and the yearly dividend yield. When stock markets are booming, investors tend to forget that stocks represent right to ownership of real companies, and instead treat them like lottery tickets. During bull markets all investors care about is finding a greater fool to their bid stocks higher, while completely ignoring fundamentals. During bear markets however investors get timely reassurance from their stocks in the form of dividends, which lower investment losses. While capital gains could quickly evaporate and turn into losses, dividends are real cash that is deposited to your brokerage account. Investors could then decide how they plan to allocate it best for their individual needs. Source: DividendGrowthInvestor ( or as PDF doc.1454)

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