Dividend investing is a style of investing that focuses on investing in shares that make regular, high and/or growing dividend payments to shareholders.
This investment style recognises that dividends are a reliable source of return and that mature companies that are growing well are able to sustainably pay good and growing dividends.
In rising markets, this style of investing may underperform the growth style that targets companies using all their earnings to grow quickly. However, stable returns over time compound and can deliver good returns for longer-term investors.
This style of investing is typically characterised by lower volatility as the shares are defensive or hold up well during bad economic times or market downturns.
This style of investing may be used in actively managed or passively managed investments.
Dividend index tracking funds
There are two main indices, each tracked by a fund available to South African investors:
This index selects the 30 shares listed on the JSE with the highest expected dividend yields for the year ahead.
The weighting of the shares in the index is based on their forecasted dividend yield.
This index consists of companies listed on exchanges in Canada, Europe, Pan Asia and the United States that not only have a high dividend yield, but have consistently paid dividends over a number of years.
Actively managed dividend focused funds
Active managers who follow the dividend investment style target shares that pay good dividends, but not necessarily the highest dividends and are selective about which shares they include.
Active managers recognise that a share may have a high dividend yield when the share price is falling because the company is in difficulty but is still maintaining its dividends.
Companies under financial stress often end up cutting dividends to conserve cash or repay debt. The dividend suspension warns investors that all is not well and these shares typically underperform.
Active managers may look for shares with more moderate dividend yields that are likely to grow those dividends over time, rather than the highest dividend yields. They may focus more on finding a quality company with a strong balance sheet and good return on capital invested in the business, as these kinds of businesses are more likely to pay good dividends on a sustainable and growing basis.
Active managers may also seek to diversify their holdings into sectors or regions that are not typically paying high dividends. For example, the IT (information technology) sector or the US may be under-represented when the focus is purely on dividend yields. IT companies typically prefer to use their earnings to grow the company rather than pay dividends and in US companies are incentivised to buy back shares rather than pay dividends.
Any investor can follow the dividend investing style.
However, many funds with a dividend focus target investors, such as retirees, who require an income. Dividend focused funds can make dividend payments on a regular basis to provide an income and the volatility is low, which is good for investors who are drawing an income.
