When it comes to the investing game, you’ll often be bombarded with advice and tips to diversify your portfolio. That’s great advice, to be frank. But there are so many types of ways that you can diversify that sometimes, you just want to fork out money and forget about your investment for a time. That’s where dividends come in. With dividends, you don’t have to bend your back looking at charts and graphs all day long. Having a wide range of dividend-payout-eligible shares on your portfolio will make for a nice and fluffy bonus come the payout date.
That being said, it’s not quite as simple as throwing money at a company to buy its shares and then expecting to reap the (monetary) benefits. Here are a few quick tips and concepts about dividends to keep in mind when you plan on diversifying your portfolio.
All About That Yield
Contrary to our headline, a high dividend yield (DY) doesn’t always necessarily mean that it’s a good thing. While a high DY could indicate a high return on your investment, it could also conversely mean that a stock price has decreased significantly since its dividend announcement.
To calculate the dividend yield, simply look for the ratio of dividend per share (DPS) with the current stock price. While we’re on the subject of ratios, also keep an eye out for the payout ratio as any (ratio) above 80% could indicate that the company has allocated too much earnings per share (EPS) to the payout which can limit future growth. Likewise, a lower ratio here could mean that the company is looking to reinvest its earnings to potentially increase its dividend payout in the future.
The formula for Payout Ratio is Dividend per Share (DPS)/Earnings per Share (EPS).On the other hand, dividend reinvestment plans (DRP) are programs that automatically uses your entitled dividend value to buy additional shares that are most times, usually offered at a lower price than the market price. This could be a great way of expanding your bags if you plan on investing long term in this particular company.
Lastly, a stock price is an excellent indicator of dividend sentiment. After the ex-dividend date, the stock price should naturally fall — theoretically by the DPS amount as stocks traded on or after the ex-date no longer have the dividend entitlement attached. Therefore, they are not worth as much unless there are other factors in play.
Let’s move on to dividend procurement strategies, for which there are two main types — dividend capture and dividend growth.
Dividend Capture Strategy: This strategy involves buying shares and stocks shortly before their ex-dividend date and immediately selling those stocks shortly after their ex-date. This strategy ensures that you will “capture” the dividend payout while also “getting rid” of those potentially low-earning stocks in the process.
Dividend Growth Strategy: Contrary to the dividend capture strategy, this strategy is more suited towards long-term investing. The idea here is to build a portfolio of shares in companies that have the potential for stable growth in the long term and to hold these shares for long periods of time to recoup your initial investments while also gaining some profits in the process.
Some criteria to take note of when picking any company for dividend growth strategy is to pick companies that increase their dividend payout each year at a rate at least equal to the national inflation rate. Also, check that these dividends are paid using actual profit and not debt.
These are the companies that tend to be more established businesses with larger amounts of assets in their books like financial institutions such as Maybank, Public Bank, etc. or REIT companies like IGBREIT. And since you’re investing for long-term growth, you’ll be less prone to be influenced by market fluctuations and FUD.
But while this strategy seems safer and less volatile, you may find a good chunk of your funds being held up by these stocks. As such, a better plan may be to use a combination of both capture and growth strategies so that you can dip your toes into short-term investments while also earning a steady stream of profits in the form of long-term assets.