Dividend Growth Investing - A Beginner's Guide - Trade Brains (2024)

In this article, we are going to discuss Dividend Growth Investing. First of all, if you are not familiar with the meaning of dividends and want to learn what exactly are dividends, their pros and cons, please read this article. I’m confident that it will be helpful to you.

Today, we’ll take our earlier dividend investing discussion to the next level and understand what exactly is dividend ‘growth’ investing and why it is an amazing tool to make money from the share market for the passive investors. Here are the topics that we’ll discuss in this article:

What is Dividend Growth Investing? And how it differs from Dividend Investing?

Dividend investing in an old and proven formula for receiving money from your investments and building wealth. It means buying shares of those companies which pay good dividends.

When you invest in dividend stocks, you get this money directly credited in your bank account as dividends. By purchasing stocks, you’re a shareholder of that company. And hence you can enjoy the hard work of the CEOs and their employees of big corporations and earn dividends.

Next, dividend growth investing is a sub-set of dividend investing. However, the major difference is that here investors not just look at the high dividend-paying companies but also at the growth rate of the dividends and the company.

As growth is the measure of financial health, Dividend growth investing involves collecting the shares of fundamentally strong companies with a high annual dividend growth rate. As a thumb rule, the growth rate should be equal to or higher than inflation.

For example, if a company gave a dividend of Rs 10 per share last year, Rs 11 per share this year and expected to give a dividend of Rs 12.5 per share in the next year, this company can fall into this category. Anyways, the dividend growth investors look at more than at least five years of growth history while picking the stocks. Moreover, the dividend growth will not always be a linear curve but will be full of ups and downs. Nevertheless, the overall trend of dividend growth should be positive.

In short, the dividend growth investors do not want just a high dividend but growing dividends over time.

Dividend Growth Stocks Characteristics

In which scenario will you be able to sleep better?

Knowing that you’re getting high dividends right now, but the dividends may fall in the future as the company is saturated. Or, the other scenario where you are getting decent dividends and have confidence that it will pay more dividends in the future as the company is continuously growing its revenue and profit.

A few characteristics of the Dividend Growth Stocks are:

1. A strong business model with a well-managed and reliable board of directors.
2. History of a shareholder-friendly company i.e. a company with regular dividends and no dividend cuts.
3. Dividends continuously growing for the past few years.
4. Strong Financials: Continous healthy growth in Topline and the Bottom line of the company’s income statement and cashflows.

These are the signs that reflect the company’s ability to grow and maintain solid cash flow to give regular dividends to its investors.

Examples of Dividend Growth Investing Stocks

For example, if you want to understand dividend growth investing, here are the examples of a few stocks whose dividends have been continuously growing for the past couple of years:

This table shows the Adj. Dividends Per Share for the given stocks from 2014-19 | (Data Source: EquityMaster)

Benefits of Dividend Growth Investing

We all know that holding good stocks for the long term can help build a huge portfolio. But what if we get regular dividends along with it. This can reduce the burden of timely selling your stocks to book profit. As dividends are continuously pumped in your account, you do not have to worry about the stock market price fluctuations. Moreover, here dividend re-investing can create wonders.

Here are a few of the common benefits of dividend growth investing:

1. Dividend growth investing can be a major source to build long-term wealth to create passive returns.
2. They can help you to get returns no matter how stocks are performing. And hence, dividend growth investing helps to avoid the biggest threat of getting no returns because of stock underperformance.
3. Investors also get tax benefits while investing in dividends. It helps in minimizing taxes as dividend tax rates are lower compared to the regular capital gain taxes. Dividend earning up to Rs 10 lakhs is taxfree in India.

How to get started with Dividend Growth Investing?

There is a common misconception that high dividend yield means high returns. However, this may not be true and sometimes high yield may also represent a depressed stock.

Dividend Yield vs Dividend Growth:

Dividend yield = Dividend per share / Stock price per share

High dividend yield can be either because of an increased dividend payout or decreased share price. If the yield is high because the share price of that company has fallen significantly, it may also represent a value trap. Here, the stock may appear as a value stock because of low valuation. However, the main reason for its low valuation can be its poor performance or bad future prospects. Overall, high yield doesn’t refect a fundamentally strong dividend stock.

Further, also check the dividend payout while researching dividend growth stocks. Payout should be sustainable and growing. If a company offers a solid record of increasing payout per share on an annual basis, it is way better than a company giving a high dividend for just that year.

Dividend payout = Dividends per share / Earnings per share

As a thumb rule, a very high dividend payout is dangerous as it means that the company is giving away the majority of its profits as dividends and not retaining enough. A company generally distributes the majority of profits only when it does not have much growth investment opportunities. Typically, a payout ratio of more than 80–85% may reflect a dividend fall or cut in the near future.

Also read: How to Plan Your Passive Income The Right Way?

Summary

Dividend growth investing is an insanely powerful way to build passive wealth by investing in stocks. Moreover, as most dividend growth investors are long term investors, time is their best friend. A few common factors to check while investing in dividend growth stocks are dividend yield, payout ratio, and dividend growth rate. Apart, the company should also be well-managed and should have a decent financial growth rate.