Dividend growth is a stock investment strategy aimed at making money more from the dividends paid to stockholders than from selling the stock at a profit. The strategy is sometimes also known as value investing. Successful dividend growth investing requires successfully predicting which industry sectors and specific stocks will pay high dividends in the future, as well as analyzing when it may be safer to take a profit by selling the stock. One key to this is to look at the underlying reasons why a particular company is currently paying high dividends.
All other factors being equal, a company paying high dividends will be one making large profits. As dividend growth investing is usually a long-term strategy, investors will usually be looking for companies that can offer high dividends consistently. This usually means finding a company that is likely to make a steady level of profit rather than one that is making extremely large profits but may be more volatile.
Picking such companies is a complex matter, but there are several factors that are common. Generally, a firm with a steady profit level will be one that is clearly established in a market. It will deal in a product or service that will likely always be needed rather than one subject to short-term fashions and trends. It will also have few or no long-term debts, meaning that revenues can go toward dividend payments rather than being eaten up by repayments and interest.
Many value investors use mathematical analysis to pick suitable stocks for dividend growth. The simplest and best known is the price-earnings, or P/E, ratio. This ratio simply compares the current stock price with the earnings-per-share, which is calculated by dividing the company's latest annual profits figure by the number of shares that have been issued. The theory is that the lower the P/E ratio, the better value the stock is for an investor prepared to hold on to it and get future dividends. This theory does assume that the company pays dividends that reflect its profit levels.
Some companies intentionally pay higher dividends than would be expected given their financial performance. This is usually done to attract investors and keep the stock price high, but can also be a way for major shareholders to access money from the company. In the short term, such companies can be useful as part of a dividend growth strategy, but the dividends may not be sustainable, meaning the high dividends cannot continue indefinitely. One way to spot such firms is to check their cash reserves: If a company is continually paying excessive dividends, its cash reserves will steadily decline.
