Investing in dividend stocks [2023]

If you already invest, then investing in dividend stocks probably has your interest. Investing in dividend stocks is a great way of investing because it can contribute to 2 aspects: the compounding effect can go hard, and you can see dividends as passive income if desired. Are you also interested in investing in dividend stocks? Read on soon!

Psst: before we get started and discover what investing in dividend stocks means, investing involves risk. You know that, right! You may lose some of your deposit. So never invest with money you can’t afford to lose. Read more about the risks of investing here.

What is a dividend?

Dividend is a portion of a company’s profits, which is given to shareholders of a company. In this way, shareholders are thus rewarded for their investment in the company. There are several types of dividends. After all, dividends are nothing more than shareholders’ rewards for their confidence in the company.

There are usually two conditions that companies must meet in order to pay dividends over the long term. First, companies must make profits that they can distribute to shareholders, because without profits, there is often no money to pay dividends. The second condition is that the company has no other, better uses for the money. How the company wants to reward that shareholder is entirely up to them.

The most common form of dividend is payment in cash. With cash payouts, shareholders receive an amount for each share they own in the company. Companies may also choose to issue additional shares instead of cash.

How much return does investing in dividend stocks yield?

That depends on how much dividend a company pays. Dividend investing can be hugely interesting because it allows your compound interest to go even harder. Dividends can also provide passive income. Suppose you have €250,000 invested in dividend stocks that pay 4% dividends per year, so you get 4%*€250,000= €10,000 per year paid on your shares every year.

Thing is, companies that pay dividends are seen as a steady investment. After all, a company must be able to make a profit in order to pay dividends. In this article, we will show, using an example of the S&P 500 index, how much more return you can make by investing in dividend stocks.

Why invest in dividend stocks?

Money machine, anyone! In addition to benefiting from price appreciation and the compound interest effect with investing, investing in dividend stocks can boost your wealth even more. And this is because of the following:

Dividend stocks provide income.

If you as an investor have a stock that does not pay a dividend then you only make a profit if you sell shares. Stocks that pay dividends provide money that you can reinvest, save or spend. Making money just by making a (one-time) investment.

Dividend stocks may have greater earnings growth.

According to U.S. research, companies that pay dividends have high growth rates in their earnings. This is because companies that do not do so are more likely to waste money on projects that do not initiate growth. So dividends can cause management to have to make sharper decisions. This, in turn, often benefits the company’s profitability.

Dividend stocks have greater earnings quality.

The majority of companies issue dividends only if they feel they can handle it financially. This creates a natural selection in which the healthiest companies pay dividends, and the less healthy ones do not. Just very briefly.

Dividend stocks are easier to evaluate.

This is because it is easier to estimate a company’s future dividend than its future stock price gain.

And the disadvantages of investing in dividend stocks?

There are so-called dividend aristocrats: companies that have been paying steady dividends for years, such as Shell. But Covid-19 taught us that even the name “dividend aristocrat” is no guarantee. Indeed, Shell cut its dividend for the first time in April 2020.

In addition, if you receive a lot of dividends, you have to be keen on tax rules, especially if the dividends are from America, for example. You may be dealing with dividend leakage. Read what that means here.

How much dividend is real?

Of course, this varies from company to company. It is interesting to look at dividend ratio. This is the following:

Dividend ratio = (annual dividend per share / current price per share) * 100%

So if you have a stock worth €50, which paid €2.70 in dividends last year then the dividend ratio = (€2.70 / €50) * 100% = 5.4%

For many investors, the dividend ratio is an important aspect. Simply because it shows how much money will flow to them in return for their investment. The higher the dividend ratio, the higher the return on your investment. Companies that pay dividends can be categorized into 3 groups:

Low dividend ratio

These are companies with a dividend ratio of less than 2%. These are often companies that focus more on growth than on delivering dividends to shareholders.

Medium dividend ratio

Companies with a dividend ratio of 2-4% fall into this category. These are often stable companies with a safe dividend ratio but also an amount of growth.

High dividend ratio

These are the companies with a dividend ratio of 4%+. As a result, they are also the stocks favored by investors seeking dividends. Stocks with a dividend ratio of 10%+ are often considered risky by the market. Indeed, these types of dividend ratios are often unsustainable over time. The disadvantage of high dividend stocks is that sometimes there is little money left over for the company to invest in growth. Some companies are already so big and don’t need to grow anymore, so always look at it carefully on a company-by-company basis.

Why don’t some companies pay dividends?

Not all publicly traded companies pay dividends. Some companies make a profit but want to invest it to grow, this is called growth stocks.

Compounding: example

High dividend stocks generate a nice income. The dividend can then be used to live on or can be invested in new shares, increasing future dividend income. The compound effect is then going to take place. Example:

You buy 10 shares of €10 each. Per share you get €1 dividend, so in period X (how often a company pays dividends varies, some quarterly, some annually) you get €10 dividend. From this dividend you can buy a new share. Then you receive dividends on 11 shares, and with that dividend, you can buy another share. You buy 10 shares once, and with the dividend you build up your portfolio, then you receive more and more dividends. Money machine on point.

Dividend shares

There are many companies that pay dividends. But how do you find stocks that suit you? That’s a question only you can answer. Read this article for more tips on how to build your own stock portfolio.

Looking at the AEX index, an index of companies listed in the Netherlands, the following stocks pay dividends:

PostNL = dividend ratio 13.55%
Randstad = dividend ratio 9.7%
SBM Offshore = dividend ratio 6.9%
ING Group = dividend ratio 6.7%
ASR Netherlands = dividend ratio 5.6%
NN Group = dividend ratio 5.6%
Royal = dividend ratio 4.1%
Unilever = dividend ratio 3.9%
Note! Dividend ratios may change. For example, Shell, which paid dividends for years, stopped doing so in 2020 because of the Corona crisis. Do your own good research to see what current dividend yields are.

Dividend ETFs

The disadvantage of investing in single stocks is that there is so much choice. There are more than 40,000 companies worldwide you can invest in, just fish out the gems. If you don’t feel like doing complicated analysis on companies and constantly monitoring the market, you can also choose to invest in dividend ETFs. For example:

Vanguard FTSE All-World High Dividend Yield UCITS ETF (Code VHYL)
SPDR S&P Gbl Div Aristocrats UCITS ETF (Code ZPRG)

Where can you invest in dividend stocks?

You can easily invest in dividend stocks or ETFs at BUX Zero and DEGIRO, among others.

The difference is that at BUX Zero you can make a free trade in EU stocks and ETFs. Buying stocks from the US is also free. However, the range of stocks and ETFs offered at BUX Zero is smaller than at DEGIRO. DEGIRO does allow you to purchase 1 ETF from the core selection for free every month.

So the choice you make for a bank or broker depends on what you are going to invest in, how often you are going to invest and with what amount you are going to invest. So creating a personal investment strategy is crucial. Elfin’s Starting to Invest e-course will give you tools to create your own plan.

Read all about investing in ETFs here