“Derek, should I only invest in companies that pay dividends?
To help answer this question it is best to understand what a dividend is in the first place. When I explain this concept to clients I discuss two terms: growth and income. The idea with investing for growth is that you buy shares of a company with the hopes that the shares will increase in value. When investing for income you are hoping that you will receive a regular and recurring payment. Some investments offer both. Let’s examine this further.
A simple example for growth and income investing is to consider the concept of buying a house to rent to tenants. The monthly rent cheque is your “income” and ideally years later you can sell the house for more than you originally paid for it, thus achieving “growth.”
However, rental properties aren’t the only way to achieve growth and income.
I often explain investing in dividend paying companies like buying a rental property. One example of a dividend paying company is well known energy company Suncor. If you were a shareholder of Suncor in Sept. 2016, you would have received a quarterly dividend paid to you of $0.29 for every share you own. Said another way, if you have 1,000 shares of Suncor, you would see a payment of $290 every four months. Using the rental property analogy, this $290 is your rent cheque. Beyond this, if Suncor’s share price has increased in value, so too has your overall investment, thus achieving growth and income.
The concept of growth and income is also referred to as total return. Or put another way, if the shares of a company increase in value by 10 per cent and they paid you a five per cent dividend over the course of the year, your total return would be 15 per cent. So investing for dividends also provides some other advantages which I’ll point out below.
One key advantage is that a dividend paying company provides a built-in return. If you know you’re going to get a five per cent dividend over a year’s time, you can assume that if the shares do not increase in value your total return would be five per cent.
The other side of this example is that if the shares of the same company declined in value by five per cent, your total return would be zero per cent. So in this case, the dividend actually provides you some protection if the shares decline in value.
Another key advantage of investing in a dividend paying company is that dividends are taxed more preferentially than other income-paying investments like GICs and bonds. In other words, a dividend payment from a taxable account will keep more in your pocket comparatively on an after tax basis.
The last point I’ll make about dividends is that there are numerous companies which have consistently paid and even increased their dividend for decades. Think of it like having a permanent tenant in a rental property without the headaches and costs of repairs and maintenance. That said there are some companies which have had to cut or even eliminate their dividends when they’ve come across hard times. So if you’re looking at a dividend investment, it’s best to look at their history of payments — the last thing you want is to buy a rental property and find out your tenants aren’t able to cut a rent cheque.
There are many dividend paying companies both in Canada and abroad and they operate in many different businesses and sectors. From banking to insurance, energy to mining, real estate to technology, you can likely find a company that will pay you a dividend.
While dividend investment may not be the perfect solution for all investors it is certainly a concept worth looking at depending on your goals and plans. As always, be sure to discuss your personal situation with a Wealth Advisor before making investment decisions.
Derek Fuchs is a Senior Wealth Advisor with Scotia Wealth Management in Red Deer and holds the designations of Chartered Investment Manager, Certified Financial Planner, Financial Management Advisor, and is a Fellow of the Canadian Securities Institute.