Dividend reinvestment is a great strategy for building wealth. However, many investors neglect this simple strategy.
Spring-loaded returns
Indeed, reinvesting your dividends can provide market-beating returns through periods of market stagnation or turbulent economic times. For example, the dot-com boom of the late 90s took the FTSE 100 to an all-time high of 6,930. Unfortunately, since then the market has not been able to surpass these highs and has suffered a decade of serious turbulence.
For many long-term investors, this has been a painful experience as their returns will have been negative during the 14-year period. What’s more, if we include the effects of inflation, the figures look even worse.
However, if we include dividends received during this period then the FTSE 100 would stand at a staggering 9200, 33% higher than its current level.
Bigger is not always better
Nonetheless, dividend investing is not as easy as it might seem at first. While many investors will seek out a large dividend yield it is often the case that bigger is not always better. Indeed, many factors such as the company’s payout history as well as dividend cover should be considered.
A prime example of this is Halma, which produces safety products for a range of applications worldwide. Halma only offers a dividend yield of 1.9% right now but the company has maintained this payout for 34 constitutive years. What’s more, the payout has grown 14-fold since 1990.
Furthermore, Capita (LSE: CPI), which currently offers a lowly yield of 2.5%, has a 30 year history of double-digit dividend payout and earnings growth. Capita is in prime position to continue this payout way-out into the future as the company is the UK’s leading provider of outsourcing solutions. Capita’s outsourcing contracts usually last a number of years and lock in future revenues, making the company’s cash flow predictable and supporting future dividend payouts.
A winning combination
Having said all of that, there are many companies that currently offer a solid dividend yield above the market average of 2.8%.
Right now, the standout candidate is Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US), which currently offers a yield of around 5% and has a dividend history that stretches back more than 60 years. Shell has one of the longest dividend histories in the world and this should continue as the company owns enough oil reserves to guarantee production at current rates for around 20 years. As oil becomes harder to find and its price increases, Shell’s profits should only grow, underlining future dividend payouts.
AstraZeneca (LSE: AZN) (NYSE: AZN.US) is also a great candidate, with a current yield of 5.3%, Astra has been paying and increasing its payout around 12% annually since 1986. Nonetheless, many investors are concerned that Astra’s payout could come under pressure as the company loses the exclusive production rights to a number of treatments during the next few years. Still, the company’s payout was covered twice by earnings during 2012 and Astra is working hard to increase its development pipeline. So, the company’s dividend currently looks safe.
