The rate at which a company increases its dividend payments could be highly significant for all investors. Not only could it mean an improving income return at a time when inflation is moving higher, it may also indicate an improving outlook for the company in question. Furthermore, companies generally only increase dividends when their financial performance is strong, which could be another reason why stocks with fast-rising shareholder payouts could help to make you a million.
Inflation issues
Since the EU referendum, the rate of inflation has surged higher. It already stands at 3% and Brexit is still around 15 months away. Between now and then it would be unsurprising for confidence in the UK’s economic outlook to come under increased pressure.
Even if a trade deal is eventually signed between the UK and the EU (which now seems more likely after last week’s ‘breakthrough’ talks), the UK is taking an unprecedented step in leaving the EU. It could be positive or negative for the economy, but ultimately it represents major change that could cause sterling to weaken and inflation to rise.
Therefore, dividend growth could become a more pertinent issue over the coming months, as investors seek to generate inflation-beating dividend rises. This could make dividend growth stocks more popular and lead to higher capital growth.
Lower risk
Dividend growth may also indicate that the company in question offers a lower risk profile than a comparable company which retains more capital. If a business is experiencing financial difficulties or has a balance sheet which has excessive leverage, it is more likely to seek to retain profits in order to improve its financial standing. A company that is happy to pay higher dividends each year may have a stronger foundation for future growth. This could mean that it offers a superior risk/reward ratio.
Improving outlook
Similarly, a stock which delivers a rising dividend could have greater confidence in its future outlook. For example, it may be seeking to maintain its payout ratio at the same level each year and expects to utilise higher earnings growth in order to pay a higher dividend. Dividend policy is decided by company management, who are generally the best-placed to determine the future prospects for their industry due to their experience and knowledge of the sector. If they are happy to raise dividends rapidly then it could be a positive sign for the company’s financial outlook.
Takeaway
While focusing on dividend growth may not be the most exciting means of deciding which companies to buy and sell, it can provide guidance on the future prospects of a business. It can also help to determine the financial position of a particular business, which may lead to an improved risk/reward ratio across an investor’s portfolio. And, with inflation moving higher, it would be unsurprising if dividend growth shares became a key theme for 2018/19 – especially as Brexit draws closer.
