When the average investor screens for robust shares to buy and hold, a reliable indicator may come in the form of a company’s annual dividend increase.
The dividend growth investing strategy is having a portfolio of shares in high-quality companies that ideally increase their dividends at least as much as the rate of inflation each year.
Today, I will discuss two main reasons why a FTSE 100 company may decide to increase dividends.
Improving business and profits
Dividends, which are usually paid from after-tax profits, are paid at the discretion of a company’s management. If it has been an especially strong year in terms of revenue, a company’s board of directors may decide to share part of the profits with shareholders.
Business growth may also help boost a company’s cash flow. As cash flows exceed the company’s expenditures, cash continues to accumulate on the balance sheet.
Then the company may decide to increase dividend payments or pay a one-time special dividend. One recent example would be the extra dividend announced in early 2019 by mining giant BHP (LSE: BHP), which has recently become a cash machine.
When management hikes dividends, it is in effect signalling that the business is performing well and that it expects to have the cash flow to pay for the higher dividend.
Help support share price
The two main ways in which a company returns profits to its shareholders are through cash dividends and share buybacks.
In general, investors tend to pay more for the stock of companies that regularly increase their dividends or buy their shares back. There are a number of established companies that do both, such as the oil major Royal Dutch Shell (LSE: RDSB).
Many established FTSE 100 companies have chosen to protect their payout in volatile and tough times in the markets as they realise how important it may be to provide investors with welcome financial relief through reliable dividends when share prices go down.
Over time, established companies that also regularly increase their dividends often prove less volatile than smaller growth stocks. Therefore, risk-averse individuals approaching retirement years tend to regard them as being more suitable for their portfolios.
For younger investors who are interested in rather speculative but potentially higher growth stocks, companies with growing dividends may help them counterbalance the downside risk of investing in smaller companies.
FTSE 100 companies
In 2019, the FTSE 100 is projected to return a dividend yield of about 4.5%. This robust dividend yield has helped support the index throughout the uncertainty caused by Brexit as well as global trade wars.
Companies operating in the financials (including banks and insurers), consumer staples (including drinks and tobacco companies), and oil and gas sectors tend to be stable dividend-payers that increase their dividends regularly.
At The Motley Fool, my colleagues regularly cover FTSE 100 shares that are set to keep growing dividends and also deliver growth. For the average investor it is important to do due diligence to see if they would be suitable for their portfolios.
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tezcang has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo and Prudential. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.