Most bonds and savings accounts offer little or no income to their holders, so it is no wonder that a great number of investors are increasingly turning to shares instead.
When the average income-seeking investor screens for robust shares to buy and hold, they may look to a company’s annual dividend increase as a reliable indicator.
A dividend growth investing strategy calls for a portfolio of shares in high-quality companies that 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 distributed 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. For example, in 2019, mining giant BHP wheeled out extra dividends.
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.
Many 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.
FTSE 100 companies
In 2020, the FTSE 100 is projected to return a dividend yield of 4.5% or so. This robust dividend yield will likely help support the index through potential market choppiness.
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.
Several examples include the wealth manager St. James’s Place, financial services group Prudential, and alcoholic beverages giant Diageo.
Outside the FTSE 100
Our readers may be interested to know that there are also investment trusts that regularly increase dividends, such as the Brunner Investment Trust or the Alliance Trust.
Within the FTSE 250, Caledonia Investments has been a dividend champion for decades. In 2019, motor insurer Sabre Insurance paid out a special dividend.
At The Motley Fool, my colleagues regularly cover 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 these shares 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.