Here’s Why Many Successful Investors Prefer Dividend Stocks

Research has shown that, among different types of stocks, dividend stocks usually perform better than the average stock in the long run for a number of reasons. Many successful investors have made impressive profits by primarily investing in dividend stocks.

More specifically, numerous successful investors have adopted one of two main strategies: dividend growth and high dividend yield. The dividend growth strategy involves building a highly diverse portfolio with stocks that have dividends which grow at an above-average rate. The high dividend yield strategy, on the other hand, involves investing in stocks with dividend yields that are above average when compared to the price of the stock.

Among the reasons you as an investor should give preference to dividend stocks is the lower accruals, lower wage bill and more buoyant share prices associated with these stocks. Let’s take a closer look.

Lower accruals due to cash flow restrictions

Learning how to analyze balance sheets and income statements is essential for successful stock trading, daunting as it may seem. This is because a company is ultimately worth the net present value (NPV) of all its present and future cash flows.

A company has to raise cash to pay its investors dividends through checks or direct deposits to investors’ bank or brokerage accounts. So the company has to be actually making money. Therefore, compared to the average stocks, dividend stocks report lower accruals between net income and free cash flow.

In simple terms, the quality of earnings for dividend stocks is high because they are in line with the reported free cash flow. It is widely known that, in the long term, businesses with low accruals perform better than those with high accruals when performance is measured in terms of total returns.

Lower wage bill due to ongoing cash commitment to dividends

Where there is surplus cash, the company’s expenses, particularly in human resources, usually expand to mop up the excess cash, even where there might have been more optimal ways of spending the money. Such expenses include higher salaries, bigger bonuses, better pension benefits, etc.

Companies that pay above-average dividends are typically more inclined toward reigning in the above expenses because of the need to always have enough cash in hand to pay dividends.

More buoyant share price during market crashes due to growing dividend yield

In bear markets, dividend stocks typically don’t fall as far down as non-dividend stocks. In cases where the dividend yield of a stock is supported by good earnings from the company, there is the low risk of a dividend cut, even if the stock market crashes and the stock price drops substantially.

In fact, when the company’s stock price drops and the amount of dividend remain constant, the dividend yield of the company improves because the dividend is a higher percentage of the share price. Other investors are likely to be attracted to the higher dividend yield. That would create demand for the stock and give the share price buoyancy that average stocks may not enjoy because of their relatively low demand.