High dividend investing or ‘high yield share investing’ is an investing strategy of investing in stocks that pay higher dividends than other stocks. Dividend shares are usually companies that are large-cap, with sound business practices and in less cyclical industries. Hence, they are usually less volatile than other shares. These high dividend-yielding stocks are often sought by investors who want a reasonable income stream with a capital growth potential.
Different types of high dividend investing
- Dividend Growth Investing: This type of high dividend investing focuses on companies with a track record of consistent increase of dividend payments over time. The goal of this approach is to receive a growing stream of income from dividends, as well as potential long-term capital appreciation.
- Income Investing: This type of high dividend investing focuses on companies that offer high dividend yields in the present, regardless of the potential for future growth or dividend increases. The goal of this approach is to receive a high level of current income from dividends.
- Value Investing with dividend-paying companies: This type of high dividend investing focuses on companies that are undervalued compared to their peers or their future growth potential. It should be noted that these companies are already paying reasonable dividends. The goal of this approach is to buy shares in companies at a discount, with the hope of receiving both a high dividend yield and potential capital appreciation as the company’s value is realised.
- Bond Substitute Investing: This type of high yield share investing focuses on companies with lower credit ratings that offer a high yield as a trade-off for the higher risk associated with their credit quality. The goal of this approach is to receive a high level of current income from dividends while also taking on the added risk associated with investing in lower credit quality companies.
It’s important to remember that each type of high dividend investing has its risks and rewards, and what may be suitable for one investor may not be suitable for another. Therefore, before making an investment decision, it’s important to carefully consider one’s investment goals, risk tolerance, and financial situation.
History of high dividend investing
The history of high dividend investing can be traced back to the late 19th and early 20th centuries, when companies began paying dividends to shareholders to attract investment capital.
In the post-World War II era, the growth of the U.S. economy and the emergence of blue-chip companies like IBM and Coca-Cola led to a significant increase in the number of companies paying high dividends. This trend continued into the 1960s and 1970s, as more companies issued stocks with high dividend yields.
As investors sought to diversify their portfolios, they began investing in stocks with high dividend yields, leading to the development of high dividend stock investing as a standalone investment strategy.
One of the earliest forms of high dividend investing was the ‘dividend imputation’ system, which was introduced in Australia in 1987. Under this system, dividend payments were taxed at the shareholder’s marginal tax rate rather than at the company’s tax rate. This system made high dividend stocks more attractive to investors, as they could receive a higher after-tax return from their investments.
In the 1990s and 2000s, high dividend investing became more popular as investors sought to generate income from their portfolios in a low-interest-rate environment. With bond yields at historic lows, many investors turned to high dividend stocks to generate a steady income stream. This trend was further fueled by the 2008 financial crisis, which led many investors to seek investments that offered higher income and stability.
Today, high dividend investing remains a popular investment strategy, with a wide range of ETFs, mutual funds, and individual stocks available for investors. The popularity of high dividend investing is driven by the low-interest-rate environment, the desire for income and stability, and the ease with which investors can access this type of investment through ETFs and mutual funds.
More on the impact of dividend imputation system on high dividend stocks
The “dividend imputation” system is a tax system that was introduced in Australia in 1987. The system is designed to reduce the double taxation of dividends, which occurs when a company pays taxes on its profits and then distributes those profits to shareholders as dividends, which are taxed again when the shareholder receives them.
Under the dividend imputation system, a company that pays dividends to its shareholders is required to attach a tax credit, known as a franking credit, to each dividend payment. The franking credit represents the amount of tax that the company has already paid on the profits that are being distributed as dividends.
When the shareholder receives the dividend, they can use the franking credit to offset their tax liability on the dividend income. The shareholder may be entitled to a tax refund if the franking credit exceeds the tax liability.
The dividend imputation system makes high dividend stocks more attractive to investors, as they can receive a higher after-tax return from their investments. The system has been a key factor in the popularity of high dividend investing in Australia. It has helped to make Australia one of the world’s largest and most liquid markets for high dividend stocks.
Please note that this is not tax advice. QuietGrowth does not provide tax advice and is not a registered tax agent. If you have any questions about your tax situation, we recommend you speak with your tax adviser or accountant.
Advantages and disadvantages of high dividend investing
- Income generation: High dividend shares can provide a regular and reliable source of income, which is especially appealing for retirees or those seeking to generate passive income.
- Diversification: Investing in high dividend shares can add diversity to an investment portfolio and reduce overall portfolio risk.
- Quality of the company: Reputed high dividend indices may have rigorous inclusion criteria and be more selective regarding the companies they include, potentially excluding companies considered ‘junk shares’.
- Volatility: Dividend shares are usually companies that are large-cap, with sound business practices and in less cyclical industries. Hence, they are usually less volatile than other shares. Thus they tend to be less volatile than other stocks.
- Potential for lower growth: Companies paying high dividends may have less capital available for growth initiatives or reinvestment in their business, which can limit potential capital appreciation.
Note that the above lists of advantages and disadvantages do not analyse “bond substitute investing” because stocks of this nature have lower credit quality.
When is a stock categorised as high dividend?
A stock is viewed as high dividend based on its dividend yield. The dividend yield is calculated as the annual dividend payment per share divided by the stock price.
A stock with a dividend yield above the average yield of the overall market or its specific sector is typically considered a high yield stock. The average yield can vary depending on the market or sector.
Proportion of blue chip firms in high dividend indices
The proportion of popular high dividend indices that are made up of blue chip companies can vary. It depends on the specific definition of “blue chip companies” and the criteria used for inclusion in the high dividend indices. Popular high dividend indices may include a mix of blue chip companies, as well as smaller, less established firms.
The exact proportion of blue chip companies in a high yield share index can change over time, as market conditions, the financial performance of individual companies, and other factors can impact the composition of the index.
It is not necessarily true that blue chip companies prefer to give high dividend yields. Blue chip companies are typically large, established companies with a long track record of stability and growth. While some blue chip companies may offer high dividend yields to shareholders, others may prioritise reinvesting their earnings into the business to fuel future growth. Conversely, not all high dividend shares are issued by blue chip companies.
Reputed high dividend indices may have rigorous inclusion criteria and be more selective regarding the companies they include, potentially excluding companies considered ‘junk shares’.
High dividend investing and thematic investing
High dividend investing and thematic investing are two distinct investment strategies with different objectives and focus on different types of securities.
High dividend investing is not a type of thematic investing because it does not focus on specific trends or themes but on companies that offer high dividend yields, regardless of their sector or business model. Also, the objective of thematic investing is to generate returns by capitalising on these trends, rather than through the income generated by dividends.
Our view at QuietGrowth
To know about our view at QuietGrowth regarding high dividend investing, refer to the ‘High dividend investing strategy‘ section in our Investment Methodology page.
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