The Power of Dividends

Feb 01, 2019 | Nick Dodds


Share

The month of February is such a "blah" month.  My apologies to those of you who are reading this blog and will be celebrating a birthday this month.  So I thought that the best way to make the month of February more exciting is to talk about investments that pay dividends.  But wait, there is more!  Let's talk about companies that pay dividends and grow their dividends.  To read more about this concept please click here.

Let's start with a basic premise.  You own a diversified portfolio of good quality companies that produce predictable profits.  This basket of companies have combined profits of $1 million dollars with an average 4% annual growth rate of profits. 

At the end of each year these profits will be divided into three segments.  The first segment (30%) is paid out in corporate taxes to the CRA.  The second segment  (30%)  is invested back into the business.  For example a company decides to upgrade their equipment or upgrade their service platform by revamping their technology.  The rationale for allocating capital is to ensure that the company remains competitive and can achieve their goal of growing their annual profits.  The third segment (40%) is to pay dividends to it's shareholders.  

Let's meet Mr. and MrsDividend.  This couple has a $100,000 investment portfolio that is well diversified across all sectors.  This couple receives annual dividends of 3%, or $3,000.  They have a long-term investment horizon.  In this situation the Dividend's are happy to learn that at the end of year 1 their companies reported a 4% year over year growth in their profits.  This means that in all likelihood there is likely to be a 4% growth rate in their annual dividends.  Hence the $3,000 worth of dividends will increase to $3,120!  Why?  Because these companies pay 30% in taxes to the CRA, invest 30% of their capital back into their business and pay the remaining 40% in dividends to their shareholders. 

Can you imagine what the dividends would look like in 10 years if we maintain the above set of assumptions?  The expected dividend income would be $4,441!  In 20 years the expected dividend income would be $6,573.

In the above scenario the dividends were paid out as income to the Dividend family.  Imagine if all these dividends were used to buy shares in these companies?

The most effective way to grow your wealth is to establish an investment discipline that is straightforward.  In this case that would be ownership of companies with predictable earnings, that pay annual dividends and that grow their annual dividends.  Finally let time work for you.  To do this means to block out the "noise" that we are bombarded with on a daily basis.