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Dividends are cash payments a company makes to its shareholders. In concept, it's similar to the interest paid on a savings account, or the yield on a bond. The main difference is that dividend payments are at the discretion of a company's management and board of directors. Dividends can be cut or raised at any time.
Investors following a dividend strategy are looking to maximize the amount of cash income generated by their portfolio - instead of trying to pick companies whose stock prices will rise. In essence, a sizable portfolio can throw off enough in cash dividends to replace the income from a job! These investors are looking for a few things:
Usually, once this investment is found, the dividend investor will re-invest dividend payments into buying more shares of stock. By doing this, they receive increasing amounts of income due to two things:
To illustrate the viability of this plan, let's take a look at a stock paying a solid and sustainable dividend: Sherwin-Williams Company (SHW).
Let's say an investor purchased Sherwin-Williams back in 2000 when its dividend yield was about 2.75%. This company had a 20 year history of dividend hikes at the time, and this has continued to raise its dividend every year. By reinvesting those payments, the investor's yield steadily rose, and the effects of compounding accelerated until today Sherwin-Williams paid nearly 8% on the original investment in 2008.
Assuming then investor continued this strategy, it is likely that this yield will continue to exponentially increase, so that by the time retirement rolls around (say, 20 years), the original investment could very well be paying us 50% of it's value, or more, annually, money that can go towards replacing working income.
Of course, there is one other matter. These dividend payers must also have cash flows that can sustain these payouts. One also needs to make sure that the company has a history of continually increasing dividends. By analyzing the cash flows and management histories of these dividend payers, one can find the stocks most likely to deliver continually rising income from an investment.
However, dividend strategies can be extremely attractive for very long term holders of stock.