One of the best stock market strategy is to invest in high performance dividend stocks, which means investing in securities that will produce large and growing dividends over time. In order to fully understand the strengths of this strategy, it is essential to understand what type of stocks should be invested, and to fully understand the concept of “cost-efficiency”. We’ll see in this article how a performance-based investment strategy works, what is “cost-efficiency” and how this notion will help you create increasing passive incomes over time, and to conclude we’ll give some examples of the returns that can be obtained after a few years with this strategy.
How to well invest in high performance dividend stocks?
Investing in performance stocks is to choose securities that will pay you more and more each year while increasing in value. If you choose poor quality securities, they will pay you maybe a big dividend today, but it is likely that they will pay you less tomorrow, because if the company is not extremely strong, it won’t be able to clear enough cash to pay dividends due. So it’s important to start by choosing stocks that pay you a reasonable and sustainable dividend in time. If you would like to know more about this topic, I invite you to read the following article explaining where are the best dividend stocks.
If you choose this type of company, the dividends paid will increase each year and so-called “cost-efficiency” will gradually increase over time, until you get a very high return on your initial capital.
What is Return on Cost?
The return on cost is the return you will get from the price you paid initially. The more you pay a low price to buy your shares, the higher your return will be. For example, if a $100 stock pays you $5 dividend today, and that it falls to $95 tomorrow by paying you always $5 dividend, you will have a better return by buying it tomorrow.
As an investor, the goal is to buy stocks with the highest and most secure performance as possible (simply buying the shares that pay the highest yield is rarely the best option). You want to have a return of the highest quality at the lowest price.
How does cost-efficiency differ from conventional performance?
Cost-efficiency differs from conventional performance by the fact that it is scalable and is unique to your portfolio. For example if the Coca-Cola costs $40 and it pays you $2 of dividends, the real yield is 5%. But if you bought Coca 10 years ago for $20, your return on cost (today’s return/initial capital invested) is 10%. So the profitability of your capital is very good. This is because the Coca’s dividend increases over time.
Stocks like Coca are often named as “dividend champions” or “dividend aristocrats” because they allow you to mechanically increase your return on cost year after year, until you arrive at two-digit returns on your initial capital. So let’s look at the example of Coca in more details.
Coca-Cola: a “good father of family”
Coca now pays a dividend of around 3%, which does not seem extraordinary. However, Coca is known to have increased its dividends for 52 years in a row at a ratio of about 9.8% per year. If you buy Coca today in 2016, and as the company continues to increase its dividend at its usual rate (around 9%), here are the returns on cost you will get in 2036.
- 15% return on cost if you don’t reinvest in your securities (you collect the cash dividend every year and you spend it).
- 58% return on cost if you reinvest your dividends in Coca shares each year.
Yes, you read it well, 58% yield. Here is the spreadsheet used to carry out this simulation, that will show you the evolution of this famous return on cost year by year:
As you can see, with a systematic reinvestment of the stock dividend, your return of $135 per year transforms into 2600 euros per year within 20 years.
I hope this article will have enlightened you on the importance of choosing stocks with increasing yields and quality, rather than focusing on pure yield if you want to invest in high performance dividend stocks.