Dividend stocks: Strategies to target dividend-paying companies

Let's start with the most obvious approach. Why not just target companies with the highest dividend yield? To answer this question, let's think about how a company might end up paying a high dividend.

How is dividend yield calculated?

Annual dividend divided by current stock price equals dividend yield.

Example of a fairly normal level of dividend yield

Suppose the annual dividend is $4 and the current stock price is $100. The dividend yield is 4%.

What happens when the share price drops?

Suppose the annual dividend remains at $4. If the share price declines to $50, the dividend yield increases to 8%. If the share price declines to $25, the dividend yield increases to 16%.

Typically, a declining share price means that a company is expected to be less profitable. In this situation, a constant dividend payment represents a larger and larger share of earnings. As a result, there is considerable risk that the company’s board of directors will reduce the dividend to match the lower level of expected earnings, or even eliminate the dividend altogether.

Let's look at the performance of companies, based on their level of dividend payout.¹ Over the period from 2004 to 2024, companies that outperformed the S&P 500 were those with medium and medium-to-high levels of dividend payout, while those with low, medium-to-low, and high levels of dividend payout underperformed.² Investors have good reason to welcome dividends — but also to be cautious about particularly high levels of dividend payout.

Rather than focus only on dividend yield, investors can also consider dividend growth — the ability of a company to grow its dividends over time. Dividend growth may indicate a strong market position and capable management team. Market data confirms the importance of dividend growth. Over the period from 1973 to 2024, S&P 500 dividend growers generated higher returns with less risk, measured by standard deviation, than companies that maintained their dividends, reduced their dividends or paid no dividends.³

Dividend growth is captured by indexes such as the S&P U.S. Dividend Growers Index, which tracks companies that have increased dividends every year for the last 10 years, excluding the top 25% highest-yielding companies.⁴ Dividend growth is also part of the Dow Jones U.S. Dividend 100 Index, which tracks high-yielding companies that consistently pay dividends. This index uses the 5-year dividend growth rate as one of its inclusion criteria. Even when investors focus on dividend yield, it can make sense to consider dividend growth as part of the picture.

In the larger world of dividend-growing companies, we highlight two relatively small groups: The Aristocrats and Monarchs; and the Initiators.

Aristocrats and Monarchs

These are companies that have grown their dividends for very long periods of time. For example, the S&P 500 Dividend Aristocrats Index tracks member companies of the S&P 500 that have increased their dividends every year for the last 25 years.⁵ The S&P Dividend Monarchs Index tracks member companies of the S&P 1500 that have increased their dividends every year for the last 50 years.⁶ In Canada, the S&P/TSX Canadian Dividend Aristocrats tracks companies that have increased their cash dividends in each of the last five years.⁷

Initiators

These are companies that have initiated or reinstated a dividend. This can indicate that management has confidence in the company's growth prospects. Initiators are typically not tracked by index funds. Investors likely have to find these names the old-fashioned way, by maintaining a longlist of potential buys and subscribing to news alerts.

Having reviewed dividend yield and dividend growth strategies, we conclude by putting dividends in a broader perspective, highlighting three considerations.

1) Dividends are not the only way to return capital

Companies can return capital to shareholders not only through dividends but also through share buybacks. Suppose a company has 1 billion shares outstanding and decides to buy back 50 million shares or 5% of the total. The company places the shares it has bought into treasury stock, effectively removing them from circulation. The remaining 950 million shares now become more valuable. All else equal, the share price should increase by about 5%. This is known as buyback yield and is in addition to any dividend yield the company might pay. Consider both dividend yield and buyback yield to get a fuller picture of how a company is returning capital to shareholders.⁸

2) Dividends are not the only game in town

Investors may apply a variety of strategies to select stocks, such as growth, value, quality or profitability. Investors may consider dividend payment as part of these or other strategies, rather than as a stand-alone strategy. Investors can also use dividend yield as a screen, requiring a positive yield in order to consider an investment for further analysis.

3) Dividends can introduce biases

Finally, it’s possible to have too much of a good thing. Investors who focus excessively on dividends can introduce biases in portfolio construction. These include:

• Home bias. The Canadian market has a strong record of dividend payment. This can result in reduced exposure to U.S. and foreign stocks.
• Sector bias. Overweighting dividend-paying sectors, such as communications, financials or utilities, can result in reduced exposure to other sectors.
• Status quo bias. Dividend payers tend to be large or established companies. This can result in reduced exposure to innovation or disruption.

In this article, we compare dividend yield and dividend growth as investment strategies.

Dividend yield: This involves focusing on companies that pay a high dividend yield. While some level of dividend yield can be good, investors should be careful about companies that pay a very high dividend yield, since this can indicate problems with profitability.

Dividend growth: This involves focusing on companies that have increased their dividends over time. Investors can focus on dividend growth as a key measure or include it as part of the picture when considering higher-yielding companies. Special cases of dividend growth include companies that have increased their dividends for very long periods of time and companies that have initiated or reinstated a dividend.

While dividend growth is important, keep dividends in perspective.

• Companies can return capital to shareholders not only through dividends but also through share buybacks. Consider both as part of a total yield.
• Investors often target dividends as part of other strategies, including growth, value, quality and profitability.
• Investors who focus excessively on dividends can introduce biases in portfolio construction, including home bias, sector bias and status quo bias.

¹ Dividend payout is the proportion of dividends that a company pays out from earnings. For example, if a company pays out dividends of $2 per share and has earnings of $8 per share, the dividend payout ratio is 25%.

² Nuveen: Why dividend growth? Opens a new window. This article provides insight on a dividend growth strategy applied to U.S. stocks. A study divided the S&P 500 into five equal groups of dividend payout from low to high and analyzed the performance of each group. Refer to Figure 6. The key point is that the highest payout ratios don’t make the best performers.

³ Nuveen: Why dividend growth? Opens a new window. Refer to Figure 1. The key point is that dividend growth stocks have outperformed non-dividend growth stocks, with less risk.

⁴ As mentioned earlier, the highest-yielding companies may not be the best-performing companies. Hence this index excludes the highest-yielding companies.

⁵ The S&P 500 Dividend Aristocrats index contained 69 names as of March 31, 2025.

⁶ The S&P Dividend Monarchs index contained 39 names as of March 31, 2025.

⁷ The S&P/TSX Canadian Dividend Aristocrats index contained 90 names as of March 31, 2025.

⁸ Dividend yield plus buyback yield equals “shareholder yield” or “total yield”. For an example, visit Morningstar Opens a new window.. The Morningstar website provides performance, risk and other data on North American stocks, ETFs and mutual funds. Enter a Canadian or U.S. stock symbol. Select the Dividends tab. The Trailing Dividend Yield percentage and Buyback Yield percentage appear, together with Total Yield percentage as the sum of the 2 components.