How you could quadruple your dividend income

Reinvesting your dividends is vital to growing your investment. And once you discover which shares you should buy, you could give your dividend income a massive boost. Brian Durrant explains.

For nearly three years now, the FTSE has been performing the same unsettled dance. One month it rises after a fresh pump of credit from central banks. The next it collapses after another scare about the health of the economy. History suggests that stock markets can behave like this for a quite a while after a big financial crash the burden of debt makes it hard for the economy to gather momentum. So we need to find a way to deal with this erratic behaviour.

The first thing to do is to switch off. We don't need to concern ourselves with short-term movements in the market if you've bought the right assets to protect your money. I'm talking about gold. That's your best protection against the financial instability ahead.

But there is another very relaxing and rewarding way to see out the years of crisis. And that is to buy stocks with high dividend yields. This strategy made money last year. It has been a very successful ploy this year too. And today I'd like to explain why we think that, years from now, you'll look back on these stocks with great fondness.

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Dividends are the key to growing your wealth

We saw this week how the UK economy continues to struggle. But thegood news is that dividend payments from UK companies continue to soar. There are two reasons for this.

First, the non-financial corporate sector has thrived in the aftermath of the credit crunch. While banks continue to suffer the legacy of daft lending decisions and governments borrow heavily to stave off a crisis, the corporate sector has been rebuilding its balance sheet by raising margins and cutting back on costs and investment. The second reason is the fortunes of UK-listed companies do not mirror the fortunes of the UK economy as many companies have the bulk of their operations abroad.

I write for the Fleet Street Letter. And we've always liked dividend-paying companies. But they are particularly valuable in a world where trust is in short supply. The payment of a dividend demonstrates a commitment to shareholders and a discipline that prevents managements from being duped by investment bankers into frittering away cash on value-destroying acquisitions.

That's why the markets have warmed to dividend payers. Investors are enjoying the steady stream of income, which amounts to hard cash and cannot, like earnings, be massaged by accounting wheezes.

In the new world of tepid economic growth prospects, there are two further reasons why markets will continue to warm to high dividend value stocks. First, as growth opportunities are more limited, companies are more cautious about embarking on costly investment projects. So dividend-paying companies are increasingly viewed as shrewd and careful rather than lacking in ideas.

Second, at a time when rates on fixed income assets are so low, investors have less of a problem with companies that are being run for cash. After all, it is easier to predict the returns of a steady dividend-paying company.

UK dividends are soaring

While UK economic output is still below pre-crash levels, dividend payments from UK-listed companies are touching record highs. The April to June period is the most important for UK investors as it usually sees the year's largest dividend cheques. Andthe second quarterdid not disappoint, with dividends jumping to a record £22.6bn, standing 18.4% up on the corresponding period last year. This level surpassed the pre-crisis peak of £22bn in the second quarter of 2007.

However, it is important not to overlook special dividends, which are not necessarily one-off items in all instances. Special dividends totalled £5.9bn in the first half of this year compared with £2.3bn paid inthe firsthalf of2011. Normally, special dividends arise from an exceptional corporate action like a disposal. But sometimes they are used by mining companies to pay back shareholders in boom times; while still pointing to a steady progressive trend in 'regular' dividend payments.

The strength of dividend payments in the second quarter surprised analysts. Capita Registrars upgraded its forecast for total dividend payments in 2012 to £78.3bn, this is £3.3bn higher than the forecast it made back in January. Nevertheless, Capita Registrars reckons that it will be a struggle to make further upside progress next year given the enormous scale of one-off payments this year.

That said, dividends are back in fashion. Of the 250 companies that paid a dividend in the second quarter, 212 either increased, started or reinstated their dividend payments. The ratio of dividend risers to fallers is now over 6:1.

According to the Ernst & Young ITEM Club, corporate balance sheets are extremely healthy with an estimated £750bn in surplus cash. So even in the event of a company having difficulty maintaining profits, firms will be keen to keep up dividend payments where they can, so as not to send a negative signal to investors who are more in tune with dividend payments than they used to be.

The importance of reinvesting your dividend income

This is not the end of the story. Dividend-paying stocks are not only well suited to the current conditions of crab-like equity markets and rock-bottom yields on fixed interest, they are a particularly powerful investment for the long term, when the power of compound interest has time to work its magic.

Every year, Barclays Capital publishes its equity gilt study and every year the merits of reinvesting dividends are made glaringly obvious: £100 invested in UK equities at the end of 1945 would have been worth £7,400 at the end of last year. But if gross dividends were reinvested, this investment total would have been £131,500.

Even in the shorter term this strategy makes a difference. In January 2009 we recommended buying a number of high-yield blue-chip stocks to our readers. One of them was British American Tobacco. At the time £10,000 invested in BATS would have bought 575 shares at £17.39 each. Taking closing prices on 24 October, the value of the tobacco shares would have grown to £18,135.

Now if dividends had been reinvested in buying further shares as soon as the dividends were paid, the total holdings of BAT shares would have increased from 575 to 681, giving a total value of £21,478. The reinvestment of dividends has elevated the value of the investment by a further 18.4% in under four years!

But here's the thing

At exactly the same time as those companies pay their regular dividends you can also use them to secretly collect a much bigger yield one that can give your finances a massive boost.

For example, did you know that Warren Buffett collects a 50% dividend from his Coca Cola shares, whilst everyone else gets 2.5%?

But once you discover which shares you should buy, it's incredibly easy to double, triple and in some cases quadruple your dividends. We explain all in our Dividend Multiplier report.

Ultimately, with equity markets crawling sideways, and very low returns available on bonds, there is a very compelling case for investing in high yield stocks that have a record of delivering steady dividend growth. With so much volatility and uncertainty to reckon with these days, these stocks are a wonderful tonic. And if you use the dividend multiplier method, you will really start enjoying your income.

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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Your capital is at risk when you invest in shares - you can lose some or all of your money, so never risk more than you can afford to lose. Always seek personal advice if you are unsure about the suitability of any investment. Past performance and forecasts are not reliable indicators of future results. Commissions, fees and other charges can reduce returns from investments. Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Please note that there will be no follow up to recommendations in The Right Side.

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Brian has contributed to MoneyWeek with his expertise in investment strategy, for example how to quadruple your dividend income and how to navigate through the stock market in the 2008 financial crisis. He’s also touched on personal finance such as the housing market and the UK economy.