Dividend stocks are popular among investors looking to generate steady income as well as earn profits through stock price appreciation. Dividends can be reinvested to buy more shares of the same stock or used to provide cash flow for your bank account.
In this guide, we’ll explain why you might want to consider investing in dividend stocks, what factors you should consider when investing in dividend stocks, and how to pick dividend stocks. So, let’s get started so you can learn what you need to know about investing in dividend stocks.
What is a Dividend Stock?
A dividend stock is a stock from any companies that pay out a portion of their earnings to investors. Dividends are usually cash payments, although some companies issue dividends in the form of additional stock shares.
Dividends are typically set by a company’s board and reward shareholders for investing in the company. While dividends aren’t guaranteed, dividend-paying companies typically work very hard to keep their payments consistent over time. Many people will use dividends to make passive income or to assist with retirement funds.
Pros and Cons of Investing in Dividend Stocks
There are pros and cons to dividend stocks, so it’s important to think carefully about whether these shares are right for your portfolio.
On the one hand, many investors like dividend stocks because they create steady income. Your investment portfolio can feed your bank account through dividend payments, allowing you to either reinvest in the market and grow your dividends further or pay for everyday expenses.
Notably, dividend stocks typically offer better returns than bonds and certificates of deposits (CDs). In addition, if your investments pay qualified dividends, you will pay a lower tax rate on your profits than you would based on your income tax bracket.
On the other hand, dividend stocks aren’t a sure thing. You can still lose money on your investment if the stock price drops by more than the dividend payout. In addition, if a company runs into financial trouble, the board can reduce or suspend dividend payouts at any time.
Moreover, many dividend stocks are concentrated in a handful of traditional industries like oil and gas, finance, and utilities. While these sectors might be fine, they don’t give you exposure to the whole stock market.
Keep in mind that, as for any type of stock investing, purchasing individual dividend stocks can be risky. You can reduce your exposure to individual companies by investing in a dividend stock-focused mutual fund or ETF.
How to Pick Dividend Stocks: Factors to Consider
If you’ve decided dividend investing is right for you, the next step is to determine what dividend stocks to buy. Let’s take a closer look at some of the key factors you should consider when comparing dividend stocks.
The dividend yield is the amount that a dividend stock pays out each year relative to the share price. So, it’s the amount you’ll receive in dividend payments as a percentage of your investment. Yields can range from less than 1% for stocks that pay small dividends to as much as 10% for some high-yield dividend stocks.
Many dividend stocks make payments to investors on a quarterly basis. However, some issue monthly dividends or annual dividends. When looking at dividend schedules, it’s a good idea to invest in shares that stagger your dividend payments throughout the year. That way, you receive a steady flow of cash month after month rather than a lump sum from all your dividend stocks at the same time.
Whether a stock’s dividend increases, decreases, or remains stable over time is another important thing to consider when evaluating dividend shares.
Ideally, a company’s board will increase its dividend year after year to reward long-term investors and keep up with inflation. A shrinking dividend can be a sign that a company is in financial trouble, although companies can also cut their dividends to invest more money in the business. Stable dividends are okay in the short term, but keep in mind that your payouts will lose value to inflation over time.
You will also want to consider whether a company has paid out its dividend consistently over time. Many companies go to great lengths to pay out their dividend, and may even do so in quarters or years when they were unprofitable or missed earnings expectations. If a board has suspended its dividend in the past, take that as a sign that the dividend could be suspended again in the future.
Company and Sector Strength
It’s worth digging into a company’s financials when evaluating its dividend. Look at the company’s cash flow, total cash on hand, and outstanding debt to determine whether it can continue to make dividend payments without running into financial trouble. A high dividend yield might be attractive, but the stock is only worth investing in if the company can keep up the yield for the foreseeable future.
Stock Price Stability
Most dividend stocks have relatively stable prices and experience only mild volatility. However, it’s important to check. A 5% dividend yield might look great on paper, but if the stock loses 10% of its value per year, you’ll still end up losing money on your investment.
Small price rises just before a dividend payout and price drops just after a payout are normal for dividend stocks.
Conclusion: How To Pick Dividend Stocks
Investing in dividend stocks offers a way to generate income from your portfolio and can potentially increase your investment return. However, dividends aren’t guaranteed, so it’s important to do your due diligence when researching dividend stocks. Make sure the company you want to invest in has a history of reliably making dividend payments and is stable enough to do so into the future.