How to Invest in the Best Dividend Stocks

dividend stocks

The idea of collecting checks for the rest of your life and generating passive income can be very compelling. If this sounds like the type of investing strategy that appeals to you, you may want to learn more about dividend investing and high yield dividend stocks. This guide to dividends was designed to help answer all of your questions and walk you through the basics step-by-step, from how to select dividend stocks to enrolling in dividend reinvestment programs.

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What is Dividend 

A dividend is a payment made by a company to owners of the company’s stock. They are a way for companies to distribute revenue back to investors, and one of the ways investors earn a return from investing in a stock.

Companies usually pay dividends quarterly, though some pay monthly or semi-annually. A dividend is paid per share of stock — if you own 30 shares in a company and that company pays $2 in annual dividends, you will receive $60 per year.

But not all stocks pay dividends — if you are interested in investing for dividends, you will want to specifically choose dividend stocks. Here is why:

  • Dividend stocks tend to be less volatile than growth stocks, so they can also help diversify your overall portfolio and reduce risk.
  • Dividend investing is based upon building a collection of so-called "safe" blue-chip stocks with large, regular dividend yields that generate money throughout the year. 
  • Dividend investors have the pleasure of seeing regular cash deposits appear in their brokerage account or bank account. 

>> Need a brokerage account? Open one today and start investing in high-yield dividend stocks with the lowest commission, 1$ per 100 shares. 

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What is Dividend Yield

Financial websites or online broker platforms will report a company’s dividend yield, which is a measure of the company’s annual dividend divided by the stock price on a certain date.

The dividend yield evens the playing field and allows for a more accurate comparison of dividend stocks: A $10 stock paying $0.10 quarterly ($0.40 per share annually) has the same yield as a $100 stock paying $1 quarterly ($4 annually). The yield is 4% in both cases.

Yield and stock price are inversely related: When one goes up, the other goes down. So, there are two ways for a stock’s dividend yield to go up:

  • The company could raise its dividend. A $100 stock with a $4 dividend might see a 10% increase in its dividend, raising the annual payout to $4.40 per share. If the stock price doesn’t change, the yield becomes 4.4%.
  • The stock price could go down while the dividend remains unchanged. That $100 stock with a $4 dividend might decline to $90 per share. With that same $4 dividend, the yield would become just over 4.4%.

For most stocks, anything above a 4% yield should be carefully analyzed, as it could indicate the dividend payout is unsustainable.

However, there are some exceptions to this 4% rule — specifically, stock sectors that were created to pay dividends, including real estate investment trusts. It’s not unusual for REITs to pay safe yields in the 5% to 6% range and still have growth potential.

One of the quickest ways to measure a dividend’s safety is to check its payout ratio or the portion of its net income that goes toward dividend payments. If a company pays out 100% or more of its income, the dividend could be in trouble. During tougher times, earnings might dip too low to cover dividends. Generally speaking, investors look for a dividend payout ratio that is 80% or below. Like a stock’s dividend yield, the company’s dividend payout ratio will be listed on financial or online broker websites.

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How to buy dividend stocks

Looking for an investment that offers regular income? Dividend stocks can be a good choice. 

We’ll cover two ways to invest in dividend stocks here: Through exchange-traded funds that hold these stocks, and by purchasing individual dividend stocks. Let’s start with dividend ETFs since they’re the easiest entry.

Investing in dividend stocks through ETFs

Like much in the world of ETFs, dividend ETFs offer a simple and straightforward solution to getting exposure to a specific investing niche — in this case, stocks that pay a regular dividend.

A dividend ETF typically includes dozens, if not hundreds, of dividend stocks. That instantly provides you with diversification, which means greater safety for your payout: Even if a few of the fund’s stocks cut their dividends, the effect will be minimal on the fund’s overall dividend. A safe payout should be your top consideration in buying any dividend-paying investment.

Here’s how to buy a dividend stock ETF:

1. Find a broadly diversified dividend ETF. You can typically find dividend ETFs by searching for them on your broker’s website. (No broker? Here’s how to open a brokerage account.)

Probably the safest choice is a low-cost fund that picks dividend stocks from the S&P 500 stock index. That offers a broadly diversified package of America’s top companies. You may want to also restrict your search to commission-free options, so you don’t pay a commission each time you buy or sell the ETF.

2. Analyze the ETF. Make sure the ETF is invested in stocks (also called equities), not bonds. You’ll also want to check the following:

  • The dividend yield. This is how much a company pays out in dividends each year relative to its share price, and is usually expressed as a percentage. Generally, higher is better, though anything above 3.5% should be examined more closely to assess the safety of the investment.
  • 5-year returns. Generally, higher is better.
  • Expense ratio. This is the ETF’s annual fee, paid out of your investment in the fund. Look for an expense ratio that is under 0.50%, but lower is better.
  • Stock size. Dividend ETFs can be invested in companies with large, medium, or small-capitalization (referred to as large caps, mid-caps, and small caps). Large caps are generally the safest, while small caps are the riskiest.

3. Buy the ETF. You can buy ETFs just like you’d buy a stock, through an online stockbroker. A good approach is to buy them regularly, to take advantage of dollar-cost averaging.

Why you should buy an ETF: The biggest advantage for individual investors is that you can buy just one ETF and don’t have to track dozens of companies, which is what you’d have to do if you buy dividend stocks yourself. Buy your dividend ETF and then add money to it regularly.

» Learn more: How to buy an ETF in 60 minutes or less

Investing in individual dividend stocks

Building a portfolio of individual dividend stocks takes time and effort, making it more complex than investing through a dividend ETF. But by picking and choosing your dividend stocks, you have the potential to personalize a portfolio and find higher dividends than in an ETF.

Before buying a stock, you’ll need to analyze the company and industry, evaluate the safety of the dividend, and then determine how much to buy.

Here’s how to buy a dividend stock:

1. Find a dividend-paying stock. You can screen for stocks that pay dividends on many financial sites, as well as on your online broker’s website.

2. Analyze the company. This step is probably the hardest but the most important. To make sure you choose a healthy company that can sustain its dividend for years, you’ll need to spend a lot of time understanding the company’s financial statements and industry.

» Learn more: How to invest in stocks

3. Analyze the safety of the dividend. What is the payout ratio? That is, what percentage of income does a company pay in dividends? The lower it is, the safer the dividend, and the faster the dividend can grow over time. A payout ratio over 80% is generally a red flag, but even that is just a rough benchmark. In some industries, you don’t want a payout ratio above 50%.

4. Decide how much stock you want to buy. You need diversification if you’re buying individual stocks, so you’ll need to determine what percent of your portfolio goes into each stock. If you’re buying 20 stocks, you could put 5% of your portfolio in each (or buy 25 stocks at 4%, 30 stocks at 3.3%, etc.). However, if the stock is riskier, you might want to buy less of it and put more of your money toward safer choices.

The No. 1 consideration in buying a dividend stock is the safety of its dividend. So when buying a dividend stock, it’s absolutely crucial that you not be a “yield pig,” focusing only on the highest dividend yields. A high yield often signals that investors are skeptical of the company’s ability to sustain the dividend and that it may be in danger of being cut. That skepticism drives down the share price, and a lower share price pushes the yield ratio higher.

If the market thinks the dividend will be cut and it is cut, the stock will go down and you’ll lose money. Plus, you’ll have a smaller dividend. So you get hit two ways.

Why you should buy individual dividend stocks: You like the challenge of combing over the market for attractive stocks and don’t mind — even enjoy — spending the time to do it. If you’re good, you’ll likely be able to build a portfolio of dividend stocks that offers a higher yield than what you could find in a dividend ETF.

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List of high-dividend stocks 2020

Here is a list of 15 high-dividend stocks. The dividend shown below is the amount paid per period, not annually.

#1 British American Tobacco (BTI)

While the energy sector is often flush with high-yielding investment opportunities, the tobacco industry has also been a famous cash flow generator since time immemorial. There are just a handful of global giants in this space with the global presence of British American, which is worth over $100 billion. The portfolio of brands includes Camel, Lucky Strike, Dunhill, Pall Mall, Newport, Natural American Spirit, Kool, Grizzly snuff and Vuse e-cigarettes, to name a few. Although shares gained over 40% in 2019, BTI remains oversold following a brutal 2018 overcorrection driven by fears vaping could cripple Big Tobacco. At 10 times forward earnings, this Steady Eddie and its 6% yield is a perfect option for conservative investors.

  • Market capitalization: $104 billion
  • Dividend yield: 6%
  • Payout ratio: 56%

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Categories:  Investing