What Is Dividend Investing?

getty

For some investors, getting paid while they own a security, instead of just when they sell it, is a priority. For those investors, dividend investing can have tremendous appeal. Dividend investing involves investing in stocks, but with a particular focus on the regular distribution of a company’s income to shareholders, known as a “dividend.” As opposed to stocks that do not pay a dividend, dividend stocks can be attractive to certain investors because they may provide two sources of return: income from the dividends and capital appreciation of the stock price.

In the United States, companies typically pay dividends quarterly, the same time frame in which they announce their earnings. The dividend is part of that announcement. Some companies pay less frequently, and a small number pay monthly. In many non-US stock markets, dividends are paid out every six months.

Benefits Of Dividend Investing

Stocks can be volatile and those ups and downs can test investors’ patience. That’s why having a regular income stream in the form of a dividend payment can be attractive. It helps the investor sit tight through that intermittent volatility. And, the stock market historically recognizes that a company that is able to distribute a regular cash payment from their earnings is a solid business. That, in turn, tends to make dividend stocks exhibit lower volatility than stocks that don’t pay dividends. This can help them outperform growth stocks in rough market environments.

Thus, dividend stocks offer two sources of return. The dividend and potentially, capital appreciation. Payment of dividends does not crimp a company’s potential for long-term growth. Strong businesses are adept at paying investors dividends as they go, but keeping plenty of earnings in-house to redeploy into efforts that produce returns above that dividend yield, longer term.

With inflation running at 3.0%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download Five Dividend Stocks To Beat Inflation, a special report from Forbes’ dividend expert, John Dobosz.

Risks Of Dividend Investing

Dividend investing is still stock investing, so it carries many of the same risks as would apply to any stock. For example, company-specific risks, which are those particular to a company’s own operation. As an example, General Electric (GE) and General Motors (GM) are two iconic companies that were once thought of as bulletproof, consistent dividend payers. But each business eventually had to endure a period in which self-inflicted wounds to their business caused their stock prices to plummet, and they had to eliminate their dividends for a period of time.

Interest rate risk is also a concern for dividend stock investors. Rising interest rates make bond investing more attractive, since bonds then pay higher fixed returns. To that end, dividend stocks are somewhat of a rival to bonds in the eyes of some investors. So, when interest rates rise, investors may see bonds as relatively more attractive than dividend stocks, since the latter still carry stock market risk.

Strategies For Dividend Investing

Not all dividend stock investment strategies are the same. In fact, over the decades, the investment management industry has developed and evolved several sub-strategies within the realm of dividend stock investing.

Two such sub-strategies among the more popular ones are high yield and dividend growth; some stocks pay very high dividend yields, but don’t offer much price appreciation. And those very high dividends may be a sign that the dividend is not sustainable. Still, high-yield stocks have been very popular with many investors who are willing to take the risk in exchange for the higher current dividend payment.

Alternatively, dividend growth strategies involve identifying stocks whose dividend yield may be relatively small, but whose payments on a per share basis are rising at a high rate. For instance, as opposed to a $100 stock that pays, say, $5 in dividends for a 5% dividend yield, a stock may pay $2 in dividends, but that payment may be increasing by 20% per year. So, even if the stock’s price does not change over the next few years, investors will get a nice sized “raise” in their dividend. High dividend growth is typically a sign of a business that is not only strong financially, but is also making a concerted effort to be more appealing to potential shareholders.

In any dividend approach, like any stock investment approach, sector diversification can be a key to keeping volatility in a reasonable range for the investor. Particularly in dividend investing, yield levels can vary widely by sector. Any one sector can fall on hard times, at least temporarily, so the diversification advantage that applies to investing generally applies to dividend investing as well.

Another factor to distinguish among dividend stocks is the quality of the company. As noted earlier, some stocks pay very high dividend yields, but those yields may be at risk if the business is not financially stable. Higher-quality companies tend to pay lower yields, and thus the tradeoff is something investors must find their own balance with.

How To Choose The Right Dividend Stocks

While there is no right way to select dividend stocks, this investing approach has been around for over a century. Thus, there are some research tenets that have traditionally been effective.

Any investment in a dividend stock should include getting familiar with company financials. After all, the business is going to pay you out of profits, so knowing the state of its profitability and stability of the business are essential. This type of information is now more easily available than ever before, via a variety of online sources that collect and summarize corporate financial statements for publicly traded companies.

Of particular concern when researching dividend stocks is how the company is funding that dividend payment. Historically, dividends were always paid out of company profits. However, in recent decades, some companies have tried to stretch to continue making dividend payments, taking on debt to fund part of the dividend. This is naturally a risk factor any dividend investor should be aware of.

If the dividend is a focus, the history of dividends paid is naturally a key research point for investors. How long the company has paid a dividend, whether that payment was ever suspended, and the trend of those payment levels over time are among the things investors might want to know.

In addition, the company’s dividend payout ratio is a key statistic to know. This is what percentage of the company’s earnings is used to pay the dividend. So, for example, a payout ratio of 15% means for each dollar of the company’s net income, 15% goes to the shareholder in the form of dividends. The lower the payout ratio, the healthier the dividend paying ability of the company. Some industries have higher payout ratios. REITs, for instance, pay out 90% of their profits as dividends.

The red flag investors should watch out for is when the payout ratio exceeds 100%. That signals that the dividend payment, which is supposed to be a sharing of ongoing earnings with shareholders, is coming from sources other than earnings.

Dividend Investing FAQs

What is a dividend?

A dividend is a distribution of a portion of a company’s earnings to its shareholders. Dividends are typically paid out in cash, but they can also be paid out in the form of additional shares of stock.

What are the best dividend stocks?

The best dividend stocks are those of companies that have a strong financial position, a history of paying and increasing dividends and a sustainable payout ratio. Examples of high-quality dividend stocks include Johnson & Johnson, Procter & Gamble and Microsoft.

What is the difference between high yield and dividend growth stocks?

High-yield stocks are those that pay a high dividend yield, while dividend growth stocks are those that have a history of increasing their dividends over time. High-yield stocks tend to have higher payout ratios and may be riskier, while dividend growth stocks offer the potential for increasing income over time.

What is the typical payout ratio for a dividend stock?

The typical payout ratio for a dividend stock varies by industry and company, but generally, a sustainable payout ratio is considered to be between 30% and 60% of earnings.

Are dividend stocks less risky than growth stocks?

Dividend stocks can be less risky than growth stocks, as they often have lower volatility and provide a regular income stream. However, investing in any individual stock carries risks and it is important to diversify your portfolio and conduct thorough research before making any investment decisions.

Source: https://www.forbes.com/sites/investor-hub/article/what-is-dividend-investing/