Investing in dividend stocks is a great way to introduce cash flow into your stock portfolio. These stocks pay out money on a reliable schedule and tend to be relatively low-risk investments.
In this guide, we’ll cover everything you need to know about how to invest in dividend stocks and how to choose the best dividend stocks for your portfolio.
What is a Dividend Stock?
Dividends are a mechanism that companies can use to distribute profits to shareholders. A dividend stock is stock of a company that typically pays dividends to investors.
Typically, dividends come in the form of cash payments distributed once per quarter or once per year. However, dividends can also be paid out in stock or on a less regular schedular. The amount paid in dividends might vary from payment to payment, although most companies try to keep their payouts consistent.
Companies that pay dividends are usually blue-chip companies that have a strong track record of profitability. These companies can be relied on to have excess profits year after year and to reliably pay out a consistent dividend to investors. Notably, these same blue-chip stocks are also among the lowest risk stocks you can invest in.
How are Dividend Stocks Different from Regular Stocks?
The main difference between dividend stocks and regular stocks is that dividend stocks typically come with a dividend. It’s not that regular stocks cannot pay a dividend to shareholders. Rather, the companies behind these shares either don’t have profits to distribute or choose to re-invest profits in the company instead of paying them to shareholders.
Since dividend stocks make consistent payments, shareholders aren’t solely reliant on stock price appreciation to profit from holding these shares. As a consequence, dividend stocks are often less volatile than non-dividend stocks in the same market sector.
How to Choose Dividend Stocks
Many of the same factors you would consider when choosing regular stocks apply to dividend stocks. At the end of the day, you want to invest your money in high-quality companies.
That said, there are several additional considerations when choosing dividend stocks to invest in:
Dividend Yield
The amount that a dividend stock pays out to shareholders is typically measured as the dividend yield. This is the ratio of dividends paid out relative to the stock’s price.
The highest-paying dividend stocks can pay a yield of 7% or more. However, most dividend stocks pay a yield closer to 2-5%, since this is more sustainable for the company during periods of slow growth.
Dividend Consistency
Not all dividend stocks are 100% reliable at paying dividends, and you need to take this into account when choosing what stocks to buy.
Look back at a company’s entire dividend history to see whether there have been instances when the dividend was suspended or reduced. Companies typically work very hard to avoid suspending or cutting their dividend payouts, so this is a red flag that future payments might not happen as expected.
Another thing to check is whether the stock’s reported dividend yield has been inflated by special dividends. These are one-time bonus payments that companies make when they have a windfall year, and they aren’t likely to happen year after year.
Company Financials
It’s also worth taking a dive into companies’ financial statements before investing. Dividends are paid out of profits, so a company needs to maintain its profitability in order to be able to keep paying at the current yield.
In particular, look at companies’ debt ratios. Moderate amounts of debt are fine for a healthy company, but dividend payments are among the first things to go when debt levels creep up too high.
In addition, check the dividend payout ratio. This is the fraction of total profits that are paid to shareholders. If this number is close to 100% – or even higher than 100% – the current dividend is likely not sustainable and it could be reduced or suspended.
Stock Price Fluctuations
While many dividend stocks have relatively low volatility, stock prices still change over time in response to news, earnings, and market trends. These price fluctuations can impact the overall value of your shares, especially if the price fluctuations are often larger than the stock’s dividend yield.
For a dividend stock to be a profitable investment, it must hold its value or gain in value over time.
How to Buy Dividend Stocks
The process to buy dividend stocks is the same as to buy any other stock. Simply purchase the shares through your stock broker.
The only extra thing you need to do when buying dividend stocks is decide what to do with the dividends themselves. Many brokers give you the option to reinvest your dividends to purchase additional shares of the company. You can also receive the dividends as cash in your account, which you can then withdraw or use to invest in other stocks.
Tips for Investing in Dividend Stocks
Making good long-term investments in dividend stocks takes practice and patience. Here are some tips to help you get started.
Keep an Eye on Price Change
As we noted earlier, dividend stocks do experience price changes just like regular stocks. If these price changes are larger than a stock’s dividend yield, you need to account for them when considering your investment.
In general, it’s a good idea to look for dividend stocks that have relatively consistent prices. That way, you can expect a predictable return from the dividend. You can invest in more volatile growth stocks with another, distinct part of your portfolio.
Consider Payout Schedules
One of the advantages of investing in dividend stocks is that the payouts offer steady cash flow. You can use the cash to cover everyday expenses without having to liquidate your investments.
If you expect to use your dividends as ready cash rather than reinvest them, make sure to look at when different companies pay out their dividends. Ideally, your dividend stocks will each pay dividends at different times of the year. That way, you have cash coming in over the entire year instead of all at once or in the span of just a few months.
Dividend Yields aren’t Everything
It can be very tempting to buy the dividend stocks that offer the highest yields. However, high yields aren’t everything.
For example, say a company pays out a very high 7% dividend yield. That looks good on paper, but if the company is struggling overall then the share price could fall more than 7% or the dividend could be cut in the future.
Instead, look for companies that offer moderate dividend yields and that have rock-solid financials. The goal is to invest in a company that can keep up with its dividend or steadily increase it over time for many years to come.
Conclusion
Dividend stocks offer cash payouts to investors that you can use to reinvest in the market or provide cash flow for everyday expenses. You can invest in dividend stocks through your broker, the same way that you would invest in any other stock. Be sure to look closely at companies’ financials when considering dividend stocks, since you want to know that the dividend will be paid out consistently for the years ahead.
