In 2021, around 25% of investors considered stocks and bonds as the safest investment type. And in recent years, more people have started investing buying stocks and bonds. But the bond investment, in real terms, has been gathering a negative yield to the point where it can’t compensate sufficiently for inflation.
Moreover, with the interest rate hike and geopolitical tensions, 2023 is at risk of recession. In such circumstances, dividend investing stocks are the best bet among investors for multiple reasons. But just as with any investment, it has its risks and reasons to consider before starting.
This article will cover how dividend stocks work, reasons for investing, as well as ways a step-by-step guide to choosing a dividend stock worth investing in.
How do Dividend Stocks Work?
Dividend Stocks or Dividend Growth Investing is an investment strategy to target companies that pay consistent and growing dividends. Generally, dividends are paid out in case a company wishes to reward its investors.
Stock dividends can reward shareholders without needing to reduce the cash balance of the company. It also has an investor tax advantage, as, unlike any stock shares, it doesn’t get taxed until the shares are sold by the investor.
Here’s an example: if you spend $10 each buying 100 shares of a company, with each share paying an annual dividend of $0.50, then you will receive dividend payments of $50 for the $1000 you invested. So the yield is 5%.
From here on, you can choose to reinvest them into buying more shares, buying another company’s stock, or saving or spending the money. On the account that the company will continue disbursing, you will receive the dividend payments, regardless of the stock price of the company going up or down.
Why are People Investing in Dividend Stocks?
Stocks dividend can offer a growing and more stable income. On common stock, there are no guarantees for dividends. But dividends are more presumably paid by companies that are well-established and don’t require reinvesting much money into their business.
It is also considered an indication of the financial security of a company. Once a company raises or establishes a dividend, the expectation of its maintenance falls upon the investors, even during tough times. If the investors think a stock can reduce the dividend, they often devalue it, resulting in a lower share price. So, even if it’s not mandated to pay dividends, enterprises and companies still invest in it to attract investors and positively impact stock prices.
According to Fidelity, during high inflation, stocks with the most increased dividends outperformed the market. Besides that, dividend paying stocks are tax-advantaged, unlike fixed-income interests, as well as less volatile compared to non-dividend paying stocks and help build wealth with time.
What are the Popular Dividend Paying Stocks?
Popular dividend paying stocks typically include firms, or dividend aristocrats, that have been providing dividends non-stop for over 25 years. Among them, here are a few dividend aristocrats that have been paying dividends for over 50 years:
- Dover Corp.: With a current dividend yield of 1.3%, it is a conglomerate industrial product manufacturer that has been paying dividends for nearly 70 years.
- Coca-Cola Co.: It is the most popular soft drink manufacturer in the world, with a dividend paying history of 59 years in a row. The dividend yield of the company at present is 3.11%.
- 3M: It is a corporation that operates in consumer goods, worker safety, industry, and US healthcare with a dividend payout history of 63 years. Its dividend yield is 2.92% at the moment.
Step-by-Step Guide to Choosing the Right Dividend Investing Stocks
While dividend investing is a reliable way of accumulating wealth with inflation protection, finding the right high dividend stocks to invest in can be challenging.
So here is a dividend investing strategy with factors you want to check into in a company before making your decision:
1. Attracts Long-term Profitability
As any company can experience occasional profit, it is essential to look for companies showing consistent annual growth. To be specific, companies with a growth expectation of long-term earnings ranging from 5% to 15% are recommended for investors. Companies with over 15% growth often encounter earnings disappointment, causing lower stock prices.
2. Generates Healthy Cash Flow
Good liquidity is necessary in order to pay dividends. So consider companies that can generate healthy liquidity or cash flow before investing.
3. Record of Strong Dividend Payouts
If a company has a few years of track record of paying dividends, it’s an indication of having continued dividend growth. Companies with a track record of five years minimum are a safe bet for investors.
4. Debt-to-Equity Ratio
Companies having excessive debt should be strictly avoided. The reason is that such companies tend to direct their funds into paying the debt off instead of applying the capital to paying dividend programs. As a result, it’s crucial for investors to assess a company’s debt-to-equity (D/E) ratio. A ratio value of 2 or higher is generally considered risky, but it depends on the industry and business.
5. Inspect Sector Trends
Apart from studying the fundamentals of a specific company, be aware that the behavior and trends of a sector can change over time. For instance, even though it has been a safe bet, historically, to invest in the soft drink industry, consumers are turning progressively health-conscious. As a result, a lot of major beverage companies have been migrating to alternative healthy drink spaces. However, this change will take time, but investors should be mindful and recognize such circumstances before investing their money.
Conclusion
Dividend investing is appealing to a wider group of people because of its income stream, similar to a paycheck. But, whether you are approaching retirement or just beginning your investment journey, dividend growth stocks can benefit your portfolio as a way of diversification.
However, if you are planning to invest in dividend stocks, companies boasting long-term earnings growth expectations from 5% to 15%, industrial strength, low debt-to-equity ratios, and strong cash flows are factors to look out for.
DividendChase offers a variety of investment plans and recommendation services for dividend stocks. Contact us to get started.
