Investors who prioritize dividends and intentionally build a portfolio of dividend-paying stocks often see great rewards in the long run, often receiving thousands in monthly retirement income. Profiting from some stocks depends solely on increases in their share price, but dividends essentially reward investors for holding the stock. If you want to become a better dividend investor, here are three things you need to do.
1. Focus on companies that increase dividends
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What largely makes you successful as an investor is seeing the potential in companies and capitalizing on it accordingly. He must make decisions primarily with the future in mind, not focusing solely on past or current metrics. A company’s current dividend yield is important, but what dividend investors should keep in mind is its ability to increase its annual dividend. Companies can pay the same dividend, but if one increases its dividend by 10% per year, it is more attractive.
Certain companies that have increased their annual dividend payments for at least 25 consecutive years become S&P Dow Indices’ Dividend Aristocrats list, while companies that have increased their dividend payments for at least 50 consecutive years are Dividend Kings. . As a dividend investor, by focusing on either, you can be more confident in your investment. Any company that has managed to become a dividend aristocrat or king has shown that it can withstand economic downturns and recessions and still have adequate cash flow to reward shareholders.
History shows that periods of market decline are inevitable; You could also invest in companies that have the financial wherewithal to get through those times.
2. Focus on paying dividends, not yield
It’s common for investors to look at a company’s dividend yield before making investment decisions, but that can sometimes be misleading. Think about it: the dividend yield is based on the annual dividend payment relative to the company’s share price. If a company pays $5 a year in dividends and the stock price is $100, the return is 5%, which is very lucrative on the surface.
However, if the stock price drops to $50 for any reason, the dividend yield becomes 10%. By all means, a 10% dividend payout is considered good, but when you consider the steep price decline that led to that return, you understand why that alone is not a good metric. It would be better if you considered what caused such a sharp price drop.
Instead of focusing strictly on dividend yields, examine a company’s dividend payout to learn more about its financial health. The payout rate is the amount of a company’s earnings that it is paying out in dividends. A payout rate of over 100%, meaning the business is paying more than it earns, is a major red flag because it’s unsustainable in the long run. It’s helpful to be skeptical of companies that have a dividend payout of more than 50%.
3. Beware of dividend traps
Dividend traps often occur when something is too good to be true. Take, for example, younger and smaller companies. Dividends are paid out of a company’s earnings, so any money paid out in dividends is money that is not reinvested in the company. For smaller companies, growth is often high on the list of priorities, and if management is giving too much of its profits to shareholders instead of reinvesting it in the company, that could be cause for concern.
There are a few exceptions, such as real estate investment trusts (REITs) and master limited partnerships (MLPs), which have high dividend yields built into their structure. But generally speaking, if the dividend yield appears to be questionably high, you probably want to take a closer look at why.
The same goes for debt. A company’s debt-to-equity ratio, found by dividing its total debt by shareholders’ equity, lets you know how much of its day-to-day operations is financed through debt. As a general rule, the higher the debt-to-equity ratio, the higher the risk a company takes. You want to watch out for companies with a lot of debt that pay dividends. Financially healthy companies should be able to pay dividends out of their profits.
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