Even for a new investor, it’s no secret that dividend stocks can be a strong addition to your portfolio.
Over the long term, high-quality dividend stocks have three big advantages over other stocks:
- They offer a steady stream of passive dividend income.
- They have a tendency to be a “safer” option than growth stocks (especially during market declines).
- They often trade in a more stable manner due to strong underlying financial performance and shareholder-friendly management.
However, it’s important not to assume that all dividend stocks are automatically safe investments. There are thousands of dividend-paying companies available on the market and they come in all shapes and sizes.
Let’s look at a few common reasons investors seek out dividend stocks before exploring how to find the best dividend stocks.
Dividend Stocks Offer Investors Passive Income
First and foremost, investors enjoy receiving dividend checks every quarter.
You don’t have to sell your shares to receive the money, the dividend payment is simply deposited into your account (typically on a quarterly basis). And regardless of the amount of shares you hold, the money gets paid to any and all shareholders.
A novice 20-year-old investor who owns only two shares of Apple (AAPL) stock will receive his dividend payment at the same time and in the same way as a multi-million-dollar expert investor.
And that’s part of what makes a dividend stock so attractive – the continued reliability and dependability promised to its shareholders.
Many dividend-paying companies are committed to paying the same dividend (or a growing dividend) at the same time, year after year after year.
There’s even an elite “club” known as the “Dividend Aristocrats” which are 57 stocks in the S&P 500 that have 25+ years of consecutive dividend increases.
Investors often view such steady, reliable dividend payments as “passive income.”
Years ago such investors bought shares in Walmart (WMT), or Procter & Gamble (PG), or Exxon Mobil (XOM), and now they just look at their accounts each quarter and watch the dividend payments roll in.
For retirees, this idea of passive income is so attractive because it provides a potential upgrade to their current standard of living.
Unlike a young investor just getting started in his career, a retiring investor has probably already saved a sizable nest egg. By investing his savings into dividend stocks, the retiree can now collect passive dividend income at an annual rate of anywhere from 1% – 5% (or more) of his total investment.
The higher the dividend yield, the more income you can collect.
Dividend Stocks Shine During Market Crashes
During a stock market crash, dividend stocks are often viewed as a safer investment (see Are High Dividend Stocks Safer During a Stock Market Crash?).
If the company’s dividend remains steady (or, even better, is still growing), then it will attract other buyers who are looking for reliable returns in an uncertain market.
In addition, investors who choose to reinvest their dividends back into the stocks that pay them (commonly known as a DRIP plan) can accumulate more dividend-paying shares for cheap.
Over time, this means they buy more shares and collect more future dividends using their present dividend payouts.
How to Find High Dividend Stocks
Collecting dividend income is a constant balancing act between finding safe stocks and finding the highest possible dividend yield.
There are many dividend stocks that currently offer dividend yields of 7%, 8%, 9%, 10%, or more – but are they safe investments?
Remember, a sky-high yield doesn’t do much good if the stock price declines dramatically.
When it comes to dividend stocks, there are a few important metrics to keep an eye on:
- Look for stocks with a sustainable debt-to-equity ratio – the amount of debt and liabilities vs. shareholder’s equity. Companies that are taking on tons of debt to fund their dividend are headed for trouble.
- Be mindful of the dividend payout ratio, which is the amount of the company’s net income it pays out in dividends to its stockholders. A healthy payout ratio shouldn’t exceed 70 percent over the long-term.
- Look for consistent, long-term dividend growth. Companies that stop or cut their dividend are more likely to be in financial trouble and less focused on pleasing shareholders.
To help investors learn exactly how to use these metrics (and others) to find the best dividend stocks, read our two lessons on dividend investing: