While most people who are attracted to the idea of earning a passive income do so in the form of affiliate marketing, course creation, or ads, investing in dividend stocks is actually a pretty easy way to earn income passively (if you know how to do it right).
Having a portfolio full of dividend stocks is a perfect fit for anyone who fancies the idea of having a stream of steady income without having to do much of anything aside from the initial research regarding which dividend stocks are best.
Oh, that’s you? Welcome! We’ll start by telling you that the best dividend stocks investments are often from companies with the potential for long-term growth and earnings, industrial-strength, and cash flow. But, there’s more to it than that. This article will show you how to invest in dividend stocks as a beginner so you can get good returns from your investment portfolio.
What Are Dividend Stocks?
Dividend stocks are stocks from companies that pay out a percentage of their earnings yearly or quarterly to their stockholders. In short, when you buy dividend stocks, you become eligible to receive a portion of that company's income (that’s called the dividend yield).
Dividend investing is the act of investing in these stocks. You build up a portfolio of blue-chip stocks (stock from large, well-established companies) that offer you regular dividend yields throughout the year.
It’s important to note that investing in dividend stocks is a bit safer for beginner investors (at least from a very general perspective). Dividend stocks tend to far less during market crashes and recessions.
Marguerita Cheng, a CFP and CEO of Blue Ocean Global Wealth explained this best by stating that, “The benefit of investing in dividend-paying stocks...is that the dividends can be reinvested. Even if the value of your stock is down because of the conditions, the reinvested dividends lower the volatility. Let’s say the stock market is down 10%, but that stock you have pays a dividend of 3%. If that gets reinvested, you don’t experience as much downside.”
How to Evaluate Dividend Stocks
All stocks aren’t worth buying and not all dividend stocks are equal, no matter how sweet they may appear. Which stock is worth buying and which one isn’t? Here's how to know the best dividend stocks to buy for long-term dividend investments.
1. Dividend Yield
The dividend yield is a financial ratio of the dividend and price per share (dividend/price). Essentially, it shows how much dividend a company pays each year relative to their stock prices.
While you might think that you can simply search for the companies paying out the highest dividend yields and win big, it actually doesn’t work that way. Relying on dividend yield alone when investing in dividend stocks may be a bit deceiving.
As a rule of thumb, you’ll want to follow this advice: Stocks with a dividend yield above 4% should be carefully scrutinized, and those with yield within the region of 10% and above present a risky territory.
When a stock has a high dividend yield, it can indicate that the dividend is unsustainable or that investors are intentionally selling their shares, bringing down the share price, and causing the dividend yield to increase.
2. Pay-Out Rate
The dividend payout rate is a good determinant of the type of dividend stock to invest in. This will show you the percentage of the company's earnings that goes into dividend payments to stockholders.
A high payout rate (usually above 80%) tells you that the company is pouring a large percentage of its earnings into dividend payments. Likewise, a payout ratio of more than 100% means that the company is going into debt trying to pay out its dividends.
A lower payout ratio (below 80%) may mean that the company's dividend payment is sustainable or that they will eventually increase their dividend. Here's how to calculate the payout rate.
Ask yourself one question: Is the company secure enough to continue paying the dividend?
Assess the history of the company and figure out whether or not it appears strong enough to slowly increase their dividend over time (as that’s the goal for you!).
This is where you’ll come to learn the term dividend aristocrats. These are companies that have increased their dividends over time, and they’re great companies to research when figuring out which dividend stock is the best to invest in at the moment.
Dividend Stock Investment Strategies
Those investing in dividend stocks find that their investment strategy falls into two categories: short-term or long-term investing. Here are a few of the best investment strategies you can use to make the most returns on your investment:
Aiming For High Dividend Yields
Those who use this strategy are hoping to generate income right away. How this works is that you look for slow-growing but well-established companies offering high-dividend payments.
However, the thing here is that companies offering super high-dividend payments may not see much growth in the value of their stock as other companies that have lower dividend yields. Just something to be mindful of, although it can still be a great strategy for short-term, high-value growth.
Choosing High Dividend Growth
This is for investors with long-term vision and the patience to wait for returns. The strategy here is to focus on acquiring stocks from fast-growing companies with a lower than average dividend.
Sure, the current yield probably won’t be much. But remember that this investment strategy is all about waiting for those bigger returns in the future. The stock prices for these are usually cheap. This makes them a great option, too, for beginner investors with less cash upfront to invest in. As the firm grows and matures, the dividend gradually increases, and the stock prices do too.
Pursuing Dividend Capture
This is a more active and hands-on investment approach. With this strategy, you don't have to keep the dividend stocks for up to a year. You don't even have to keep them for an entire quarter before earning the dividends.
What happens here is that you swoop in and buy the stock before the dividends are paid. However, you have to purchase the company's stocks before the ex-dividend date to be eligible to receive the dividend.
So, is Investing in Dividend Stocks Worth It?
This article wouldn't be complete If we failed to mention here that investing in any type of stock is risky. You can lose money, and you can also make a lot of money. However, having a diversified portfolio full of different dividend stocks is one of the safest investments you can venture into.
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