A great investment plan may include dividend investing. Historically, less volatile dividend stocks have outperformed the S&P 500. This is due to the fact that dividend stocks offer two types of income: consistent dividend income and stock price growth. Over time, this total return may increase.
Dividend stocks frequently appeal to investors looking for lower-risk investments because of their lower volatility, particularly those in or approaching retirement. But if you don’t know what to steer clear of, dividend stocks can still be dangerous. Here’s a closer look at the books that can teach you the dividend stock investment process.
What drives dividend stocks?
Let’s examine a case in point. Consider purchasing 100 shares of a company for $10 each, with each share paying a $0.30 annual dividend. If you invested $1,000, you would earn $30 in dividend payments over the course of a year. That amounts to a 3% yield, which is not bad.
It is entirely up to you what you decide to do with your dividends. One can:
Reinvest them to purchase additional company shares.
Purchase shares of a different company.
Save your money.
Use the funds.
You would continue to receive those dividend payments as long as the company kept paying them out, regardless of whether the stock price of the company increased or decreased.
The appeal of dividend-paying stocks is that a portion of your return comes in the form of dependable quarterly payments. The COVID-19 pandemic has shown that not every company offering dividend stocks can maintain a dividend payout in every economic climate. However, a diversified portfolio of dividend-paying stocks can generate steady income in any weather.
When you combine those dividends with capital growth brought on by the increasing value of the companies you own, your total returns may even be greater than those of the general market.
Dividend Yield and Other Important Financial Ratios
Knowing how to assess dividend stocks is crucial before you purchase any. These measures can aid in your understanding of dividend yield, dividend reliability, and, most importantly, how to spot warning signs.
The annualized dividend is expressed as a percentage of the stock price and is known as the dividend yield. The dividend yield, for instance, would be 5% if a corporation paid $1 in annualized dividends and its stock was trading at $20 per share. When you contrast a stock’s current yield with its previous levels, yield can be a useful valuation metric. All other things being equal, a greater dividend yield is desirable, but it’s more important for a company to be able to keep paying out dividends and, preferably, increase them. An unusually high dividend yield, though, can be cause for concern.
The dividend payout ratio measures how much of a company’s earnings go toward paying out dividends. The payout ratio is 50% if a corporation has net income of $1 per share and distributes a dividend of $0.50 per share. In principle, a dividend should be more sustainable the lower the payout ratio.
Cash dividend payout ratio: This measures the dividend as a proportion of a company’s free cash flow, which is operational cash flows less capital expenditures. This metric is important because GAAP net income is not a cash measure and because a company’s earnings and free cash flow can vary greatly from one quarter to the next due to a variety of non-cash expenses. The payout ratio of a company may occasionally be misleading because to this unpredictability. The cash dividend payout ratio and the basic payout ratio can both be used by investors to determine if a dividend is sustainable.
Total return: This includes dividend payments as well as stock price growth (sometimes referred to as capital gains). For instance, if you invest $10 in a stock that rises in value by $1 and yields a $0.50 dividend, your total return would be 15% on the $1.50 you’ve acquired.
Earnings per share (EPS): This statistic compares the profits of a firm to the price per share. The best dividend stocks are those whose companies have demonstrated a consistent capacity to enhance earnings per share and, consequently, dividends over time. Growing earnings over time is frequently proof of long-lasting competitive advantages.
P/E ratio: This ratio is established by dividing the share price by the earnings per share of a company. Along with dividend yield, the P/E ratio is a metric that can be used to assess the fairness of a dividend stock’s valuation.