Don’t you dream of passively collecting a monthly stream of income for the rest of your life ? Well, dividend investing can offer you just that. In this article, I will give you 12 tips to start buying dividend paying stocks and setup a complete dividend strategy.
It will give you all the basics steps to understand dividend investing, what are dividend reinvestment plans, how to invest in dividend ETFs, and how you can build yourself a regular monthly cash inflow.
Let’s get started.
1. Why choose dividend investing and how does it work?
When you invest in dividend paying shares, you collect a sum of money (the dividend) every time the company whose stock you purchased pays its dividend. That could be yearly, quarterly or monthly, making it a great source of regular income. All this comes without any intervention from your side, which differentiates dividend investing from so many other passive income ventures.
Companies usually pay dividends in cash (« cash dividends »), but occasionally some companies will pay stock dividends to their shareholders (also called « stock splits »). When buying a stock, pay attention to that.
Dividend investing is truly passive
If you’re trading stocks and your income relies on making profitable trades, you’re going to have to work hard to get your entries and exits right, and as soon as you stop trading (vacation, break, or whatever other reason) then the income dries up.
If you are a real estate investor, you have to find, purchase, fund, and manage your properties. Another source of passive income, but you’ll have to put in some hard work to keep things rolling. And if some tenants move out of your properties, bam … the rents stop coming in and the income dries up.
With dividend investing, you purchase the shares once, and then you simply wait for the dividend to get paid, can’t get any easier. The whole science is to find the right stocks, the ones that will pay a good, steady and ideally growing dividend.
So how do you find good dividend paying stocks ? Let’s move on.
2. What should you look for in dividend paying stocks ?
Before we get into the actual method you should use to find good dividend stocks, let’s take a look at what we should be looking for.
Since dividends are a share of profits (or reserves) that companies distribute to their shareholders, the first thing to look for is obviously a profitable company. A loss-making company won’t sustain a dividend payment policy for very long.
Not all companies pay dividends, which isn’t necessarily linked to profitability. For example, companies in a high growth segment (a lot of tech companies) will prefer to reinvest their funds to keep the business growing rather than distribute them to shareholders. Amazon is a good example, the company still hasn’t paid a dividend. Read this article « Will Amazon ever pay a Dividend? » to know more.
Similarly, dividend policies change over time, a company can decide to lower its dividend (dividend cut) or increase it (dividend hike) at any point in time.
Note : If you want to understand some fascinating concepts around the corporate life cycle, dividends and company valuation, watch this fabulous speech by Aswath Damodaran, the god of valuation and legendary NYU professor.
Coming back to the selection of your dividend paying stocks, beyond profitability you should look at several things to help you get confirmation that the stock is a good candidate.
Here are the 10 things to watch when selecting dividend paying stocks:
- Invest in high quality companies
Companies that have a proven long-term record of stability, growth, and profitability. Steady and rising dividends over long periods are an extremely good signal, probably the best. See the Dividend Aristocrats and Kings further below.
- Buy stocks that have a good solid dividend yield
The best is usually just above the average market yields (S&P 500).
- Look for stocks that are trading below their long term average
I recommend stocks well below their 52 week high, and check the P/E also. That way you will make sure you’re not buying an overpriced stock.
- Watch the dividend payout ratio
It should not be too high, 40-70% is a good figure. For example, JNJ, one of the best dividend stocks, has a 45% payout.
- Look for stocks that occasionally repurchase their own shares
It’s a good signal that there’s ample cash flow and when times get tough that safety margin could prove crucial to sustain the dividend.
- Invest in companies that people still invest in during market crises
They will do better in the long run
- Don’t keep stocks that run into overheated territory
A huge bull run on a share might push it to levels of relative over-valuation. Take your profits and reallocate.
- Another reason to exit are dividend cuts
Usually not a good signal so keep an eye on them.
- Be careful with debt
For example, some REITs might have high dividend yields but on the back of highly leveraged capital structures.
- Look for companies with solid growth
To measure that, nothing better than the earnings per share indicator.
This all sounds like quite a tedious task, right ? The good news is there are different types of tools that can help you select the best dividend paying stocks. We’ll get to that in a minute, but before we do let’s look at a very important concepts in dividend investing, I’m talking about Yield and Dividend Growth.
3. Should you go for High Yield or prefer Dividend Growth?
You’ve decided that you want to start building a dividend earning portfolio, now you have to choose a strategy. Among the many available strategies, high yield and dividend growth usually come out as the most popular.
Let’s try and understand.
Be careful in rushing towards high yields
Simply put, to calculate the dividend yield of a stock, just divide the dividend by the stock price (before payment), and that’s the yield, expressed in %.
The good thing about yield is that it makes it easy to compare different forms of investments, such as stocks, bonds, mutual funds, real estate etc… You will quickly notice that some stocks pay yields that are way higher than bonds or mutual funds, especially in recent market environments.
Some sectors typically offer structurally high yields, such as REITS (Real-Estate Investment Trusts), MLPs (Master Limited Partnerships) or BDCs (Business Development Companies). The reason is that the US Treasury forces these companies to pass on most of their profits to shareholders. But beware, they can be quite volatile.
So the obvious thing for a dividend investor would be to just go for high yield dividend stocks (usually more than 4%) and let the cash flow in right ?
Well, unfortunately it’s not that simple. Because there could be bad reasons for an unusually high yield. For example a stock price that has taken a beating because of adverse financial performance or business concerns. That would push the yield much higher (and it usually precedes a dividend cut).
An unusually high dividend payout ratio (paying out more than the earnings, by taking from reserves) can also be a bad sign, with the risk of a volatile dividend.
For that reason, it is not considered to be a good idea to just catch high yielding stocks without a look at a second very important criteria: Dividend Growth.
Go for Dividend Growers, they perform better over time
A study by Royal Bank of Canada has shown that Dividend Growers (companies that consistently increase their dividends over time) outperform the S&P/TSX Composite Index by quite a significant margin with an astonishing 11.7% compounded return over 30 years (1986-2016) vs 6.6% return for the Index.
That’s huge, and in times of high market volatility, this can be a reassuring factor for investors.
The reason is simple. Steady dividend growth is usually a sign that the earnings are stable and growing, and that dividend policy is sustainable, which is exactly what we are looking for. And since dividends will add to capital appreciation to form your total return, solid dividends will give your portfolio a head start.
Now that we know what we’re looking for, where can we get help in finding our preferred dividend players ?
4. Use dividend screeners
The first method you can use to find the best dividend stocks is Stock Screeners. There are a couple of good ones, most of them free.
Finviz is one the best known free screeners, giving you a huge number of criterias to search from. Company financials, stock performance, charting patterns, fundamentals, it’s all there for you to establish your preferred list of stocks.
How to search for Dividend Stocks in Finviz ?
Let’s take an example. Say we’re looking for stocks in the Technology sector, with a Dividend Yield above 4%, with a payout ratio below 80% and a EPS (Earnings Per share) growing above 20% for the last 5 years .
Here are the five steps to follow in Finviz:
- Go to the Finviz Screener
- Under the Descriptive Tab, choose “Sector” and select “Technology”
- Still under Descriptive tab, click “Dividend Yield” and select “Over 4%”
- Next, go to the Fundamentals tab and in the “Payout Ratio” box, select “below 80%”
- Finally, still on the Fundamentals tab, in the “EPS growth past 5 years” select “Over 20%”
That’s all it takes, 2 minutes. You now have yourself a shortlist of Dividend Stocks, totally free.
Dividend.Com is a more elaborate tool, because it incorporates proprietary research into it. This screener will allow you to filter stocks by Sector & Industry, with an option to sort stocks by Dividend yield, Annual Dividend and Pay Date. But the value is in the DARS Criteria.
The DARS rating (Dividend Advantage Rating System) is a proprietary service that ranks stocks to find strong and reliable dividend stocks. It uses five factors to assess each stock : relative strength, overall yield attractiveness, dividend reliability, dividend uptrend, and earnings growth.
You have to take a premium membership to access all proprietary research and tools. I have been a longtime subscriber and the service is clearly one of the best if you don’t have time to do the research and want a turnkey list of top Dividend Stocks.
5. The Dividend dates you need to watch
To fully master Dividend investing, you need to know what are some of the key dates used to communicate around dividend policy. As an investor, this will be very important because it will enable you to time your entries and know when to expect payments and stock adjustment.
- Declaration Date: date when the Board of Directors announces the dividend;
- Ex-dividend Date (or Ex-Date): you must own the stock before Ex-Date to be eligible for the dividend. Usually it is set one business day before Record Date;
- Record Date (or Date of Record): you must be registered on the company’s books as a shareholder before Record date to be eligible for the dividend;
- Payment Date: date when the dividend is paid.
6. Consider monthly dividend stocks for regular income
Most Dividend-paying companies pay dividends on a yearly or quarterly basis. However, some stocks pay a monthly dividend, which can be interesting if you’re looking for a steady stream on income to cover your monthly expenses.
Unfortunately, there are not too many monthly dividend payers. You can use Dividend.com’s Monthly Dividend list, it’s available for free.
7. Dividend Aristocrats and Dividend Kings
In the Dividend investing world, two categories of companies stand out from the rest and serve as a reference to any serious dividend investor:
- Dividend Kings: S&P500 companies that have a history of 50+ years of consecutive Dividend increase;
- Dividend Aristocrats: S&P500 companies that have a history of 25+ years of consecutive Dividend increase
You can find a regularly updated list of these Dividend Kings and Dividend Aristocrats in many websites, but if you can also shortcut your way to purchasing these stocks by going for a Dividend Aristocrats ETF. That way, you don’t have to worry about keeping an updated list of the aristocrats, the ETF will do the work.
The one you can go for is ProShares NOBL. There’s an interesting article on Cabot Wealth about the NOBL ETFs, it takes an in-depth look at the stocks composing the ETF, ranking the by expected growth rate (Revenue and EPS).
8. Take a contrarian view in your Dividend Investing Strategy
If you want to build a high yielding Dividend portfolio, I mean north of 6-8% yield, taking a contrarian view is probably one of the only ways to get going. And to help you, there’s a website that clearly stands out : Contrarian Outlook
Brett Owens, editor of Contrarian Outlook, started with an acknowledgement :
Today, it’s almost impossible to find good stocks that pay a quality yield.
So what he did was take a contrarian approach to locate high payouts that are available thanks to some sort of broader misjudgment. Howard Marks would describe that as “second-level thinking.”
What Brett is actually doing is looking past the widely accepted consensus on specific investments to try and map out a range of probabilities to locate value.
He contends that it’s possible to find secure yields of 6% or more in today’s market, and that’s exactly what Contrarian Outlook is about.
Brett Owens is a regular contributor on Forbes.com, he publishes well-researched articles with useful investing tips for high yield dividend searchers.
His premium newsletter Contrarian Income Report is themed around finding secure, stable income through an “8%+ No Withdrawal portfolio.” I am a regular subscriber and can vouch for the high quality of the recommendations and the solidity of overall yields. Give it a try.
9. Two websites to help you Invest in high quality dividend stocks
There are two services I recommend you to check out to setup a solid dividend strategy, they have a lot of free content and some premium options:
Suredividend: invest for the long run
Another service I have been using is Suredividend. Articles, monthly newsletters, dividend investing courses, the website is focused on high quality dividend stocks to hold for the long run. Their goal is to help you achieve financial freedom through an investment portfolio that pays rising dividend income over time. Lots of free articles to check out.
Simplysafedividends: setup a predictive dividend strategy
Simplysafedividends focuses on the stability and reliability of dividend payouts for individual stocks. They have a great free service where you can input the stocks from your portfolio and the proprietary tool gives you a dividend safety score for each of your stocks, taking into account multiple factors. Great service, lots a valuable advice to help you avoid being hit by nasty dividend cuts.
10. Read books on dividend investing
Books are a great way to keep learning. Two of them stand out when it comes to Dividend Investing:
Dividend Growth Machine, how to Supercharge your Investment Returns with Dividend Stocks, by Nathan Winklepleck
The Single Best Investment: Creating Wealth with Dividend Growth, by Lowell Miller
Both of these books promote dividend investing as a way to produce returns far superior than other investment strategies. That’s mainly achieved through quaity businesses paying rising dividends.
If you’re fond of investing books, I also have several articles that could help you get ahead on your investing strategies :
- the top 12 investment books for beginners
- the top 10 day trading books
- the top 10 books on Real Estate Investing
11. Consider dividend ETFs for a more passive approach
If you don’t have time or the desire to select and follow individual dividend stocks, and you’re reluctant to pay for premium services, you have an interesting option in buying Dividend ETFs (Exchange Traded funds).
Investing in an ETF is equivalent to investing in all the shares that compose the fund, all in one go. The ETF market is so developed that there are now basically ETFs for any sector or sub-segment of the market. Hence Dividend ETFs, specialized in Dividend paying stocks. Your goal is to find the right one.
Here are the top 4 Dividend ETFs:
- NOBL: Track the Dividend Aristocrats
- SDY: the SPDR S&P Dividend ETF tracks the High-Yield Dividend Aristocrats Index, which includes companies from the S&P Composite 1500 with at least 20 consecutive years of growing dividends
- VIG: the Vanguard Dividend Appreciation ETF. Another famous ETF tracking the Nasdaq U.S. Dividend Achievers Select Index, a market cap-weighted group of companies that have increased dividends for a minimum of 10 consecutive years
- DVY: the iShares Select Dividend ETF, the largest ETF to track a dividend weighted index
If you want to dig deeper and do more research on Dividend ETFs, searching for high yield ETFs for example, there’s a very good service called justetf.com, they have a special article on the Best ETFs for Global Dividend stocks.
12. Go for dividend reinvestment plans (DRIP)
Dividend Reinvestment Plans (DRIP) are programs offered by companies to allow investors to reinvest their cash dividends into additional shares or fractional shares of the given stock on the dividend payment date.
The advantages of such plans are that the shares will usually be purchased without commissions. On top of that, companies might offer a discount, usually between 1% to 10% of the current share price.
But the biggest benefit in the long run is the compounding effect of automatic dividend reinvestment
Forbes has an interesting article on the best dividend reinvestment plans.
Bonus tip: try a Dividend Capture Strategy
There are alternative strategies you can use in Dividend Investing, such as Dividend Capture. In essence, Dividend Capture consists in buying stocks whose stock price recover quickly once the Dividend is paid.
Remember, we explained that a stock’s price will dip when a dividend payment is made. So if you buy a stock likely to have a quick price recovery, you “capture” the Dividend, wait for the price to recover its initial level pre-dividend, and sell at break even with a significant gain (the dividend) in a short period of time.
This strategy can be very lucrative. If a stock has a 4% dividend yield, then you pocket a 4% return for just holding the stock the time it took its price to recover.
You can try Dividend.com’s Capture Tool which provides you with the stocks that combine a high DARS rating, a good dividend history, have recovered within 5 days at least 6 times in their last 10 Dividend payouts and are going ex-Dividend in the next 10 days.
We’ve come to the end of these 12 tips to Buy Dividends. I hope you found some useful content.
Dividend Investing is one of the best ways to generate passive income, you just need a good Strategy to get going.
Do you have any tips you’d like to share on Dividend Investing ? Strategies that work for you ? If so, don’t hesitate to drop us a comment below.