May 17, 2023
Stocks That Pay Dividends: A Guide to Investing in Dividend Stocks
A dividend is one way a company’s earnings are distributed to its shareholders. Companies that don’t pay dividends, reinvest all their earnings into the company, whereas dividend-paying companies will set aside a portion of earnings to distribute to shareholders. When you invest in a company that pays dividends, you share in their profits, earning a dividend or sum of money, based on how many of their shares you own. For example, if a company pays $1 per share in dividends each quarter and you own 20 shares, you’d earn $20 in dividends every quarter.
Investing in stocks that pay dividends is one way that investors can see a predictable return on their investment.
In this article we’ll cover:
- The benefits of investing in dividend stocks
- Factors to consider when choosing stocks that pay dividends
- Examples of top stocks that pay dividends
- Risks and challenges of investing in stocks that pay dividends
- Strategies for investing stocks that pay dividends
Benefits of investing in dividend stocks
There are many reasons investors choose to invest in companies that pay dividends. Like all investments, dividend stocks have risks. However, investing in dividend-paying stocks offers two potential sources of profit: through the stock prices rising and through dividend distributions made by the company. While a stock’s value can rise and fall with the market, dividends are generally paid out consistently either quarterly or yearly, depending on the company.
Additionally, stocks that pay dividends are often more likely to be in less volatile sectors, which can help reduce risk compared to investing in stocks in growth stocks. Many investors choose to invest in dividend-paying stock for consistency, compounding through reinvestment, and stability.
Key benefits of investing in dividend stocks include:
- Predictable income stream and cash flow for investors
- Potential for long-term growth and capital appreciation
- Potentially lower risk compared to growth stocks
- Hedge against inflation
- Offers some stability during market downturns
- Potential tax advantages with qualified dividends
What to consider when choosing stocks that pay dividends
Not all companies offer dividends, and not all dividend stocks offer the same stability and results. You’ll need to consider the company’s dividend yield, dividend payout ratio, dividend growth, financial performance, and larger industry trends before investing in a dividend-paying stock.
The dividend yield is the percentage of a company’s share price that is paid out in dividends each year. Keep in mind that dividend yields are subject to change as the market fluctuates.
Dividend yield = Annual dividends per share / Price per share
For example, a $20 stock that pays an annual dividend of $1 has a 5% dividend yield. Generally, 4% is considered a favorable dividend yield.
Dividend payout ratio
The dividend payout ratio shows how much of a company’s after-tax earnings are paid out to shareholders. Companies that don’t pay dividends have a 0% ratio, and companies that pay their entire net income in dividends have a 100% ratio. Experts say that a payout ratio under 60% is a sign of stability in a stock that pays dividends.
Dividend payout ratio = Dividends paid / Net income
For example, a business that makes $10 million and pays out $5 million in dividends has a 50% payout ratio.
Company financials and stability
Since dividends are paid from a company’s cash flow, it’s important to understand its ability to generate profit over time. Some indicators you may want to look for in a company are healthy cash flow, consistent growth, and a low debt-to-equity ratio. You might also consider how consistent a company’s performance has been, as fast or unstable growth can be seen as a marker of potential risk.
Dividend growth history and share price performance
Stocks that pay dividends often increase their dividend payouts over a number of years; understanding a company’s dividend growth history can help you assess its stability. It is recommended to look for a minimum five-year track record of strong dividend payout signals and limited stock price volatility. For consistent annual dividend increases, consider companies that have increased their dividend in at least eight out of the 10 prior years.
Industry trends and outlook
A company’s performance can be heavily impacted by its industry. In addition to the industry’s historical performance, consider current trends and the outlook for the future. Are consumers shifting towards or away from an industry? Is the industry being affected by changes in technology or government regulations? Tracking trends may help you identify potential risks in the sector overall.
Using dividend-focused stock screeners
A stock screener is used by investors to choose stocks based on their specific criteria. A dividend-focused stock screener helps you identify stocks with dividends based on price, dividend ratio, debt-to-equity ratios, sector, and more.
There are numerous free and paid stock screener options that will provide you with a list of suggested stocks, which can be faster and easier than exploring each stock one at a time.
Examples of top stocks that pay dividends
There are several categories of dividend stocks that are more likely to provide stable income and potential capital appreciation. Tracking the performance of blue chip stocks, high-yield dividend stocks, and dividend aristocrats can help you form your dividend investment strategy.
Blue chip stocks
A blue chip stock is a well-established, financially sound company with a generally long history of dependable earnings. These companies are often stable market leaders who are solidly profitable, but they are not expected to grow as fast as newer “growth” stocks. . While not all blue chip stocks pay dividends, those that do are often appealing options for investors who prioritize stability and consistency.
Here are a few examples:
|Company||Dividend yield 2023|
|Johnson & Johnson (JNJ)||2.96%|
|Chevron Corp. (CVX)||3.86%|
|Procter & Gamble Co. (PG)||2.96%|
High-yield dividend stocks
High dividend yields can be seen as either a sign of a strong opportunity or a warning. The higher the dividend yield, the more money you’ll receive for each share you own. But that doesn’t necessarily ensure a strong investment: dividend yields tend to go up when stock prices plunge, making an opportunity seem strong when it might actually be a red flag. Companies that offer a high dividend yield are also returning a significant percentage of profits to investors, instead of growing the company, which can have a long-term impact on stock performance.
When considering high-yield dividend stocks, investors also look at the company’s stock price trends, dividend payout ratio, and dividend yield to get a more complete picture.
Here are a few examples:
|Company||Dividend yield 2023|
|Walgreens Boots Alliance (WBA)||6.18%|
|International Business Machines (IBM)||5.41%|
A dividend aristocrat is a company in the S&P 500 that annually increases the size of its dividend payout. These companies are often considered nearly recession-proof and enjoy steady profits and growing dividends. They have raised their dividends consistently for at least 25 years, providing a stable income for shareholders, but potentially at the expense of their own growth opportunities.
There are usually fewer than 100 dividend aristocrats at any given time, so your dividend aristocrat options are limited.
Here are a few examples:
|Company||Dividend yield 2023|
|Coca-Cola Co. (KO)||2.87%|
|McDonald’s Corp. (MCD)||2.05%|
|ExxonMobile Corp. (XOM)||3.44%|
Risks and challenges of investing in stocks that pay dividends
Like all investments, stocks that pay dividends come with their own set of risks. Dividend-paying stocks are subject to economic downturns, market corrections, and volatility. While many companies with dividend-paying stocks are more stable than the rest of the market, that doesn’t mean that they will stay that way forever or that broad trends, fluctuations, or changing marketing won’t impact your investment.
Risks you may wish to consider include:
- Dividend cuts or suspensions: A company may choose to reduce dividend payments or even suspend them altogether. Generally, a dividend cut is considered a sign that a company is experiencing cash-flow issues or other performance problems. When dividends are cut, stock prices are more likely to fall, which can result in significant losses for investors.
- Interest rate risk: Rising rates can result in higher volatility for stocks and lower values, and can heavily impact debt-heavy, interest-rate-sensitive industries. When interest rates rise, corporate profitability and stock prices can be negatively impacted.
- Market volatility: Market volatility tends to impact the more stable dividend-paying stocks less than non-dividend-paying stocks. That said, market volatility can still affect a company’s stock prices, as well as its profits. Even if you’re receiving income from dividends, the value of your shares can drop.
- Tax implications for dividend income: Dividends are classified as either qualified or regular dividends, and the latter is taxed at your ordinary income tax rate. That rate is often higher than the capital gains rate that’s assessed on most other investment earnings.
How to invest in dividend stocks and funds
Okay, now that you know what a stock that pays dividends is, it’s time to figure out how to do the actual investing.
- Educate yourself: Before you start selecting specific investments, you’ll want to understand the nuances of how dividends work and how often dividends are paid. You should also stay up to date on broader market and investment news and start tracking the performance of companies you’re interested in.
- Open a brokerage account: A brokerage account is a taxable investment account you use to buy and sell securities. This is where you can deposit money and buy, sell, and store your securities. You’ll need a brokerage account in order to purchase investments, including stocks that pay dividends.
- Choose your dividend-paying stocks:: Your next step is to research specific stocks. Consider starting small, with a couple of investments, and research their financials, markets, and dividend yield. Take a look at their performance over the past few years and the outlook in their sector.
- Consider investing in dividend ETFs: In addition to investing in individual stocks, consider investing in exchange-traded funds (ETF) that contain dividend-paying stocks. Dividend ETFs offer investors a way to diversify their portfolio across different sectors, industries, and geographic regions. This can help to reduce your exposure to any one company or sector and potentially lessen your overall risk.
- Diversify: Diversifying your investments helps you avoid putting all your eggs in one basket. You may wish to purchase multiple stocks in different sectors. As you start purchasing stocks, keep an eye on your asset allocation, industry diversity, and even the geographic location of your investments. You may also want to diversify the types of securities you own by purchasing bonds and funds in addition to dividend-paying stocks.
- Decide how much to invest: How much you choose to invest is a personal decision that can be driven by many factors, including your income, age, risk tolerance, growth goals, and comfort. It may be valuable to start small and build up your portfolio over time, as you become more familiar and comfortable with your investment strategy.
- Invest in your dividend stock or fund: Now it’s time to place your order. Select your stocks with dividends from within your brokerage account and make your order. If you use an online brokerage or investment app, you can buy your stocks right from your phone.
- Monitor your investments: You’re not done once you’ve made your first purchase. You’ll want to check in on your stock investments over time to track your portfolio’s growth. You might also consider what you want to do with your dividend income when you receive it, such as using a dividend reinvestment program (DRIP) to buy additional shares with your dividend earnings.
Ready to start investing in stocks that pay dividends?
Many investors are drawn to dividend-paying stocks because they can earn income from both dividends and potential returns when the share price increases. And reinvesting earnings with a DRIP can help them increase the power of compounding. If you’re ready to invest in stocks that pay dividends, Stash makes it easy with fractional shares and an ETF dedicated to dividend-paying stocks. And you can get started with any amount.
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