Dividends are a share of the profits that a company makes. Companies pay dividends as a way to attract investors and create demand for their stock. By investing in stocks that pay dividends you can earn passive income in addition to the growth in your portfolio's value from asset appreciation.
When investing in dividend stocks, it’s important to consider a company’s dividend policy - the likelihood that the company you’re investing in will continue to pay dividends. There are many things to consider when assessing this. Here are a few:
Dividend Payout Ratio: As explained by Investopedia, “the dividend payout ratio is the ratio of the total amount of dividends paid out to shareholders relative to the net income of the company”. The dividend payout ratio is an indicator of how much money a company is returning to shareholders versus how much it is keeping to reinvest in itself.
Dividend History: Certain companies, like Procter & Gamble or Coca-Cola, are famous for having consistently increased their dividends over decades (these companies are considered “Dividend Kings”). This may be a good sign, albeit not a guarantee, that the companies will continue to increase their dividends in the future.
Industry Stability: Look for companies that have a history of revenue growth and healthy cash flow. Emerging industries are at a greater risk of having to discontinue their dividends.
Dividend investors usually focus on either a high dividend yield approach or a high dividend growth rate strategy. Let’s take a quick look at each approach below:
Dividend Yield: The dividend yield is a company’s annual dividend compared to its share price. The dividend yield is a measure of a dividends return on investment and, because the dividend itself tends to be changed infrequently, the dividend yield will generally rise when the share price falls and decline when the share price rises.
Dividend Growth Rate: Dividend yield isn’t everything. Sometimes, a high dividend yield may indicate that a stock’s price hasn’t met expectations and that the dividend will get cut. As a way to avoid this sort of dividend yield trap, it might be worth taking a look at how consistently a company has raised its dividends.
Dividend paying stocks are like any other stocks, as they may lose value. There are additional risks associated with investing in dividend-paying stocks, including the risk associated with a company’s ability to pay dividends, and risks associated with interest-rate changes, among others.
You can start investing in dividend stocks today. With Passfolio, you can invest in US stock with as little as $1 - all with no commission fees¹². We make investing in US assets accessible and even accept local deposit methods such as TEDs.
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