Dividend stocks are a smart addition to one’s investment portfolio. Not only do you earn returns on your investment from value appreciation of the stock itself, but you also earn a quarterly dividend yield. Depending on the sector you invest in, you can earn anywhere between 2 to 15 percent dividend yield. Here’s four things to look for when selecting dividend-paying stocks to invest in.
Company’s Capital Allocation
Look at where the company is allocating its capital. Companies can only maintain a consistent dividend payout schedule if it allocates its available capital in a disciplined manner. If the company’s cashflow is mismanaged by its executives, whether through bad investment choices or extravagant purchases, dividend payouts may be reduced over time, if not completely halted.
Market-Indepedent Performance
A company should be able to pay its shareholders a dividend, regardless of how the underlying market performs. In fact, a good dividend stock should be able to pay out dividends when the market is producing little to no annual returns. Albeit, it is still prudent for investors to cultivate a “big picture” view of the sectors they are investing in to be able to predict future performance.
Debt to Equity Ratio
Investors should steer clear of companies that are accumulating excessive amounts of debt. Essentially, companies that have huge debt obligations will allocate any additional funds they have to paying off the debt rather than paying dividends to their shareholders. Use debt-to-equity ratio as a filter to narrow down companies that have a favorable debt situation. Ideally, the stock’s debt-to-equity ratio should be 2.00 or less.
Historic Dividend Growth
Choose companies that have a minimal track record of consistently rising dividend payouts. The timeline can be anywhere between 5 to 10 years. Avoid choosing companies solely based on a few profitable quarters. For instance, a tech company may have had a good IPO debut and, thus, an impressive quarterly earnings report. But companies who experience fast short-term growth also tend to experience drastic earnings disappointment in the long haul.
Investing in dividend stocks is a simple yet effective long-term strategy. It offers a clear path to profitability and gives you, the shareholder, confidence that the company’s and your interests are aligned. For the strategy to work, however, you’ll have to commit your portfolio to a longer time frame.