High Dividend Stocks 101

You can make money in two ways by investing in stocks. First, when the stock price increases, and second, when the company pays a dividend.

And if you have index funds, you’ll collect dividends every quarter. I started calling it “Dividend Day” and do a little jig as soon as the cash hits my account.

A dividend, is quite simply, an investor’s share of the company’s profit.

When a company makes a profit, it does one of four things:

  • Invest it entirely back in the company’s business to grow it
  • Give a part of it to its shareholders (dividend)
  • Pay back debt

A dividend is like an income you get for simply owning the stock. All the while, you can also benefit from an increase in stock price.

What Is a High Dividend Stock?

As you can imagine, high dividend stocks can be extremely appealing. Some investors see them as a higher guaranteed return.

But you may be wondering how much dividend actually qualifies as a high dividend.

That’s the dividend yield comes in handy. It’s the dividend as a percentage of the stock price. For example, if a stock priced at $100 pays a $1 dividend, it’s dividend yield is 1%. The higher the yield, the more money you will get as dividend in relation to the stock price.

For me, any stock with a dividend yield of more than 2% is a high dividend stock.

Why 2%?

There are two reasons:

  1. For the past 10 years, the S&P 500’s average dividend yield has hovered around 2%.
  2. The yield of 2, 10, and 30 Year US Treasuries is under 2%.

Not all companies can afford to pay high dividends. Some stable and established ones have excess cash in their hands that they pay as a dividend. Specific stocks like REITs are traditionally high dividend-paying because they must distribute 90% of their income to shareholders. At the same time, stocks in the pharma, biotechnology, and IT sectors tend to have lower dividends. They prefer investing profits back into the business for research and development, among other things.

Starting to pay a dividend is a big decision for any company. Once it starts, a reduction or stoppage in dividends is considered as a bad sign by investors, and that may cause the stock price to drop.

The Benefits of High Dividend Stocks

High dividend stocks offer a few advantages apart from additional income:

  1. Cash Flow

Dividends are an easy way to get cash flow off your stocks without having to sell anything. And if you invest through an index funds, you’ll get automatic dividend payments every quarter.

It’s like magic, the money suddenly appears in your account.

  1. Reinvesting Dividends

You can use dividends to buy additional stock. Over time, the gains from compounding interest on dividends build nicely.

This works beautifully with dividends on index funds. Every quarter, I get my payment and I’ve set Vanguard to automatically reinvest the dividends. Even if my income drops and I can’t invest like I used to, the dividends buy up more shares every quarter without me having to do anything.

  1. Guard Against Inflation

Profits tend to rise along with inflation. As dividends come from profits, they also tend to rise proportionally.

  1. Ownership and profits

I bought some Tesla shares 2.5 years ago. They have grown by about 20% since then. But the only way I can enjoy this profit is by selling the stock as Tesla doesn’t pay any dividend.

The situation is different with high dividend-paying stocks. I can continue to own them and still get money from them through dividends.

Here’s an example. In the past 2.5 years, Apple’s stock has grown by 100% and has paid a total dividend of $7.12 per share. Guess I should have bought Apple instead.

The Potential Downfall of High Dividend Stocks

Dividends are not rainbows. They have some shortcomings too.

  1. Slower Growth

While this is not always the case, high dividend stocks can tend to grow slower than those that don’t pay a dividend. This makes sense. Paying out profits as dividends means less money to reinvest back into the company. That means less growth in the future.

And the slower a company grows, the less it’s stock price will grow. You might make more in dividends but you’ll make less in the appreciation of your stock price.

  1. No Guarantee

A stock might offer a high dividend today but there’s no guarantee that will continue. Companies can cut dividends at any time and you don’t have any recourse if they do.

So tread carefully if you depend on that dividend income. It might not arrive.

One good way around this is to rely on the dividends from index funds. They won’t be higher than normal since indexes match their respective markets but you also won’t be beholden to the dividends from a few companies. While a company can halt dividends, the market as a whole will keep paying them.

  1. If It Looks Too Good to Be True, It Is

Companies know that some investors prefer high dividends. Some of them will juice dividends past what’s healthy in order to attract investors and keep the stock price afloat. Sooner or later, they won’t be able to sustain it and it’ll all collapse.

What to Look For and How to Find Good Ones

While picking dividend stocks, a bigger dividend yield is not always better.

It’s essential to invest in good and trustworthy companies. If the stock price drops and the dividend yield stays the same, you will be getting a smaller dividend as the dividend yield is a percentage of the stock price.

I’ll be honest. It’s incredibly difficult to pick stocks, including those that pay high dividends.

To make things simpler for you, I have listed a few factors below that will help you find good high dividend stocks.

  • Profit: Profits drive companies. Don’t even consider buying the stock of a company that doesn’t have a dependable track record of making profits. By now, you know that dividend comes from profit. So, it’s obvious that you must choose consistently profitable companies while selecting high dividend stocks. You should also have conviction that the company can maintain that profit level into the future. There needs to be a competitive moat that keeps other companies from cutting into that profit.
  • Payout Ratio: The payout ratio is the percentage of a company’s income that is paid as a dividend to its shareholders. If a company makes $1,000 and pays $500 in total as dividend, then the payout ratio is 50%. As a thumb rule, it should be between 25% and 75% for most sectors.
  • Dividend-paying History: Only invest in companies that have consistently paid a dividend at least for the last 10 years. You should also look at dividend growth. A rising dividend is a great sign. It tells you that the company is doing well, which also leads to a higher share price and a regular and higher dividend.
  • Dividend Yield: Investing in stocks that have too high a dividend yield can be tricky. The company may not be able to sustain giving a high dividend. I’d avoid stocks with dividend yields of above 6%.

5 High Performing High Dividend Stocks Last Year

You know that a high dividend yield should not be the only factor to consider while investing in high dividend stocks.

Considering that, I have compiled a list of the five best performing high dividend stocks by also looking at other factors like stock growth, dividend-paying history, and company’s credibility.

  1. AT&T: This is a popular high dividend stock. It has a dividend yield of 5.3% and has paid a dividend for the past 36 years.
  2. ExxonMobil: The energy sector has been the highest dividend-paying sector in the past 12 months. Exxon is a heavyweight in the industry and has paid a dividend since 1882. Its dividend yield is 5% and has risen every year for the past 30 years.
  3. W.P. Carey: One of the oldest REITs in the world, I like this high dividend stock as it has a dividend growth streak of 20 years. If that was not enough, its dividend yield is 5.2%
  4. Dominion Energy: This company specializes in electric power. It has a dividend growth streak of 16 years and a dividend yield of 4.5%.
  1. Apple: With a 1% dividend yield, Apple may not seem lucrative. But it’s a fundamentally strong company with a history of growing dividends. With an 84% rise in the stock price in 2019, hundreds of billions of dollars in cash, and a low payout ratio of 27%, Apple is a good bet.

How to Invest Into High Dividend Stocks

You will need a brokerage account to invest in high dividend stocks. I recommend TD Ameritrade. Opening an account with them is simple. Their platform is secure and easy to use. They also don’t charge you to buy stocks.

Once your brokerage account is set up, you can invest in high dividend stocks in two ways. You can directly buy high dividend stocks if they meet the factors I mentioned above. Or, you can purchase High Dividend Yield Index Funds. These funds invest in multiple high dividend-paying stocks, lowering your risk. They offer a dividend yield of about 3%. The Vanguard High Dividend Yield ETF (VYM) is a good fund.

90% of your stock investments should be made through index funds. You can use the rest to “scratch your itch” to buy individual stocks. You can invest in high dividend stocks through index funds as a part of the 90% if you want to give them a portion of your overall portfolio or buy individual stocks as a part of the remaining 10%.

Are High Dividend Stocks Worth It?

The short answer is no. Don’t worry about it.

You’ll get much better returns over time by investing into a US stock, bond, and international stock index funds consistently for decades. If you want to get a bit more advanced, rebalance every year and maybe add a REIT index fund to your portfolio.

Once a company has a reputation as paying out a nice dividend, all future dividend payments get factored into the purchase price of the stock. And whether you make money from stock appreciation or dividends, the end result is the same. So it doesn’t really matter.

High Dividend Stocks 101 is a post from: I Will Teach You To Be Rich.