Dividend stocks are a great way to invest over the long term. If you are going into retirement, the dividends are a nice quarterly source of income. And, as you prepare for retirement, dividend reinvestment plans let you roll your dividends back into more shares of stock without paying any commissions. But, not all dividend stocks are created equal! All too often, companies that are struggling maintain their dividend. The stock price is down and the dividend yield is fantastic. But, some of these high dividend yields are dangerous. One day the dividends will disappear just as the struggling company goes out of business! Here are a few of our thoughts on choosing the best dividend stocks.
Finding Dividend Stocks to Invest in
It is easy to find dividend stocks. But, rather than looking first for stocks on Yahoo Finance or Google Finance, go to a site like Dividend.com for a huge list of dividend stocks and Macy’s on page 22 paying a 9% + dividend. They are preceded by stocks that pay for more than 100% of the share price. When you see a stock like Macy’s that is having trouble competing in the brave new world of online sales and Amazon.com, you can understand why they are keeping their dividend up to attract investors even as sales and income fall. But, when a company is listed as paying more than the share price, something is drastically wrong. You should think twice before buying Macy’s for the dividend but when you see stocks with ridiculously high dividends, it is time to run and hide! So, how do you go about choosing the best dividend stocks that reward you for investing while also being safe over the long term?
Choosing the Best Dividend Stocks
There are just a few rules to follow in order to find the “goldilocks” group of dividend stocks that provide excellent returns and are secure over time. The process looks a lot like assessing intrinsic stock value when investing in stocks.
Investing in Dividend Stocks with a Large Margin of Safety
Some refer to this a looking for a strong operating mote. Whether this is a “high cost of entry” business like a natural gas pipeline that has overcome numerous obstacles to get built, a utility that is licensed to serve a specific region, or a world famous trade name like Coca Cola, companies that these competitive advantages are likely to be secure investments and dividend cash cows for year and years.
When Investing, Stay with Dividend Yields That Match Those of the Competition
This gets back to the business of avoiding companies that are struggling and don’t want to reduce their dividend for fear that it will alert investors as to their dire straits. A healthy business in any given sector will typically pay dividends in a given range. When the dividend is higher or lower than expected, you need to check that out before investing.
Understand and Check Out the Payout Ratio before Investing
This is similar to being leery of too-high dividends. A company will typically pay out a set portion of its income in dividends every year. The dividend goes up as they make more money and the dividend should go down when they go through difficult times. The market may not have caught on that a company is having trouble or doing better than expected, but if you follow their payout ratio, you will have a good idea. Then you can make an intelligent decision to buy more of the stock, hold what you have, or sell before the bottom falls out. Likewise, if you are putting your money in a stock and want to sleep well at night, you want a company whose balance sheet is healthy.
Investing Companies with Increasing Dividends
Companies that have been paying in dividends for decades or even more than a century have typically been increasing their dividend over the years. This is a sign of a healthy business, a good margin of safety, and intrinsic stock value. Picking stocks whose business plans you understand and who dividends go up every few years is a good way of choosing the best dividend stocks without spending too much time looking at the details!