Many people asked about stocks that pay dividends and how to identify a good dividend stock during the 1:1 stock analysis coaching session. Due to the frequency of this question, I decided to write a blog post to explain. Before I dive into how to identify a good dividend stock, let me explain the meaning of dividend stocks.
What Is a Dividend Stock
Companies usually pay cash to their shareholders quarterly, although some pay monthly or semi-annually. This form of payment is called dividends. Companies that pay dividends share part of their profits with shareholders. The payout is usually per share, and it is one of the ways to make money as a long-term investor. For example, if you own 100 shares of a specific company and the company pays $3 in annual dividends, you will receive 300 dollars per year.
Although many companies pay dividends, some dividend investments perform much better than others. So when you are picking dividend stocks, identify the right ones; companies that will continue to grow their dividend payouts no matter the circumstance. You do not want to invest in companies that historically cut their payouts.
Where Do Dividends Come From?
When companies generate profits from their businesses, they can do multiple things. They can choose to reinvest in the business, pay back debt, hold onto the money, buy back stocks, or pay a dividend to shareholders. History has shown that dividend stocks tend to perform better than non-dividend stocks.
One thing to keep in mind is that dividend payout is only a portion of your returns. Once you purchase a stock, it can go up or down. Two things to look for when picking dividends stocks are to pick strong dividend-paying companies and companies with a competitive advantage.
Strong Dividend Stocks
You have to look at the history of the company. The record will show how consistent the company pays out dividends. One of the best places to find companies with a strong dividend track record is the S&P 500 Dividend Aristocrats. Dividend Aristocrats are companies in the S&P 500 that have paid and increased dividends for 25 consecutive years. As of the date of this writing, the list currently consists of 66 companies. The point here is, if a company is on this list, chances are, you are in a great place.
Competitive Advantage
A crucial way to long-term dividend investing is to find companies that can deliver reliable, and growing earnings to keep their dividends going. Competitive advantage can be because of the brand of the company, the network effect, or the low cost. One company that comes to mind with a trusted brand is APPLE (I am not recommending APPLE). Apple can charge whatever they want for their iPhones, and people will still buy it. The brand speaks for itself. The network effect is when a business becomes more valuable because more people use it. Think about Facebook, Uber, MasterCard, and Visa. What all these companies have in common is its use by nearly everyone. For another company to beat them, they will have to generate the same or better network. Low cost is a competitive advantage. It is the reason Walmart can sell their product at lower prices than its competitors.
Overall, to identify a dividend stock, you must ask yourself the following questions:
- Is the dividend good enough?
- Does the company have a competitive advantage?
- Does the company have a history of stable and growing dividends?
If you can answer yes to at least two of the above questions, then that particular company may be a good one for your buck.
If you are just starting your investment journey and you need help to analyze and pick good stocks, sign up here for the 1:1 coaching session.
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Till next time,
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