Learn how to start investing in dividend paying stocks, understanding their stability, growth potential, and how to select the best ones for your investment portfolio.
Investing in stocks can seem a little more complex than other investments, but it doesn’t have to be a confusing process. And one of the easiest places to begin investing is with dividend paying stocks. Dividend paying stocks are shares from companies that actually pay part of their profits back to you as a shareholder (nice!). So, how do you get started on investing in these types of stocks? Here’s your simple and straight-forward guide.
Step 1: Start by Learning
Where can you find some of the best stocks? Start by looking at what stocks professional investors are buying. Exchange-Traded Funds (ETFs) and mutual funds are kind of like big baskets of stocks that people can buy. And the companies who run these funds usually buy stocks they think will make them money.
For instance, if we look inside Vanguard Canadian High Dividend Yield Index ETF (VDY.TO), we’ll find stocks like:
Royal Bank
TD (Toronto-Dominion Bank)
Canadian Natural Resources
Enbridge
Bank of Montreal
Bank of Nova Scotia
Suncor
CIBC (Canadian Imperial Bank of Commerce)
Manulife
TC Energy Corp
Microsoft
Apple
Apple Inc. is an American multinational technology company headquartered in Cupertino, California, that designs, develops, and sells consumer electronics, computer software, and online services. It is considered one of the Big Four tech companies along with Amazon, Google and Facebook.
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Broadcom Limited is a diversified global semiconductor leader built on 50 years of innovation, collaboration and engineering excellence.
JP Morgan Chase.
Exxon Mobil.
Major Holdings
UnitedHealth Group
Visa
Mastercard
Home Depot
Procter & Gamble is the largest component of XLP, where it currently makes up 11.82% of the fund’s overall portfolio. The global consumer goods giant pays a generous dividend that yields around 3%. Proctor & Gamble has increased its dividend annually since 1958, which demonstrates not only its ability to pay a reliable dividend but also its long-term commitment to growing shareholder value.
Step 2: Look for Dividend Aristocrats
Dividend Aristocrats are stocks that have increased their dividend every year for 25 years straight. They’re typically very stable and are “blue-chip” stocks, which means they’re large, well-established, and financially sound.
Some examples of U.S. Dividend Aristocrats might include companies like:
Coca Cola
Johnson & Johnson
McDonald’s
In Canada, Canadian Dividend Aristocrats are companies that have consistently raised dividends for at least five years in a row.
Adding Dividend Aristocrats to your portfolio can be advantageous because they have rewarded shareholders with increasing dividend payments year after year.
Step 3: Discover Dividend Champions or All-Stars
As great as Dividend Aristocrats can be for their uber stability, you may also want to look at Dividend Champions or All-Stars. These are companies that haven’t quite hit the 25-year mark but have still been increasing their dividends for a very long time. They could potentially be a future Dividend Aristocrat in the making.
You can find these Dividend Champions or All-Stars list online, like on The DRIP Investing Resource Center. For instance, for U.S. Dividend Champions and the Canadian Dividend All-Star List.
These companies may reply with an even larger dividend growth rate making them better returns if they continue growing their dividends.
Why Invest in Dividend Stocks?
A lot of people buy stocks with the hope that the price will go up and they can sell them later for a profit. This is known as price speculation. Every now and then, you’ll hear tales of people who bought a stock when it was cheap, and now it’s worth ten or twenty times what they paid for it – if not more.
Someone who bought Alphabet (GOOGL) right after it first went public could have made out like a bandit if they still held onto all those shares as the company grew.
That being said, it is not impossible to find them. There are people who have been successful in buying multi-bagger stocks and making a fortune from them, but they are rare and usually very knowledgeable investors themselves. It takes time and experience to be able to recognize companies with such growth potential.
With dividend stocks, the concept is much simpler. A company that can sustain consistent dividend payments for many years must be a stable business that has the potential for growth over the long term. If you can buy their shares when they’re undervalued and hold on to them as their value increases over time, not only will you earn some passive income through dividends in all likelihood, but you’ll see your capital appreciation grow as well.
How to Analyze Dividend Paying Stocks
Now that you have a list of dividend stocks, you’ll want to do a little research to help determine which ones are worth investing in. Here’s an easy way to start.
Step 1: Make it Short
If you have a long list of stock ideas, the first thing you will want to do is shorten that list. You can use some easy filters for this:
PE Ratio (Price-to-Earnings Ratio) should be less than 20. This means the stock isn’t too expensive compared to how much the company is earning.
Dividend Yield should be more than 2.5%. This shows that the stock is paying a decent dividend.
Payout Ratio should be less than 75%. This means company is not distributing too much of its earning as dividend and company has room for growth.
5-Year Growth Rate should be greater than 5%. This means company has been growing.
Step 2: Further Narrowing Down
Is your list still long? You can make it even shorter by considering some more things:
Return on Equity (ROE): Look for stocks with an ROE over 10%. This means the company is making good use of its equity to generate profits.
Sales Growth: Check if the company’s sales have been growing over the past 5 years.
Earnings Per Share (EPS) Growth: Look for positive EPS growth over the past 5 years, and see if analysts expect it to continue growing in the next 5 years.
You can find this information on financial websites like Yahoo Finance or Morningstar.
Step 3: Do More Research
Once you’ve got your shortlist it’s time to do some research. Here are a few things you want to look into:
Quarterly and Annual Reports: Found on a company’s website. How is a company doing and what they are planning to do. Dividend Growth History. How long has the company been increasing its dividends? Has it ever cut or frozen their dividend? If so, why?
Earnings History vs. Analysts’ Estimates: Determine if a company is outperforming its competitors in the market by how much they are surpassing expectations. If a company continually outperforms expectations, their stock price will continue to rise.
PEG Ratio: This is similar to the PE Ratio, but it accounts for the growth of the company. A lower PEG ratio generally implies that a stock is undervalued and is more likely to increase in value.
Intrinsic Value: This will help you determine if the stock is undervalued or overvalued based on its future cash flows. If a stock is undervalued, it may be a good time to purchase.
This research can give you an idea of what stocks are potentially good buys.
Investing In Dividend-Paying Stocks
Getting started with investing in dividend-paying stocks doesn’t have to be difficult. Do what the pros do, concentrate on Dividend Aristocrats, Champions, and All-Stars and do some simple research. Before you know it you will have built yourself a solid portfolio that can generate regular income and capital appreciation over time. The secret is to be patient and think long-term.