Some investors play the stock market to make money quickly by buying low and selling high. Others take a different path and try to generate as much income as possible through the magic of dividends – or payments made to you by the company for each and every share you own.
Many companies pay dividends, and while some dividends aren’t anything to write home about, others are large enough that they definitely worth your attention. Here, I’ll explain how you can find a high-paying dividend stock for the cash flow you desire.
All About Dividends
First, let’s look at dividends and what they mean to you.
A dividend is a payment given to you every so often based on your ownership of the company (by having shares). Dividends come from a company’s profit; it is a way to give you a return on your investment when the company does well.
Dividends are usually given on a quarterly basis. In other words, you’ll receive a nice payment every three months. Most of the time, they are paid in cash; occasionally they are in the form of extra shares. Dividends are taxable, although you’ll only pay the capital gains tax rate instead of your standard income tax rate.
The main takeaway for dividends: They generate income from stocks you hold and can supplement – and in some cases outstrip – the growth in stock price that may or may not occur during a period of time. For example, many major companies that pay dividends do not experience a lot of growth throughout the year. For investors holding stock in these companies, they get the bulk of their ROI on their dividends, not on any substantial growth.
How Much Do Dividends Pay?
The amount of money you’ll receive from a dividend all depends on the dividend yield, which is the most recent full-year dividend payment divided by the current share price. Let’s take Company X. Company X, last year, paid out a dividend of $2 per share. The current share price is $30. Based off those numbers, the dividend yield will be 6.6%.
Dividend yields can also be estimated for the upcoming year, though you have to be careful – these are just estimates.
Just how much can you make off dividends? Well, it depends on which companies you pick and your particular strategy. To give you an idea of possible yields, the current average dividend yield for stocks in the Dow Jones Industrial Average is 3.03%. AT&T (T) has the highest yield in the Dow, at 5.29%; Bank of America (BOA) has the lowest, at 0.85%.
Outside of the Dow, dividends can be stratospheric. Currently, the highest dividend yield is a whopping 26.12%, produced by Oxford Resource Partners (OXF). Of course, there are drawbacks to high dividend stocks and some issues you’ll need to consider before investing.
Finding Top Dividend-Paying Stocks
What is the best dividend stock for you? That depends on your preferences, really. Stocks with high dividends are preferable than stocks with low dividends – although stocks with really high dividends can be problematic. Check the stock’s payout ratio, or the dividends per share divided by the stock’s earnings per share. I don’t like payout ratios below 40% or above 60%. The higher the ratio, the more cash the company is paying to its shareholders (and not spending on expansion, research and development, etc). Ratios that are too low aren’t worth the effort.
Earnings drive dividends, so companies that produce consistently-growing earnings and issue dividends can give you a nice surprise when they boost the dividend.
It also helps to find undervalued stocks. One method I use is to take a look at the price-to-earnings ratio (P/E ratio), which tells you if the stock is trading above or below its value. A stock with a P/E ratio below 20 is a good start; aiming for 10-15 is even better. Why does this matter? Well, one component of the P/E ratio is earnings. If a stock costs $20 a share, and earnings came in at $2 per share, your P/E ratio would be 10.
Let’s say your earnings go up to $3 per share. Your P/E ratio would fall to 6.67 – which means the stock’s price hasn’t really factored in the extra money your company is bringing in. If you buy this stock, there is a good chance that you’ll make even more ROI from price appreciation in addition to your dividend.
Finally, stay away from companies that have a lot of debt. Check the company’s debt-to-equity (D/E) ratio, which divides the total liabilities by shareholders’ equity. A D/E ratio that is higher than average for an industry is bad news for a company when it comes to dividends because it calls into question the company’s ability to produce solid earnings and pay out dividends.
All of these parameters and many more can be searched for using a stock screener.
Using these steps will help you find the best stock for dividends for your investment strategy. Use a stock screener to easily narrow down the list of thousands of stocks to the handful that meet your goals. Before you know it, dividends will begin rolling in – and you’ll profit.