How to Invest in Dividend Stocks in 2 Simple Steps
How to Invest in Dividend Stocks in 2 Simple Steps
Author: Dividendium.comOne way to invest in dividend stocks is the buy-and-hold strategy. You buy a dividend paying stock and hold it forever. While you own the stock, it will pay you dividends as income deposited directly in to your account. Basically, you are buying an income.
If you expect to own a dividend stock forever, you want two things from that stock:
- High dividends
- Continued payments
The amount of a dividend is quoted either as a dollar amount or as a percentage. The dollar amount is how much you will get paid per year on each share of stock you own. The percentage, also called the yield, is that dollar amount divided by the stock's current price.
The yield represents the amount you would be paid based on how much you invested. This is very similar to interest you earn on money deposited at a bank. By looking at this percentage you can easily compare investments to find the one that will pay you the most for your money.
For example, if you purchase 100 shares of stock at $10 per share, you will have invested a total of $1,000.
100 shares x $10 per share = $1,000 invested
If the stock's yield when you bought was 8%, you can expect to receive a payment of $80 deposited into your account every year.
$1,000 invested x 8% = $80 dividend per year
This means that the stock pays you $0.80 for every share of stock you own.
$80 / 100 shares = $0.80 per share
However, if another stock also paid $0.80 per share, but was priced at $20 per share it's yield would be 4%. You are still receiving the same $0.80 per share, but with the same $1,000 investment, you were only able to buy 50 shares at $20.
$1,000 investment / $20 per share = 50 shares
So now you receive, 50 payments of $0.80, which is only $40.
50 shares x $0.80 per share = $40
Comparing Dividend Investments
So the best way to compare dividend investments is to compare their yields.
Only Your Yield Matters
Note that the only yield that matters is the yield for the price that you bought at. Even if the price of the stock goes up or down after that, you still get paid the same amount of money because you still own the same number of shares.
So if you bought the 100 shares at $10, and the price later goes up to $20. The people buying at $20 get a yield of 4%, but your yield is still 8% because you still own 100 shares, which pay you $0.80 per share. So you still receive the same $80 per year.
Finding High Yield Stocks
To find stocks ranked by their yield, go to Dividendium.com. They list the stocks from highest to lowest yield every day, so it's always up to date. The list can be found at http://www.dividendium.com/dividends.php?mode=0&count=0.
The second thing you want is to make sure that the stock will continue to pay dividends. Owning a share of stock is the same as owning a piece of a company. The dividends are paid out of that company's income and savings.
So to make sure that a company can continue to pay a dividend, you want to make sure they payout less than they earn in income. One way to determine this is by checking the stock's payout ratio.
Payout Ratios Explained
The payout ratio is the amount a company pays in dividends divided by the company's income. So if a company pays out $100,000 in dividends, and brings in $1,000,000 in income, then it's payout ratio is 10%.
$100,000 dividends / $1,000,000 income = 10%
A payout ratio greater than 100% means that the company is paying out more in dividends than they make in income. Think about how long you could continue to stay in business if you spent more money than you made. The answer is probably not very long. And definitely not forever, which is how long you expect to own the stock.
Sustainable Payout Ratios
A sustainable payout ratio is generally less than 75%. Meaning that a company pays out 75% of its income to you and other stockowners. The remaining 25% of income is used to reinvest in the company. To create new products, advertise to new customers, and generally just grow the business. If no reinvestment is made then the company's income could shrink over time.
If the company's income shrinks, then the payout ratio for the stock will go up. For example, if the company above had it's income drop over time from $1,000,000 to $500,000, the payout ratio would rise to 20%.
$100,000 dividends / $500,000 income = 20%
So it's important that a company maintains or grows its income by reinvesting in itself.
A payout ratio of 75% or less also provides a cushion for the company in case of hard times. If the economy turns down, most companies' incomes will also go down. If a company is paying 100% of the previous income as dividends, then they will have to lower that dividend to match the current income.
A company's board decides how much to payout in dividends. Sometimes the board will approve a high payout ratio, higher than 75%, because they feel that in the future the company's income will increase. This may be true, but it is a gamble and if they are wrong, you will be the one paying the price when they have to lower the dividend.
Finding Payout Ratios
Dividendium.com lists a stock's payout ratio next to its yield so you can verify that the yield is sustainable.
To invest in dividend paying stocks for the long-term, an investor has two main concerns. The first concern is finding dividend paying stocks with high yields. The second concern is that those stocks have payout ratios less than 75%. Both of these concerns can be addressed quickly and easily at http://www.dividendium.com.
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