There’s no one-size-fits-all dividend stock — each one comes with its own unique characteristics. Therefore, the key is to develop techniques to find the dividend stocks that best suit your investment strategy. This article will help you do so, exploring which stocks pay dividends, what differentiates those, and what to look for in a dividend stock.
If you’re considering building an investment portfolio that generates passive income, dividend stocks could be for you. Once you start your research, you’ll quickly discover that the main challenge isn’t finding dividend stocks, because there are plenty to choose from. Instead, the real task lies in identifying the ones that align with your specific investment goals.
This article will explore strategies for finding and identifying dividend stocks that match your investment strategy.
Which stocks pay dividends?
In theory, any publicly listed company can pay dividends, but not all do. The decision ultimately comes down to the nature of the underlying business, and whether it decides that any profits will be reinvested or returned to shareholders.
The ability of a company to distribute profits to shareholders is determined by three main factors: its profit margins, its need for reinvestment, and its balance sheet. Those companies with large profit margins and strong balance sheets don’t need to worry as much about cash flow compared to others, and, thus, have more freedom to invest capital back into operations or business development — as well as return money to investors.
Tip: The size and timing of any dividend payments will be determined by the management team of a company.
Usually, information about dividend payments is readily available to investors and prospective investors.
Companies that have sound business models, but limited scope for further growth could well pay generous dividends. These types of companies may include those within a sector where there are significant barriers to entry, and profits are consistently generated, but with few opportunities to expand market share. Large blue-chip stocks, such as utility company United Utilities, Inc, also typically pay dividends to their shareholders.
One way to find solid dividend stocks is to identify companies with a high level of dividend cover. This can be calculated by dividing earnings per share (EPS) by its dividend return per share. When the ratio is above two, it can indicate that the company’s dividend is well covered by earnings. A ratio below one can be a sign that the dividend return is unsustainable in the long term.
There are no hard and fast rules about which stocks pay dividends, but there are certainly underlying trends. Ultimately, the best way to identify dividend stocks is to use analysis tools, such as a dividend calendar, to equip yourself with an overview of the options available, and a collection of stocks to filter and from which to choose your own investments.
What are dividend aristocrats?
“Dividend aristocrats” and “dividend kings” are terms that are often used to refer to stocks that are deemed to be the most stable dividend payers.
Below are some common criteria used to select dividend aristocrats:
- The stock is part of the S&P 500 Index.
- The stock has paid a dividend for at least 25 consecutive years, and that dividend has increased each year.
- The market capitalisation of the issuing company is a minimum of $3bn.
- The daily trading volume of the stock is at least $5m.
Unlike dividend aristocrats, dividend kings aren’t required to be part of the S&P 500 Index, though most are. Dividend kings are a smaller, more exclusive group of stocks.
Examples of dividend aristocrats
Typically, certain sectors (including real estate, finance and utilities) contain a greater proportion of dividend stocks.
| Company | Dividend yield |
|---|---|
| Walgreens Boots Alliance, Inc. | 7.15% |
| 3M | 6.12% |
| Realty Income Corp. | 5.99% |
| Amcor PLC | 5.31% |
| Franklin Resources, Inc. | 4.44% |
What are high dividend stocks?
High dividend stocks are those that pay dividends well in excess of the market average. The average dividend yield of the stocks that make up the UK’s FTSE 100 Index is currently 3.76%. The higher a company’s dividend yield is over that benchmark, therefore, the more likely its stock is to be considered a high dividend stock.
Examples of high dividend stocks
Stocks that pay a high dividend can be found in a wide range of sectors and markets. The list below details the dividend yield of a selection of large- and small-cap stocks that have consistently paid a dividend over a five-year period.
| Company | Five-year average dividend yield |
|---|---|
| Big 5 Sporting Goods Corp | 18.57% |
| Medifast, Inc. | 13.50% |
| Arbor Realty Trust, Inc. | 13.28% |
| PennyMac Mortgage Investment Trust | 10.97% |
| Reckitt Benckiser Group | 4.29% |
An important caveat to make is that while high dividend yield rates might be an attractive consideration, it is worth remembering the impact that any potential capital gain will have on your returns. For instance, the price of any stock rising may potentially outweigh returns generated by dividends, if those returns are subject to capital gains tax.
What to look for in a dividend stock
There are a range of ways in which dividend stocks are subdivided, reflecting the fact that the sector is relatively large and diverse. This means that different dividend-paying companies can offer investors different benefits, and have various attributes.
For investors selecting dividend stocks, it is important to conduct thorough research. This must start with an analysis of your investment goals, and what you want to achieve. Some factors to consider include:
- Frequency of dividends: If you are using dividend income as cash flow for personal expenses, you may prefer a stock that pays dividends quarterly, or even monthly, rather than annually.
- Holding period: If you are a long-term investor, you will need to consider metrics such as operating profit margin to ensure that the current level of dividend payment is sustainable.
- Capital growth: Total investment returns will be a combination of dividend income and capital gain, which is determined by whether the stock price goes up or down.
- Size of dividend: The cash amount of any dividend can be converted into a dividend yield number, which shows the dividend as a percentage of the share price. This makes it easier to carry out a comparative analysis of different stocks.
Investors should also consider the potential risk factors associated with investing in dividend stocks. For instance, the approach relies on the assumption that past performance is a guide to future activity. This assumption can sometimes be incorrect, and dividend stocks can depreciate in value if the share price of the issuing company lowers. This is why, as with any investment, you should always seek to manage the risk of loss through portfolio diversification, due diligence and regular monitoring of your assets.
Final thoughts
Useful metrics such as dividend yield make it easy to identify dividend stocks, and establish candidates in which you might consider investing. While dividends can form an attractive stream of passive income, there are benefits to considering other aspects of a stock’s potential and factoring them into your analysis.
Use the eToro Academy to learn more about investing in dividend stocks.
Quiz
FAQs
- Should I build a portfolio containing only dividend stocks?
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Standard investment advice states that you should aim to build a diversified portfolio, as this can spread risk and smooth out returns. Blue-chip dividend stocks may have relatively low price volatility and, therefore, constitute lower risk, but there is still benefit in using them as part of your portfolio rather than allocating all of your capital to one strategy.
- How do interest rates impact dividend investment strategies?
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During periods of an economic cycle when interest rates are higher than the long-term average, investors may decide to hold cash in a savings account rather than invest in dividend stocks. Both approaches offer ways of generating a passive income, and investors can make their own decision in terms of relative risk-return.
- How much confidence can I have that a stock will continue paying high dividends?
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The assumption that underlies the dividend investing approach is that a company with a track record of paying high dividends will continue to do so. Nothing is ever guaranteed in the financial markets, but through careful analysis, it is possible to form an opinion on the likelihood of your target stock being a good fit.
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past performance of a financial instrument, index, or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.