When a company makes money, it sometimes sends part of that profit back to its owners in the form of cash dividends. A dividend investor is someone who uses his money to invest in the stocks of companies that tend to pay high dividends.
Why Invest in High Dividend Stocks?
Investors go for high dividend stocks because they want to earn passive income that can provide a good standard of living, particularly during their retirement years. When this type of investing is done with enough discipline and over an extended period of time, it's even possible to get rich from dividend stocks.
Successful dividend investors strive to build a collection of the highest dividend stocks they can find because the richer the dividend, the more money that they'll find automatically deposited in their bank accounts each year—or, in the case of some old-fashioned investors, they'll find some nice paper dividend checks stuffed in their mailboxes.
What You Need to Know About High Dividend Stocks
You can find good and appropriate stocks for your portfolio in multiple ways, but pinpointing the highest dividend stocks is a bit trickier. Like all things in life, dividend investing is rarely as simple as it sounds.
Finding the highest dividend stocks can be fraught with danger because companies often have high dividend yields for a reason. Most commonly, these yields are the result of investors avoiding the shares. This can occur because they believe the dividend is in danger of being cut, or because they think the business is in trouble and might not survive in the long term. It's important to watch out for the dividend trap. Sometimes high dividend yields and low P/E ratios are an illusion.
How to Find the Highest Dividend Stocks Without Taking on Too Much Risk
You can look for certain things if you want to build a portfolio of the highest dividend stocks, but you'll still want some protection against the downside. Taking some or all of these precautions can help you avoid some of the risks.
- Make sure the dividend payout ratio doesn't exceed 60% to 70%. This means that the company is retaining at least 30% to 40% of its earnings for expansion.
- Your dividend stocks should be in companies that have pricing power. This means that they can increase prices to offset a high inflation rate and keep the checks rolling into your bank account even if the government is printing money like crazy.
- Look for stocks that have a debt-to-equity ratio of less than 1.0. This means that a company has at least $1 of net worth for every $1 in debt. In financial terms, this is called the capitalization structure.
- Look for stocks that have a p/e ratio of 15 or less. This can offer some additional downside protection in the event the dividend is cut.
Please consult with a financial advisor for the most up-to-date trends. The information contained in this article is not intended as investment advice and it is not a substitute for investment advice.