Getting started with investing can be a scary proposition. Schools don’t teach personal finance, even though most people wish that they did. This means that few people know where to start investing when they get to adulthood. This is where dividend investing can come into play. It may seem like investing in a company that pays dividends would be an easy choice. However, this isn’t necessarily the case. Here are some considerations that are key to effectively evaluating a dividend stock.
The Dividend Yield
The percentage of a company’s income that it pays out in relation to its stock price is known as the dividend yield. A stock that has a share price of $200 and gives a $0.50 dividend per quarter would have a yield of 1 percent because a $2 annual dividend divided by $200 gives 1 percent. A $10 annual dividend on a similarly priced stock would give a yield of 5 percent. This does not necessarily mean that you should buy the stock with the larger yield, however. The yield is only one consideration. A high yield may not be sustainable for the long run.
You should also look at whether a company has a history of growing its dividend over time. Dividend cuts are frequently a reason for concern, as the company may not have the stability that you’re looking for. The dividend growth investing community refers to companies that have increased their dividends for at least 25 years in a row as Dividend Aristocrats. While these companies may not keep up this growth forever, they are a good place to start if you’re looking for a steady dividend player.
The Payout Ratio
This number shows a relation between a company’s dividend and its net income. Generally speaking, a lower number is better. A company that pays out 80 percent of its income will usually not have enough wiggle room to pay an increasing dividend without increasing this income. Therefore, it’s important to look at the company’s trend. Is a high payout ratio an anomaly because of some one-time expenses? Has it been growing for several years? In the former case, the company may be a good investment for a dividend growth investor. In the latter, there may be cause for concern going forward.
The Revenue Trend
While dividends come from income, revenue is also an important factor to look into. It is true that companies can buy back stock to improve their net incomes, but a slowing or negative revenue growth can be a concern in many instances. Companies must have revenue in order to make money. Less revenue over time can be a canary in a coal mine. Increasing earnings per share will eventually have to start trending in the opposite direction without revenue to support them. Therefore, it’s a good idea to screen the revenue trend before clicking the buy button with your brokerage.
Dividend-paying stocks can be a great source of passive income for those who are about ready to retire. However, not all dividend stocks are created equal. It’s a good idea to screen any stocks that you are considering. Some of the criteria to consider are the revenue and income trends, the dividend payout ratio, and the dividend yield. By putting all of these numbers together, you’ll be less likely to make a mistake when investing.
