A dividend investing strategy is a great way for investors to boost their profits, but what does the term mean, and is it right for you?
Sept. 23, 2021
A dividend investing strategy is a very popular investing style. Remember, a dividend is a cash payout of a portion of a company’s profit to its shareholders issued at predetermined times. They are usually paid out monthly, quarterly, or on a yearly basis.
What is a dividend investing strategy?
Simply put, a dividend investing strategy is when an investor buys stocks that pay out dividends. This method gives stock investors two potential sources of profit.
The first is the income an investor receives from regular dividend payments and the second is the capital gains of the stock, i.e how much a share price increases from the time a stock is bought to when it is sold.
Not all companies pay a dividend so it’s important to find this out before investing in a stock if you want to strictly follow a dividend investing strategy. Alternatively, buying a few stocks that pay out a dividend can be a great way to diversify your portfolio — Which is one of MyWallSt’s 6 Golden Rules.
How do I receive dividends?
If you have bought a stock that pays out a dividend, you should receive the cash automatically. However, shareholders must fulfill a few requirements to ensure they receive a dividend payout. To qualify for a dividend, investors must be a “shareholder of record” or have bought the stock at a particular date designated by the firm’s board of directors.
It’s important to check that you have bought shares before this date, which can be easily checked on the company’s investor relations website.
What is a dividend yield?
A dividend yield is the ratio of how much cash flow investors receive for each dollar they have invested in the stock.
It may seem odd, but as a stock’s share price jumps, its dividend yield actually decreases. So, a higher stock price does not result in a higher dividend yield. The average dividend yield fluctuates between 2-5%.
Let’s look at how a dividend yield is calculated, here’s an example.
You buy 100 shares in Apple (NASDAQ: AAPL) stock at $100 per share, giving you a total investment value of $10,000. The 100 shares are the basis for your dividend distribution.
The company has had a good year so the board decides to pay a dividend of $10 per share annually. If you hold the stock for a year, your 100 shares will equate to $1,000 in dividend payments.
So, the annual yield for Apple stock is the total dividend amount ($1,000) divided by the investment/cost of the shares you own ($10,000) which equals 10%.
But say you actually bought the stock at $200 per share. The yield would, unfortunately, drop to 5% as the 100 shares now actually costs you $20,000. This is because your original $10,000 investment now only gets you 50 shares instead of 100.
In summary, if the share price jumps higher, the dividend yield drops and vice versa.
Benefits of investing in dividend-paying stocks:
1. Dividends come from a company’s profits, so they are usually a sign that the business is in good financial health.
2. Normally, only established companies pay out dividends so investing in these stocks is generally less risky than buying shares in younger companies.
3. Following a dividend investing strategy can add stability to your portfolio as you receive regular payments to boost your portfolio. These funds can help you top up positions or be used to buy new stocks.
4. Dividends also cushion the blows if a stock price drops as that means a higher dividend yield.
High-paying dividends stock:
National Presto Industries (NYSE: NPK) Dividend Yield: 7.48%
ONEOK Inc (NYSE: OKE) DY: 7.12%
Chevron Corp (NYSE: CVX) DY: 5.54%
Risks to buying dividend stocks
Remember, dividends are not guaranteed and depend on a company’s profits. That’s why it’s always important to buy a stock because you believe it has long-term potential. One other risk is that dividend stocks do not usually enjoy the high growth that new and younger companies do. Learn more about growth investing here.
For access to our shortlist of market-beating stocks, start your free access with MyWallSt right now. Get on the path to financial freedom by subscribing today.