Not sure where to begin with dividends? Here’s your dividend investing 101 class, with everything you need to know to profit.
There are a multitude of approaches to investing, though, for the most part, you can whittle them down to a few general ideas. Depending on your goals, one method may be more preferable than another. One thing that’s certain, however, is that one of the safest and surest ways to make money in the stock market is through dividends. We’re introducing this dividend investing 101 tutorial to help you get started.
What makes dividend investing a safer way to invest? And what do you need to know to start? It’s actually a straightforward strategy. You don’t need any special tricks or techniques. You don’t have to be an expert at reading stock charts. You don’t have to watch your stocks every day to make sure they aren’t about to crash. It’s just about the closest thing you can get to a guarantee in the stock market.
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Dividend investing 101: What it is and why it works
A dividend is a share of earnings that a company pays to its stockholders, usually every quarter. When a company pays a dividend—and especially if it increases that dividend every year—it shows that it cares about rewarding shareholders. Paying a dividend is also a savvy way to attract investors, which is why the share prices of most dividend stocks increase over time.
As a definition, dividend investing is simply the act of investing in and holding dividend stocks in your portfolio. You buy a stock, and every once in a while, the company sends you money just because you own the stock. Pretty cool, huh?
And from a safety standpoint, companies with the cash flow to pay regular dividends typically make safer, more reliable investments. The best dividend-paying stocks are high-quality, long-lived companies with predictable business models—they aren’t going to suddenly crash due to a lousy quarter or an adverse news event.
However! Rule #1 in our dividend investing 101 guide is that you always need to look beyond just whether or not there is a dividend. Yes, dividend stocks are safer, but that doesn’t mean every stock that pays a dividend is a good investment—more on that in a minute.
First, let’s take the idea of dividend investing a step further, shall we? The real secret to profiting with dividends is through a dividend reinvestment plan (DRIP). Rather than taking the cash, your dividends get reinvested into the stock. You then start earning dividends on those new shares, and those dividends get turned into more shares, and so on. Over time, the number of shares you own and the size of the dividend checks you receive every quarter will both gradually increase, without you doing a thing. If there is such a thing as free money, this is it!
Beware! Dividends can be devastating
When you think about investing in dividend stocks, one thing that can lead you in the wrong direction is the dividend yield. The dividend yield is the annual dividend per share, divided by the price per share. For example, a 10% yield on a $100 stock would give you a $10 dividend.
One of the primary problems here, though, is that the math is relative. A substantially lower yield of 3%, for example, pales compared to the 10% yield. But if that’s on a $500 stock, your dividend is $15. So your yield is lower, but your stock is worth more, and your dividend is higher. Therefore, dividend investing 101, rule #2 is don’t be swayed by numbers unless you know where those numbers come from.
This isn’t to say that you can’t have high-quality stocks with high dividends. Just don’t let a single number influence your buying decision.
Where to get high-quality dividend stocks
Okay, the third and currently last rule in our dividend investing 101 guide is this: Don’t be afraid to spend money on good stocks. Dividend Aristocrats are companies that have raised their dividend rates at least once every year, for a minimum of the previous 25 years. Most of these stocks range in price from around $30 to over $200, but don’t mistake price for value. In the words of investing great Warren Buffett, “Price is what you pay. Value is what you get.”
Now, if you want to know the names of some of the best dividend stocks today, I highly recommend subscribing to our Cabot Dividend Investor advisory, where as of this writing Chief Analyst Tom Hutchinson boasts an average total return of 34.5% on his dividend stock recommendations, with an average dividend yield north of 4%.
To learn the names of his market-beating dividend stocks, click here.
What questions do you have about dividend investing? Let us know in the comments.