3 Ways To Become The Best Dividend Investor

This article was originally published on Fool.com. All figures are in US dollars, unless otherwise stated.

Investors who prefer dividends and deliberately creating a portfolio of dividend-paying stocks typically see huge rewards in the long run, often receiving thousands monthly retirement income. Earnings on some stocks depend solely on increasing the value of their stocks, but dividends essentially reward investors for holding stocks. If you want to become a better dividend investor, here are three things you need to do.

1. Focus on companies that increase dividends

What pretty much makes you successful as an investor is seeing the potential in companies and capitalizing accordingly. You need to make decisions primarily with the future in mind, rather than focusing solely on past or current indicators. The company’s current dividend yield is important, but investors should carefully consider its ability to increase annual dividends. Companies can pay the same dividends, but if one increases dividends by 10% annually, it is more attractive.

Some companies that have increased their annual dividend payments for at least 25 consecutive years are part of the S&P Dow Indices dividend aristocracy list, while companies that have increased their dividend payments for at least 50 consecutive years are the king of dividends. As an dividend investor, if you focus on one of them, you can be more confident in your investment. Any company that has succeeded in becoming an aristocrat or a king of dividends has shown that it can withstand wider economic downturns and downturns while still having its due cash flow to reward shareholders.

History shows that periods of market downturn are inevitable; You could also invest in companies that have the financial means to survive such times.

2. Focus on dividend payments, not profitability

Investors usually look at companies dividend yield before making investment decisions, but this can sometimes be misleading. Think about it: dividend yield is based on the annual payment of dividends relative to the value of a company’s stock. If a company pays $ 5 annually in dividends and the stock price is $ 100, the return is 5% – which is very profitable on an external level.

However, if the stock price for any reason falls to $ 50, the dividend yield is 10%. Of course, the payment of 10% dividends is considered good, but given the sharp drop in prices that led to this return, you understand why this in itself is not a good indicator. It would be better if you considered what caused such a sharp drop in prices.

Instead of focusing strictly on dividend income, study the company’s dividend payout to get a better idea of ​​its financial condition. The payout ratio is how much profit a company pays in dividends. A payout ratio above 100% – meaning the company pays more than it earns – is a serious red flag because it is unsustainable in the long run. This helps to be skeptical of companies in which dividend payments exceed 50%.

3. Watch out for dividend traps

Dividend traps often arise when something is too good to be true. Take, for example, younger, smaller companies. Dividends are paid from the company’s income, so any money paid as dividends is money that is not reinvested back into the company. For small companies, growth is often at the top of the list of priorities, and if management gives too much of the profits to shareholders instead of reinvesting it back into the company, it can be a cause for concern.

There are some exceptions – for example real estate investment funds (REITs) and the parent limited liability company (MLP) – which have high dividend yields embedded in their structure. But overall, if dividend yields seem questionably high, you’ll probably want to take a deeper look at why.

The same goes for debt. The debt-to-equity ratio of a company – obtained by dividing its total debt by equity – allows you to know how much of its daily operations are financed by debt. Generally, the higher the debt-to-equity ratio, the greater the company’s risk. You want to be careful with companies with a lot of debt that pay dividends. Financially sound companies should be able to pay dividends from their profits.

This article was originally published on Fool.com. All figures are in US dollars, unless otherwise stated.