How to Pick Dividend Stocks For Your Portfolio
Dividend investing can be a good investment strategy and a near effortless way to earn passive income.
For instance, a S$10,000 investment in a stock with a 5% dividend yield will give you S$500 in annual dividend income without you having to do anything.
In fact, dividend stocks are less volatile than the S&P 500 and have historically outperformed the latter. Why? Because they provide two sources of returns: regular (i.e. steady) income from dividend payouts and stock price appreciation. These boost your total returns and add up over time. (Don’t underestimate the power of compounding returns!)
Due to their lower volatility and steady income, dividend stocks tend to appeal to investors seeking lower-risk investments, particularly those who are nearing or already in retirement.
However, not all dividend stocks are created equal. They can still be risky if you pick the wrong ones. Here's how to invest in them.
How to Pick Good Dividend Stocks
Look at the following factors to select the best dividend stocks.
1. Dividend Track Record
One way to find dependable dividend stocks is by looking at the companies that have been paying — and even increasing — their dividends for many years. Popular Singapore and US dividend stocks include Singtel, Singapore Airlines, Keppel Corp, Apple, Microsoft, and more.
Investors eyeing a specific company’s stock can delve into its dividend history on financial and investment websites, as well as stock market indexes such as Nasdaq, S&P 500, Straits Times Index and more.
2. Dividend Payout Ratio
The dividend payout ratio is the percentage of a company’s earnings paid out as dividends. To calculate it, simply divide the dividend per share by the earnings per share.
What the payout ratio shows us is whether a company is using too little or too much of its funds for dividends. In general, a ratio of 50% or more is considered high as that means more than half of the company’s profits are paid to shareholders as dividends.
A payout ratio that is too high (>75%) could mean that the dividend is unsustainable and therefore irregular, especially in times of recession. If the company runs into cash flow problems, it may reduce or suspend dividends.
That said, payout ratios vary by sector. Therefore, there is no hard and fast rule for what’s considered a “good” payout ratio.
3. Dividend Growth Rate
It’s important to look at a stock’s dividend growth rate over several years rather than just the past year so you can get a sense of the company’s growth trajectory and potential. Consistently upward trending dividend growth rates suggest that this is a good investment, and indicates to potential shareholders that the company has a bright future.
Generally, a company whose dividends consistently grow by 5% to 10% annually is considered promising.
4. Current Dividend Yield
It might be tempting to pick stocks with the highest dividend yield, but a dividend yield is not the only factor to focus on.
The current dividend yield is calculated by dividing a company’s annual dividend by its share price on a specific date. For example, if the stock price is S$100 and the annual dividend is S$5, the dividend yield would be 5%.
However, if for whatever reason (perhaps even due to company mismanagement) the same stock falls to, say, S$50, the dividend yield then becomes 10%, even though the company’s stock has fallen and the annual dividend remains unchanged. This is what’s known as a dividend yield trap.
Therefore, dividend yield may be one metric to look at, but a savvy investor should also assess the company’s sustainability and the growth of its dividend payouts over time.
5. Company Fundamentals
A company with decreasing profit and revenue would likely respond no to the above questions. And a company like that would likely have little cash left to distribute to shareholders as dividends.
The Power of Compounding Returns
However, reinvesting your dividends depends on whether the dividend yield is consistent. Also consider your time horizon — if you are a long-term investor with many years left to invest, then it’s a good idea to reinvest your dividends. Otherwise, you might be better off withdrawing them for short-term needs.
Want to learn more about investing? Check out our investment guide and pick up some tips on how to be a better investor.
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