If you are looking for a way to create reliable passive income in your portfolio, investing in dividend-paying stocks could be a great option. These stocks may have a higher degree of risk than stocks that do not pay dividends, but they also have the possibility of higher returns.
While you don’t necessarily need a financial degree to succeed with these stocks, it can help to understand at least the basics. Here are six guidelines you can use to make better choices when investing in dividend-producing stocks.
1. Invest in Well-Established Companies
To help mitigate risk, it is a good idea to stick with companies that have a long track record of paying out their dividends consistently and generating strong quarterly earnings. If you want to know how a stock will perform in the future, a good starting point is to examine how it has done in the past.
When selecting dividend-paying stocks to invest in, check for those with a “dividend aristocrat” status. This status means that the company has consistently paid increasing dividends for each of the past 25 years. These companies tend to be household names that you will recognize, and they have a reputation for steady cash flow over the long haul.
2. Diversify, Diversify, Diversify
It is always important to maintain a properly diversified portfolio, and with dividend-paying stocks, it is no different. By spreading out your investments across a wide variety of industries and companies, you can help to minimize risk in your portfolio and reduce the effect of a significant market downturn that affects one particular sector more than the others.
3. Check Each Company’s Dividend Payout Ratio
The dividend payout ratio of a company can be an indicator of how risky or safe it is as an investment. This number tells you how much is paid out to shareholders and how much income the company can retain.
For example, let’s say you look up the dividend payout ratio for a company you are considering, and you find that they have a very high dividend payout relative to their income. This information indicates that the company has a minimal margin for how much revenue it could afford to lose before it would need to start cutting dividend payouts. If the company were to experience a minor reduction in its income, they would need to reduce or stop dividend payouts to investors almost immediately.
4. Know When to Ride Out the Storm, and When to Abandon Ship
Wise investors know that they need to invest for the long term to experience maximum growth in their portfolios. However, they also know when it is time to cut their losses and dump a bad investment to trade up to a better one. Sometimes there can be a thin line between waiting out a dip and sticking around too long and losing money.
Sometimes a stock will appear to be a high value on the surface, but after you invest, the company fails to grow over time. There are three primary reasons to sell a stock: your initial analysis of the company was wrong; the price has gone up drastically; or the current price reaches an unreasonable rate. The trick to identifying when to sell a stock is to avoid emotional mood swings and rely on the data.
5. Search for Companies with Potential For Growth
Some newer companies may offer high dividend payouts to entice investors but may not be able to grow those dividend payouts over time. Other, more substantial companies may have lower dividend payouts now, but have a long and healthy track record of steady growth. Investing in the one with lower dividend payouts may seem counterintuitive. However, the smaller company may have started paying out too high a dividend relative to its size, creating fewer growth opportunities and more risk for investors.
This position does not mean that all new companies lack growth potential – far from it! It is merely essential to examine the financials of a company to see how far they are stretching themselves and how much potential they have for growth. When selecting a dividend-paying stock with an opportunity for growth, look at what the stock is currently trading at relative to its long-term outlook for growth. This information can help you discern how profitable it could be as far as dividends are concerned.
6. Look for Quality Rather Than Quantity
One of the most important things you can check when reviewing the quality of a potential dividend stock investment is the dividend yield. The higher that number is, the better the returns will be. But be careful, as these numbers can potentially lead you astray. The stock’s payout level must be sustainable for the long term. If the payout level is not sustainable, the enticing dividends that drew you in the first place could disappear with the next market downturn.
Finding a stock that will perform reliably over the long haul may require sacrificing a bit of dividend yield in the short term. If you want to buy and hold the stock for an extended period without worrying, these are the types of investments to investigate. They can provide you with a relatively reliable stream of passive income for many years to come.
Hopefully, these tips will prove helpful to you in your quest to make wise choices when investing in dividend-producing stocks. If you have any suggestions of your own, we invite you to share them in the comments below.