The portfolios of the most successful investors almost always contain dividend stocks. In fact, investing in dividend stocks is one of the key ways to build a reliable income stream.
Are you looking to invest in dividend stocks but don’t know where to start? This article discusses five rules you should adopt for a successful dividend investment journey.
But before we go into that, let’s find out what dividend investing is all about.
What is Dividend Investing?
Dividend investing is the act of investing in the stocks of companies that pay out regular dividends to their shareholders. These dividends are typically paid on a quarterly basis. However, some companies pay out dividends on a monthly basis, while others do so yearly.
Dividends are paid by already established companies, not by those in their growth phase. That’s why investors see dividend payments as a sign of the strength of a company.
Generally, investing in the stock market is one of the best ways to build wealth. However, just like forex trading, it’s necessary that you have a solid understanding of both fundamental and technical analysis.
Why Should I Invest in Dividend Stocks?
To some young investors, dividend investing is a means to build wealth. To achieve this, they consistently reinvest dividend payments in order to grow their capital. This guarantees them bigger payouts in the future.
However, older investors see it differently. To them, dividend investing is a good way to receive a steady inflow of income. Having reinvested their dividends when they were young, the dividends received in their senior years are used to take care of their expenses and needs. With a huge portfolio made of dividend stocks, one doesn’t need to sell shares to enjoy a fun-filled retirement. Consider a portfolio worth $1,000,000 with an annual yield of 5%. That’s about $50,000 per year in dividends, which is enough to live a comfortable senior life.
While investors have different reasons for investing in dividend stocks, one thing is certain: it’s a reliable income source. However, dividends are not guaranteed. When companies get affected by business and financial uncertainties, paying dividends becomes difficult. That’s why it’s important to know the right stocks to invest in and the rules to follow to achieve profitable results.
Rules for Successful Dividend Investing
Top investors have mastered the art of investing in dividends that guarantee steady income. With these five rules, you can take part in successful dividend investing:
1. Chase Sustainable Dividends
Most amateur investors make the mistake of focusing on the dividend yield of a stock. They channel their investments into stocks with huge payout potential without considering how sustainable the payouts can be.
This is a mistake most experienced investors don’t make, and you shouldn’t either. You should find stocks with sustainable dividend payouts, even if they have a lower yield. Most experienced investors, upon sighting an unsustainable dividend payout, tend to pull out their investments. This results in the company not having the resources to do business and pay dividends. It could still lead to them reducing the dividend amount they usually pay.
Huge dividend payouts are good, especially if the company is making so much. However, when a company uses over 70 percent of its profit to pay dividends, it’s a sign of poor management. That is unsustainable, especially when it is a growing company. A dividend payout of that amount means there’s less than 30 percent retained for business growth.
2. Established Companies Guarantee Safety
Investing in established companies that have achieved “dividend aristocrat” status never goes wrong. These companies have a record of stability in their dividend payouts. In fact, to attain “dividend aristocrat” status, a company must have consistently paid out increased dividends every year for 25 years in a row.
This means, based on their past performances, your investment is more likely to yield increased dividends in the foreseeable future. The same cannot be said about growing companies that do not have a proven track record.
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3. The Payout Ratio Says a Lot
Paying good attention to the payout ratio of a company’s stock will help prevent your investments from plummeting with the company. This is one of the top rules most successful dividend investors never joke with, as they dread investing in companies with an unsustainable payout ratio.
The payout ratio is a good metric to determine the phase of a company’s business life cycle, the management’s capability, and the future of the company. A company that’s focused on growth doesn’t pay out all its earnings in dividends.
Except when it’s already established, a company should keep a larger percentage of its annual earnings. This can be used to invest in company development, which would result in increased earnings and thereby increase the share price. Additionally, the management has the option of repurchasing company shares with retained earnings to lower the overall circulating stock. The fewer shares in circulation, the more valuable the shares become.
A company that has a payout ratio above 70 percent is questionable, especially when it’s a startup or still in its growth phase.
4. Pay Attention to Dividend Growth Potential
The developments and investments of a company indicate its growth potential. While some investors focus on the current dividend payout of companies, others look at the investment activities the company is embarking on to increase its earnings.
The growth of the company determines how profitable your investment will be in the long run. If the current income stream for the business closes, what plans are in place to ensure the company doesn’t fold up? Businesses invest in research on the goods or services they will provide in the future to ensure longevity. Companies that made a lot of money in the analog era had to evolve in order to stay relevant in the digital era.
If Apple stops producing newer gadgets today, it means it has stopped growing. While it might still be profitable in the present due to its current products, it would not be in the future as other businesses must have taken its market share with their latest products.
5. Reinvest Your Dividends
One thing every successful dividend investor will tell you is, “Don’t spend your dividends; reinvest them.” This might not go well with you if you’re just looking to build a steady income stream to enable you to sort out your present needs. However, if you’re looking to build wealth, especially for the future, you’ll look beyond your current needs and reinvest the dividends for future payouts.
You must not necessarily reinvest your earnings in the same stock. You can diversify your portfolio by picking up well-performing stocks of other established companies too.
Conclusion on the Top 5 Rules for Successful Dividend Investing
It is not the absence of risks that makes experienced investors successful. Rather, it is the practice of the right investing rules and principles. Knowing which stocks to buy, when to buy them, and when to sell them is critical if you want to avoid a financial disaster.
Hopefully, this article has taught you important rules for dividend investing success.
