Income investors often start by searching for the best dividend stocks. A dividend is a share of a company’s profit paid to its owners, usually every quarter. Steady dividends can add income and help your money grow when you reinvest them. This guide explains how dividends work and how to judge the best dividend stocks without chasing the highest yield.
New to investing? Read our guide to the best stocks to buy first, then come back here.
How Dividends Work
When a company earns a profit, it can reinvest the money, pay it out or do both. Mature companies with steady sales often pay dividends. Fast growing companies usually keep the cash to grow. Neither choice is wrong, but they suit different goals.
What Dividend Yield Tells You
Yield is the yearly dividend divided by the share price. A two dollar dividend on a fifty dollar stock is a four percent yield. A very high yield can look attractive, yet it often means the price has fallen because investors doubt the payment will last. Treat a surprisingly high yield as a question, not a prize.
Five Checks for the Best Dividend Stocks
Is the dividend covered? Compare the payment to profit and cash flow. If a company pays out nearly everything it earns, there is little cushion.
Does it have a record of paying? Some companies have raised dividends for decades. A long record shows discipline, though the past never guarantees the future.
Is the business growing? Dividends come from profit, and profit comes from sales. Our guide on reading a company profile shows how to check.
How much debt does it carry? Interest comes before dividends. High debt can force a company to cut its payout.
How big is it? Large, established companies tend to pay more steadily. Compare size with our market cap explainer.
Dividend Stocks or Dividend Funds?
You can hold single companies or buy a fund that holds many. Funds spread risk, while single stocks give you more control. See stocks versus index funds for a simple comparison.
Taxes and Reinvestment
Dividends are usually taxable in a regular account. Many investors reinvest them to buy more shares. Learn the basics of taxes and investing before you plan your income.
Common Mistakes
Avoid choosing only on yield, ignoring debt, putting everything in one sector and forgetting that a company can cut its dividend at any time. Review each holding every quarter after new reports come out. You can read them free on SEC EDGAR.
Keep Building Your Skills
The best dividend stocks are found through patient research. Practice with our free investing games and get one lesson each week from the free Positive Stocks brief.
What dividend yield tells you
Dividend yield is the yearly dividend divided by the share price. A 3 percent yield means about 3 dollars a year for every 100 dollars invested at the current price. It changes whenever the price changes.
Why a high yield can mislead
If a stock’s price drops, the yield goes up, even though the business may be in trouble. An unusually high yield can be a sign the market expects a dividend cut. Always ask why the yield is high.
Checks to run
Look at the payout ratio, which compares the dividend to profit. Check free cash flow to see whether cash covers the payment. Look at debt and at how long the company has paid and raised its dividend. Read the yearly report for any warnings.
Balance yield and growth
A company with a lower yield that grows its dividend and its business can be worth more over time than one with a high yield and no growth. Think about total return, which includes both dividends and price changes.
Mistakes to avoid
Do not buy only for the highest yield. Do not assume dividends are guaranteed. And spread your money over several companies and sectors.
Keep reading
- Best Penny Stocks: How to Research Them Safely
- Best Stocks to Buy: How to Find Them Yourself
- OTC Markets Explained: Opportunity and Risk
This article is for education only. It is not investment advice, and it does not recommend any security. Every investment carries risk, including the loss of your money. Do your own research or speak with a licensed advisor before you invest.