The 3 Best Ways to Invest in Dividend Stocks
There are many advantages to investing in dividend stocks. In the last issue I covered the basics and outlined some of the perks of investing in them.
But let’s start off today by going over the three prime ways to invest.
1. Buy Shares Directly in the Company with a Brokerage Account
2. Buy Exchange-Traded Funds.
A lot of good ones focus on indexes of stocks that pay dividends.
They include an ETF for dividend-paying stocks in the S&P 500. But it doesn’t have the S&P 500 stocks that don’t pay dividends. Therefore, the dividend yield is higher than the usual S&P 500 ETFs and index funds.
Some ETFs focus on utility stocks, which all pay dividends. And you can buy ETFs of foreign stocks that pay dividends, including foreign consumer stocks, utilities and real estate.
That’s an easy way to diversify your portfolio so you’re not dependent on the good ol’ United States dollar.
3. Enroll in a Dividend Reinvestment Plan (DRIP).
Many mature companies sponsor these plans to encourage people to buy and hold their stock. They keep your stock for you, like a brokerage would.
You can get started with small amounts of money, from $25–$200. That’s a big advantage over brokerages. If you can afford only a fraction of one share, that’s okay.
You earn the same dividends as every other shareholder. They’re automatically reinvested.
But they don’t charge you transaction fees, either to open the account or to buy additional shares by reinvesting dividends. That’s another major advantage over a brokerage account.
What a lot of people do with DRIPs is open the account, then forget about it (except to add more money) for 30 years.
Types of Dividend Stocks
Many dividend stocks provide consumer goods and services. These range from Hershey and Wrigley to Bank of America.
Warren Buffett has always liked dividend stocks, even though Berkshire Hathaway itself doesn’t pay a dividend. Berkshire now owns 32 stocks that pay dividends, including Coca-Cola and WalMart. Obviously, Warren Buffett likes receiving dividends — he just doesn’t like to pay them.
Utility companies are a major type of dividend stock. Because they need so much capital and are so highly regulated, growth investors avoid them like crazy.
But that same regulation guarantees them a profit, a large chunk of which they pass on to investors.
In return for juicy tax breaks, the government requires real estate investment trusts (REITs), master limited partnerships (MLPs), business development companies and yieldcos to pay at least 90% of their profits to their investors.
Small Stock Dividends
So far, I’ve been telling you about cash stock dividends. However, companies also have the option to give shareholders stock dividends instead. In that case, everybody receives additional shares based on the number of shares they already own.
Small stock dividends are when the company pays out a distribution of 25% or less of outstanding shares to all the owners of stock, based on how many shares they already own.
This usually happens when the company doesn’t have enough cash to pay shareholders. Therefore, they reward them with additional shares in the company.
Sometimes they’re also used in mergers and corporate restructuring deals.
Small stock dividends usually don’t affect the market price, so the company values the stock at its fair market value.
Large Stock Dividends
When a company pays out stock dividends of 20% or more of the outstanding shares, that’s known as a large stock dividend.
The company’s internal accounting values the shares at par value.
It might feel good to go from owning 1,000 shares to 1,500, but consider opting for the cash dividends — you can’t pay your bills with additional shares of stock.
Highest Dividend Yield
The dividend yield is simply the percentage you receive in return for the money you have to spend to buy the stock.
Therefore, it’s dependent on the stock’s fair market value, which changes constantly.
If you have $5,000 to invest in dividend paying stocks, you want the highest dividend yield — all other things being equal.
If you can find a stock or ETF with a 2% yield, that’s around average in this bull market.
You might find some yielding 4% or 5%, and that’s great. Yield is always based on current market values.
Another good thing about dividend stocks is, the companies keep paying the dividends as long as they’re profitable — no matter what the stock price is.
Say this current bull market crashes 50% next week. A company with a 2% dividend yield will suddenly have a 4% yield just because its price was cut in half.
During the Great Depression, dividend yields were high simply because market prices were so low.
However, all other things are rarely equal. A stock may have a higher dividend simply because it’s not in a sexy sector of the market, so analysts, brokers and most investors ignore it.
However, be suspicious of dividends so high they seem out of whack with the market, especially other companies in the same sector.
Sometimes a company’s stock is low for a good reason. Though it probably goes without saying, buying stock in a company on the verge of bankruptcy isn’t a good idea.
That’s like putting your cash into a savings account in Argentina because it pays 60% interest! That’s not enough to reward you for the risk you’re taking.
Thinking of diving in yet? You might consider buying individual stocks or ETFs.
But I’ll cover that with you tomorrow. I’ll go over my top tips on how to choose dividend paying stocks.
— Tim Sykes
Editor, Penny Stock Millionaires