Watch Money Roll in with This Simple Strategy
Dear Penny Stock Millionaire,
Today’s article is a bit different than my typical fare about trading, because I’m not going to be focusing on penny stocks. Shocking, I know, but it’s important that you know about all the different facets of the stock market to be a well rounded trader. You don’t need to be an expert, but you do need to know about them.
This post gives you an introduction to high dividend stocks, including what they are, how they work, and what considerations to keep in mind to ensure that you make the most intelligent choices when choosing stocks.
What Are High Dividend Stocks?
Before you can understand what a high dividend stock is, you need to understand the general concept of dividends.
What is a Dividend?
A dividend is a payment issued by a company or corporation to shareholders. It might be issued as cash (referred to as “cash dividends”) or as stock (referred to as “stock dividends”).
Typically, dividends are paid out quarterly, but sometimes they may be issued in response to stand-alone events such as a big merger.
The value of dividend payments is figured out by something called a yield. In the context of the stock market, yield is a way of measuring the dividend relative to the share price.
Quite a few big companies offer dividends. Why? Since large-cap companies tend to be stable, their stock prices don’t move a ton. Dividends are a nice perk to offer to entice and retain shareholders. It’s their way of showing they notice and appreciate you.
As the shareholder, it’s kind of like you’re receiving a little bonus based on the company’s profits. Usually, dividends are part of a long-term plan for investing, where individuals reinvest the dividends into the same company and get to enjoy larger dividends as a result.
Defining High Dividend Stocks
High dividend stocks are just what they sound like: stocks that offer a higher rate of return with their dividends.
There isn’t one official rate or dividend yield that is considered the cutoff for high versus low dividend stocks. This is partially because it’s relative to the market. For instance, what might be considered a high yield today might have seemed very low a decade or two ago.
At the time of this writing, most financial articles and investors would probably say that 4% or greater would be considered a high yield, though some might include 3% and some might say 5% or higher.
To get a better idea, you can view a list of the highest dividend stocks on the NASDAQ to see what’s available.
However, you shouldn’t just be drawn to the stocks with the highest dividends! If a stock has a super-high dividend, it’s typically a riskier investment. Yes, the dividends are higher, but so’s the risk level.
Stocks aren’t the only option for high dividends, either. You can also explore high dividend exchange traded funds (ETFs), which offer a different type of investment and the chance to diversify.
Benefits of Trading High Dividend Stocks
Why trade high dividend stocks? Here are some of the reasons you might be tempted:
- Regular payouts. When you trade high dividend stocks, you’re banking on the fact that you’ll receive a payment on a regular basis.
Dividends are usually (but not always) issued on a quarterly basis, so this means that at reliable intervals, you’ll receive a payout that you can save, reinvest in the same company, or use for other investments.
- Potential to outperform the market. With high dividend stocks, you have the potential to make the most of your trading dollars. High dividend stocks have the potential to outperform the market, but only if you’re smart about it.
The key here is to be ahead of the trend. You’re probably not going to make waves in your account by going with a low-yield yet stable company stock. That may be reliable, but it won’t grow your account fast.
High dividend stocks are riskier, but offer the potential for better returns. Be sure to look at the company, do fundamental and technical research, and look at their earnings reports and balance sheets.
Consider why the yield is so high. Sometimes, a good company can have a bad patch. If the market conditions or short-term company issues have made the stock price decline, it can raise the yield.
If you’re proactive and your research tells you that things may level out soon, you can stand to benefit from trading a high dividend stock.
- Tax efficient. Yes, you have to pay taxes on dividend income. But depending on the dividend, the tax rates might be lower than on other types of investment income. How do you know?There are two types of dividends: qualified and nonqualified. It’s the qualified ones that are taxed at the lower rates. For a dividend to be qualified, it needs to do two things. First, it has to be issued by a U.S. corporation, a corporation in a U.S. territory or U.S. possession, or a foreign corporation that is on a U.S. stock exchange. You also have to make sure that you’ve held the stock long enough. You have to have had the stock paying the dividend for more than 60 days within a 121-day holding period. All of that can get confusing, so suffice it to say that you should check with your accountant about the rules before assuming you’ll get a great rate.
- Take advantage of low interest rates. Stocks with dividends are often affected by interest rates, which can affect the underlying businesses in question. If interest rates are high, dividends are less enticing.
- Compounding. Compounding is the term used to describe using your dividends to reinvest in the same company, which leads to more dividends.
When to Buy High Dividend Stocks
There’s a time for everything. So, when should you invest in a high dividend stock? Here are some things to consider when timing out a trade:
Are the interest rates low? As mentioned above, interest rates have an effect on dividends. So if interest rates are low, it can be a good indicator that now is a good time to be looking for dividend stocks.
Have you done your research? Since high dividend stocks carry a similarly high level of risk, you’ll want to devote plenty of time to research your choices before executing a market order.
Seriously, do the research. It’s worth the time. If you want to be in a position to benefit from high dividend stocks, you can’t skimp on your research. If you haven’t thought out potential investments and tried to get ahead of the curve, you have no business trading high dividend stocks.
The January Effect
While it might sound like something the Weather Channel invented to attract viewers, the January effect is actually a seasonal stock market phenomenon.
The January effect refers to the reliable increase in stock prices at the start of the year. This might seem backwards, since most people are winding down with spending following the holidays. But remember: that’s in retail. In the stock market, things follow a different cycle.
In December, when most people are spending at the mall, investors are selling so that they can maximize the losses on their tax returns.
In recent years that has been changing somewhat as more and more people are using tax-sheltered retirement plans, but it’s still a common enough phenomenon.
Also, plenty of people have cash bonuses they received at the end of the year that they are putting into the market come January.
Small- and micro-cap companies are more affected than mid-/large-/mega-cap companies because the former are more liquid.
Be sure to poke around the market starting in the early winter months and see how high dividend stocks are performing. It can be a good time to seek out deals before the big buying time in January!
The Bottom Line
Investing in stocks that pay out high yield dividends can be a great way to build your account if you know what to look for. It’s an investment strategy that has been used forever on Wall Street. But just because it’s an old technique doesn’t mean it doesn’t work.
Tomorrow I’ll explain what to look for if you are looking to invest in high yield dividend stocks. Like I said, this strategy isn’t without risk, so you can’t jump in without all the facts. Tune in tomorrow and I’ll tell you what to avoid to protect your investments.
Editor, Penny Stock Millionaires