.jpg){kind=small}
What are dividend stocks?
Dividend stocks are stocks of companies that have declared a dividend payment to shareholders. These payments typically come from the company’s profits or reserve funds and are paid out regularly. Dividend stocks are often found among blue-chip companies in mature industries with a long history of dividend payments, such as utilities and financial services. When a company declares a dividend, it will also announce the amount per share and when investors receive their payments - usually quarterly or yearly.
When you buy shares of stock in a company that pays dividends, you become entitled to those dividends as long as you own the shares. The amount of each dividend payment is determined by the board of directors and is typically a percentage of the stock’s current market price. For example, if a company pays out a dividend of £0.25 per share and you own 100 shares, you will receive £25 in dividends.
Why should you invest in dividend stocks?
Dividend stocks can provide investors with a steady income and potential capital appreciation due to their reliable dividend payments. Additionally, because the payment is made regularly, the cash flow is predictable over time, which can be especially beneficial for those looking for steady income or reinvesting in other investments. Furthermore, some companies are known to increase their dividend payments over time which can lead to higher returns in the long term.
For example, assume you own 100 shares of a company whose current market value is £50. If the company pays a quarterly dividend of 2%, your total dividend payment will be:
100 x £50 x 2% = £10
At the end of each quarter, you will receive a payment of £10 for every 100 shares, totalling £100.
In addition to that, if the stock price increases to £60 over time, your quarterly dividend payment will also increase to:
100 x £60 x 2% = £12
In this case, you’ll receive a payment of £12 per share or a total of £120. This increase in dividend payments benefits investors by giving them a greater return on their investment.
How to research dividend stocks?
So far, we’ve discussed dividend stocks and why they can be valuable investments. Now, let’s take a look at how to find the stocks that have the potential for a good return.
1. Dividend yield
When researching dividend stocks, the dividend yield is one of the most critical metrics. It measures the annual dividend paid per share relative to the stock’s price. Generally, a higher yield indicates higher returns but also more risk and vice versa. Therefore, it's also best to consider whether or not a company can maintain its dividend payments over time before investing.
To calculate the dividend yield, use the following formula:
Dividend Yield = Annual Dividend / Stock Price
For example, if a company pays out an annual dividend of £2 per share and the stock price is £50, the dividend yield will be:
Dividend Yield = £2/£50 = 0.04 or 4%.
2. Dividend payout ratio
The dividend payout ratio measures how much of a company’s profits are paid out in dividends relative to its total earnings. A high payout ratio may indicate that the company is not retaining enough cash for potential growth opportunities and future investments, which can lead to lower returns in the long run. On the other hand, low payout ratios may indicate room for future growth as more money will be reinvested into the company.
To calculate the dividend payout ratio, use the following formula:
Dividend Payout Ratio = Dividends per Share / Earnings Per Share
For example, if a company pays out £1 in dividends per share and has earnings per share of £4, its dividend payout ratio will be:
Dividend Payout Ratio = £1/£4 = 0.25 or 25%.
3. Earnings per share
Earnings per Share (EPS) measures a company’s net income relative to the number of shares it has issued. This metric is essential when evaluating a company’s ability to generate profit and pay out dividends and its growth potential. Generally, a higher EPS indicates that the company is doing well and may have more money to reinvest in future growth opportunities.
To calculate EPS, use the following formula:
Earnings Per Share = Net Income / Outstanding Shares
For example, if a company has a net income of £50 million and 10 million outstanding shares, its earnings per share will be:
EPS = £50/£10 = £5
4. Price-to-earnings ratio
The price-to-earnings ratio (P/E) measures how much an investor pays for a stock relative to its earnings. This metric can indicate whether or not a stock's current price is overvalued or undervalued compared to its expected performance. Generally, a lower P/E suggests that the stock is undervalued and may offer a good return on investment.
To calculate the price-to-earnings ratio, use the following formula:
Price to Earnings Ratio = Current Stock Price / Earnings Per Share
For example, if a company’s current stock price is £50 and its earnings per share are £5, its price-to-earnings ratio will be:
P/E Ratio = £50/£5 = 10
5. Sector and industry analysis
Finally, when evaluating dividend stocks, it’s crucial to consider the sector and industry of the companies you are investing in. Different sectors and industries have different levels of risk and potential for growth, so it’s important to consider these factors before investing.
For example, if you are looking for reliable dividend payments, investing in companies from the utilities or real estate sectors may be a safer option than investing in companies from the entertainment or technology sector.
Own a dividend-paying stock in five steps
Now that you know how to research dividend stocks, let’s look at how to purchase them.
Step 1: Decide how to invest. Generally, there are two ways of investing in dividend stocks: individual dividend stocks or mutual funds. When deciding to invest, it is essential to consider your financial goals and risk tolerance and determine what type of investment will best fit you.
Buying individual stocks provides more control over your investments and carries higher risks than investing in a diversified portfolio through mutual funds.
Step 2: Open a trading account. Before you can start investing in dividend stocks, you will need to open a trading account. When considering which broker to use, it is important to compare fees and features such as customer service, research capabilities, and user-friendliness of the platform. Check out our list of top 10 trading platforms for UK investors for more information.
Some companies provide a direct stock purchase plan (DSPP) which allows you to buy stocks directly from the company without a broker.
Step 3: Research the stocks to invest in. Once you set up a trading account, the next step is researching the stocks you want to invest in. Consider the previously explained factors such as dividend yield, dividend payout ratio, earnings per share, and price-to-earnings ratio.
Step 4: Decide how much to invest. Once you have identified the companies you want to invest in, decide how many shares of each company you would like to buy. Diversification is critical– spreading your investments across different stocks to reduce risk is important.
You should consider both short-term and long-term goals for maximum returns on your investment.
Step 5: Execute the trade. Once all the research has been done and decisions made, it’s time to execute the trades. If you're trading on an investment platform, simply input the stock ticker and the number of shares you wish to purchase.
Wrapping up
Investing in dividend stocks can be a great way to generate income and long-term returns for your portfolio. However, it is vital to research stocks and understand the fundamentals before investing to ensure you make wise decisions. Additionally, make sure to diversify your portfolio across different stocks and sectors to minimise losses while maximising potential gains.
.jpg)
