Stocks offer three ways to earn profits. The first is the most common, buying the stock low and selling it when it goes up in price. The second is also well known, dividends. The third is not as common and involves renting out your stock. Using all three methods, could increase the amount of return you receive for your investments.
What Are Dividends?
Let’s look closer at dividends. When you buy shares of a stock, you are becoming a partial owner of that company. Sometimes, when a company is doing well in its operations, it will share the profits with those owners. The dividend is the sharing of the profits. There are several things to consider when choosing a company to invest in in order to receive the dividends.
How to Get a Good Yield from Dividend Investments
You must buy shares in a company in order to receive the dividend. You want to receive a high dividend in relationship to the amount you are spending on the shares. While there is not a set number you should be looking for, obviously the higher the yield, the better. A dividend yield of 4 to 6% is considered to be good. Finviz has a heat map on its website that shows the dividend yield of many stocks. The dividend yield is the dividend in comparison to the stock price.
Getting a Good Dividend Payout Ratio
You also want to make sure the dividend is sustainable. The payout ratio is the percentage of earnings that is being paid out in the dividend. If the dividend payout ratio is close to 100% of earnings it may not be sustainable. Therefore, you would like to see a lower number so that the dividend is likely to be continued in the future. A dividend yield under 35% is very low and is not typical for income investing. 35% to 55% is a healthy dividend payout ratio and a good target for many investors to seek.
Companies that offer dividends higher than 55%, may be paying out too much of the profits and that means the company is not reinvesting that money into itself. It may not be focused on growth and investors may not see dividends increase in the future. Increased dividends due to growth in the company also increases your returns and is your goal.
What Are the Company’s Growth Expectations?
Another consideration is if the company is truly doing well and likely to continue to do well and grow its earnings in the future? Dividends are a sharing of the earnings, if the earnings stop or even shrink, there won’t be anything to share! When looking for companies to invest in, you can look at the earnings and the growth of those earnings. Many people focus on the earnings per share (EPS) growth. A better analysis could be to look at the return on equity (ROE). This is rumored to be an important number for value investors, like Warren Buffett. Your ROE is the amount your ownership is increasing in value. Do not just look at one year’s ROE as it can be misleading. Instead, look at the average ROE for the last 5-10 years. If a company is maintaining a ROE over 10%, they are likely doing well in their operations and growing the value of the shareholder’s ownership.
In addition to looking at growth as a value of earnings per share and return on equity, you can also look at other factors like institutional ownership when deciding where to invest. The reason for searching growth in earnings is obvious, but the institutional ownership assists in being able to time your entries and exits into the stock itself. In order to capitalize on price movement like the major institutions do, we should look to invest where and when they do as well. There are websites and brokerage software that offers screeners to help you search.
In the beginning of this article, we discussed using leverage and multiple assets. In my next article I’ll discuss how to buy these stocks at a discount and how to rent them out for increased income and protection against price drops using options. Until next time, may all your trades be green and your losses small!