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Highlights
- Investors are always on the hunt for dividends stocks to boost their passive income.
- However, one must keep few things in mind while buying a dividend stock.
- Rather than blindly falling for the allure of high-dividend stocks, investors should be careful and do their due diligence.
Dividend stocks are keenly looked upon by investors. It is a proven fact that the companies start getting more traction, when they announce their record dates for dividends or bonus shares. Thus, investors are always hunting for dividends stocks to boost their passive income. These stocks make all the more sense in wake of the COVID-19 pandemic, which saw people’s income being adversely affected. But before you go for dividend stocks, you must know the answers to these questions – how to pick a particular dividend stock? What are the things to keep in mind while investing in dividend stocks?
First, let’s understand, what is dividend?
Dividend is a part of profit that a company shares with its shareholders. Companies’ announcements with respect to dividend payouts are generally followed by a proportional rise or fall in their stock prices.
Source: © Phillipminnis | Megapixl.com
How to pick a dividend stock?
Here are a few key metrics to consider while purchasing dividend stocks.
- Dividend yield - The ratio of a firm’s annual dividend to its share price gives the dividend yield.
- Payout ratio - The dividend as a percentage of a firm’s earnings.
- Total return - The increase in stock price plus dividends paid.
- EPS - This metric normalises a company's earnings to the per-share value.
Drooling over dividend stocks? Here are things to keep in mind
Should you always invest in stocks with high-dividend yields?
Even as stocks with high-dividend yields may be enticing, investors should be careful while doing so due to several reasons. A stock’s high dividend yield could be driven by a significant fall in its stock price, implying a financial trouble in the future. A company facing challenges on the financial front may not be able to sustain a high dividend yield for long and hence it would be unwise to invest in such a stock.
Let’s understand through an example.
Suppose a company with a stock price of AU$50 pays a $3.50 annual dividend for a 5% yield. However, the company’s stock price halves to AU$25 due to some distress. Now, the company appears to be paying an 7.5% dividend yield. But it is possible that the company may soon reduce the dividend.
A few general tips to know:
- Investors must evaluate the payout ratio of a company while gauging a dividend’s sustainability.
- Investors must always have a detailed idea of a company’s dividend history.
- Investors must also be aware about how dividends are taxed.
How do investors use dividend income?
Investors can use dividend income in a variety of ways. They can:
- Buy stocks in a different firm.
- Save or spend the cash.
- Reinvest the income to buy more shares of the same company.
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