Investing in stocks that pay a dividend is a good way of ensuring that you have passive income coming in every month or every quarter. Because many stocks have tanked in recent years, you cannot rely on simple stock price appreciation to make money anymore. These days, it pays to have dividends as a back-up strategy for making money on the stock market.
Many different companies pay a stock dividend, from mortgage securities investment companies such as Annaly Capital Management to old standards such as health care giant Johnson & Johnson. How can you differentiate between all these different companies and decide which dividend-paying stock is best for you? Here are 10 things you should look at before investing in any dividend-paying company:
#1. The Dividend Amount
Given that many CD (certificates of deposit)’s pay an annual yield of 3%, and given that CD’s are a much safer investment vehicle than stocks, it does not make much sense to purchase stock in a company that pays anything less than a 3% dividend yield.
#2. P/E ratio
While obtaining a dividend yield of 5 or 6 or even 10% is great, it will mean nothing if your stock price tanks. The P/E ratio, which is the price of the company stock divided by its earnings, is a good indicator of whether or not the stock price is overinflated and therefore prone to depreciation. If a company stock has a P/E ratio of 20 or higher, it may be time to start looking elsewhere.
#3. Gross Revenue
American companies listed on the stock market must file a yearly income statement (also known as a statement of operation). In the income statement are listed items such as gross revenue, operating expenses, and net income. If a company does not show its gross revenue to be increasing or at least holding steady compared to the last several years, there may not be much of a future left for this company.
#4. Growth in Sales
If the company’s sales are increasing, that is a good measure of its overall health. More sales typically result in higher profits, which trickle down to continued or even increased dividends.
#5. Net income
If a company does not report a positive net income, or if it reports a smaller net income compared to the prior two to three years, there may be good reason to not invest in this company.
#6. Operating Costs
Contrary to popular belief, operating costs should not decrease year after year but actually increase in proportion to the gross revenue. If they are decreasing, especially drastically, that could mean that the company is laying off workers to bump up its own bottom line. Alternately, the company may be preparing itself for a big change, such as moving overseas or just shutting down.
#7. Dividend Trend
A company that is increasing its dividend payout year after year is usually a company that intends to keep its dividend around for a long time. This is useful because you don’t want to have the nasty surprise of seeing your dividend payout suddenly reduced or eliminated.
#8. Sector Health
While a specific company is not its sector and vice-versa, stocks do trade on strong psychological factors. As a result, a dividend stock that is purchased in a sector that is doing poorly may also start doing poorly.
#9. Future outlook
Are the company’s patents expiring soon? Does the company have exciting and new products in the pipeline? How many other companies are producing and/or providing the same product as this particular company? These are all questions to ask when analyzing a company for dividend payout, since that payout may not be seen for several weeks or months into the future.
#10. Explaining the Business
Does a company’s dividend look great but you have no idea how the money is actually made to pay that dividend? If you cannot understand the business or the industry, you may be better off looking at companies whose business models you do undertand.
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