Dividends can add a significant source of income to your investment portfolio. But what are dividend stocks exactly? Find out everything you need to know in this guide.

When you thinking about the stock market, you likely think of movies like The Wolf of Wall Street with high-powered brokerage firms calling all the shots. But everyday investors can get started investing with just a little know-how. With two potential profit sources, dividend stock investing is one of the most viable options for investors – both new and experienced alike.

This relatively low-risk investment strategy allows for capital appreciation and regular income in the form of dividend payments. So, what are dividend stocks, how do they work, and how do you buy them? Let’s investigate. 

What are dividend stocks?

What Are Dividend Stocks? The Good, The Bad, And The Ugly - What are dividend stocks?

When you buy stock in a company, you buy a representation of ownership in that company. In other words, you technically become one of the company’s owners.

Some companies have retained earnings they don’t need to fund their operations or R&D. In this case, they will reward their stockholders by paying cash into their investment or brokerage accounts. 

This cash you receive as a reward for investing in the company is called a dividend, and the stock that includes this distribution is called a dividend stock.

What are the two types of dividends?

Two types of dividends exist: cash dividends and special one-time dividends.

Cash dividends are regular payments that a company makes to its shareholders out of retained earnings. Companies may choose to pay cash dividends monthly, quarterly, twice per year, or annually.

In addition to regular cash dividends, the company’s board of directors may approve a one-time distribution in the form of stock, cash, or even property. These distributions are not a regular occurrence. A board of directors will only approve them following a profitable period or an event such as the sale of an asset or a litigation win.

How do dividend stocks work?

Generally speaking, you receive a portion of the company’s retained earnings for every share of stock you own.

For example, Company A has two million shares, and it wants to distribute a million dollars of retained earnings to its shareholders as dividends. This means that Company A can pay out $0.50 per share (retained earnings divided by shares of stock).

In the above example, if you own one stock, you will receive $0.50 in dividends; if you own five stocks, you will receive $2.50.

Let’s look at the various metrics you can use to evaluate dividend stocks.

Dividend yield

Yield is the annual cash dividend as a percentage of the stock price. For example, if you receive $0.25 per quarter, and the stock price is $10 per share, the dividend yield is 10%.

Earnings Per Share (EPS)

EPS is a company’s net income divided by its total number of outstanding shares. The higher a company’s EPS, the higher its profitability.

Payout ratio

A dividend payout ratio is the dividend per share as a percentage of the company’s earnings per share. If the earnings per share are $2 and shareholders receive a dividend of $0.20 for every stock they own, the payout ratio is 10%.

Total return

Total returns are the sum of the increase in stock price, or capital gains, and dividends. If the stock price increases from $10 to $12, and you receive a dividend of $1 per stock, the total return is $3.

Consecutive years of dividend increases

The number of consecutive years that the company has increased its recurring dividend distributions indicates its sustainable competitive advantage.

Who can buy dividend stocks?

What Are Dividend Stocks? The Good, The Bad, And The Ugly - Who can buy dividend stocks?

A dividend stock investment strategy is ideal for anyone who wants to build long-term wealth and generate a passive income. Because companies that issue dividend stocks are generally well-established, you can also buy dividend stocks if you have a relatively low risk tolerance.

Robinhood makes this strategy easy, too. Among the greatest selling points of Robinhood is the mobile app. You can view, at a glance, how all your investments are doing, and with just a couple of taps on your phone, you can buy or sell a dividend stock. Additionally, Robinhood has $0 commission stock trades.

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You may also invest in dividend stocks even if you don’t have a sizeable investment amount. People generally believe that only rich people invest in stocks, but this is a myth. In fact, an effective dividend stock investment strategy will play an integral role in your pursuit of financial freedom.

How are dividend stocks purchased?

After evaluating and selecting a dividend stock, you can purchase it directly from the company or through a broker. When you buy dividend stocks through the company, you may find that a minimum investment requirement exists of up to $500 or higher. This minimum investment depends on several factors, including the price per share and the company’s policies.

TD AmeritradeUsing an online broker, such as TD Ameritrade, you can easily purchase dividend stocks. TD Ameritrade offers a $0 commission on stock trades, which will allow you to purchase your dividend stocks for free. They also offer options and bond trading, as well as a thinkorswim upgrade that allows you to trade futures, forex, and funds.

After buying a dividend stock, you can use your brokerage account to collect your dividends through a direct cash payment. You can reinvest your dividend payment into more stocks. Your brokerage account allows you to track your dividends and make calculated investment decisions.

When do dividends pay out?

What Are Dividend Stocks? The Good, The Bad, And The Ugly - When do dividends pay out?

Dividends pay out whenever the company’s board of directors approves the distribution. You need to know four key dividend dates:

The declaration date is when the board of directors announces its intention to distribute a special one-time dividend and the payment date. On the declaration date, the company will enter the distribution in its books as a liability.

The ex-dividend date is when you already have to be a stockholder to receive a dividend. If you purchase the stock on or after this cut-off date, you will not be eligible to receive the payment when the company pays it from the retained earnings.

The date of record is when the company reviews its records to determine who the holders of record are. These are the shareholders who hold the stock before the ex-dividend date.

The payment date is when you receive the dividend in your investment account.

Should I focus on dividend yield?

New investors should be careful not to base their investment decision solely on dividend yields. While it is true that higher yields are critical to a successful portfolio, this metric doesn’t show you the bigger picture.

An unusually high yield may indicate problems if it reflects shareholder skepticism that a company can continue distributing the high dividend. This phenomenon is often known as “the dividend yield trap.”

Seeking out the stocks with the highest yields can be a sound investment strategy. However, make sure that the other metrics are also favorable.

These measures include the payout ratio, which indicates a dividend’s sustainability. You should also consider the company’s consecutive years of dividend increases, balance sheets, and environmental factors such as demand, competitors, and disruptors in the industry.

Do I have to pay taxes on dividends?

Dividends are income, and so you have to pay taxes on them. Your tax liability for dividends depends upon whether you are receiving ordinary or qualified dividends. The IRS taxes ordinary dividends at marginal rates ranging from 10% to 39.6%

The tax treatments for qualified dividends are better, with rates ranging from 0% to 20%. According to the IRS, dividends need to meet specific requirements before they are taxable under the qualified classification.

Some kinds of stock, such as real estate investment trusts (REITs) and master limited partnerships (MLPs), generally have a high dividend yield. Consequently, your tax obligations with these stocks may be higher.

Are dividend stock investments risky?

What Are Dividend Stocks? The Good, The Bad, And The Ugly - Are dividend stocks risky?

Because a company pays dividends from retained earnings, it must establish itself within the market with stable cash dividend payout and price-to-earning ratios. Generally, most companies that offer dividend stocks are financially stable, making dividend stock investing relatively safe.

However, companies don’t have a legal obligation to pay dividends. If expense cuts are necessary, your annual dividend payout may be at risk. Mitigate this risk by building a diverse income portfolio with a generous margin of safety. 

Another way to mitigate risk is by purchasing fractional shares of dividend stocks. Public allows you to buy any stock as either a full share or a fractional share, for as little as $5. This means you can invest $5 in a dividend-paying stock and not have to worry about paying for a full share, thus mitigating your risk and getting you comfortable with trading these types of stocks. All trades are commission-free, too!

Stocks that pay dividends

Now that you have a better understanding of dividend stocks and how they work, I’ve put together a list of some stocks that pay dividends as a point of reference to help you begin your journey of researching these types of stocks.

S&P Global

Formerly McGraw Hill Financial, S&P Global has a majority stake in S&P Dow Jones indices, and it owns S&P Global Ratings, S&P Global Market Intelligence, and S&P Global Platts. The company has distributed an annual dividend since 1937, and it has also increased its dividend every year for at least 47 years.

Sherwin-Williams

Sherwin-Williams is one of the largest home improvement and paint companies globally and has a dividend yield of 0.9%. This stock offers a steady and rising dividend stream, and it has boasted a consecutive annual dividend increase of 42 years. In February 2020, the dividend distribution increased by 19%, and the company pays 27% of its retained earnings as dividends.

Ecolab

Ecolab offers a wide range of water treatment and maintenance services to the healthcare, food, and oil industries. For the past 28 years, Ecolab’s shareholders have seen a consecutive annual dividend increase, with a current dividend yield at 0.9%. In December 2019, Ecolab raised its quarterly dividend payout by 2% to $0.47 per share.

Brown-Forman

Brown-Forman is a prominent producer and distributor of alcohol with well-known brands that include Jack Daniel’s Tennessee Whiskey and Finlandia Vodka. This company has paid dividends every year for the past 74 years, with 36 consecutive annual dividend increases. In November 2019, Brown-Forman increased the dividend distribution by 5% to $17.43 per share. 

Carrier Global

Carrier Global is one of the largest companies in the climate control systems industry. The company’s business segments include fire and safety, refrigeration, heating, ventilation, and air conditioning (HVAC). Carrier Global increased dividends annually for the past 26 years, and the current dividend yield stands at 1.3%.

McCormick & Co.

McCormick & Co. manufactures flavorings such as spices and herbs. The company has paid a dividend consecutively for 95 years and has raised it annually for the past 34 years. In November 2019, McCormick & Co. increased its dividend payout by almost 9% to $0.62 per share—double the dividend it paid shareholders in 2012.

Abbott Laboratories

Abbott Laboratories is a leading supplier of diagnostic and nutrition products, medical devices, and generic drugs. The company’s most notable products include i-Stat diagnostic devices and Glucerna diabetes management products. Abbott Laboratories has raised annual dividends consecutively for 48 years, with the current dividend value at $0.36 per share and the dividend yield at 1.6%.

Walmart

As the world’s largest brick-and-mortar retailer, Walmart maintained a 46-year streak of annual payout increases. This stock doesn’t pay the biggest dividend, but it has a stable dividend yield of 1.7%, and, in 2020, the company hiked the payout to $0.54 per share. With the introduction of the Walmart+ service and online expansion, this dividend is likely to continue rising.

W.W. Grainger

In addition to supplying a wide range of industrial tools, W.W. Grainger also offers B2B inventory management services. This stock has maintained an annual dividend growth for the past 48 years, with a current payout ratio of 31%. In April 2019, W.W. Grainger approved a 6% dividend increase to $1.44 per share.

Hormel Foods

Hormel Foods is a prominent packaged food company and the supplier of products that include Skippy peanut butter, Spam, Dinty Moore, and House of Tsang sauces. In November 2019, Hormel Foods approved an 11% dividend hike to $0.2325 per share, which was the 54th consecutive yearly payout increase.

Stanley Black & Decker

Stanley Black & Decker, the familiar power tool manufacturer, managed yearly and uninterrupted dividend distribution for 143 years. In July 2019, the stock’s dividend increased by 4.5% to $0.69 per share, marking the 52nd consecutive annual dividend increase.  Currently, Stanley Black & Decker has a $21.4 billion market value and a dividend yield of 2.0%.

Air Products & Chemicals

Despite going through restructuring and selling Performance Materials during the past few years, Air Products & Chemicals managed to pay yearly dividends without interruption. In fact, the company increased dividends on an annual basis for 38 years in a row. In May 2019, the board approved a 15.5% payout increase, which is the largest in company history.

Clorox

Clorox’s products include the popular Clorox bleach, Hidden Valley salad dressing, and Glad trash bags. The company has had a consecutive yearly payout increase for the past 43 years, and its current dividend yield stands at 2%. The most recent dividend increase was in May 2020, when the payout grew 5% to $1.11 per share.

Atmos Energy

Atmos Energy is a leading supplier of natural gas distribution and storage solutions. The company achieved 25 years of consecutive dividend growth in November 2019, when it approved a 9.5% increase to a quarterly payout of $0.575 per share. Currently, it has a $12.2 billion market value and offers a dividend yield of 2.3%.

T. Rowe Price

Rowe Price is currently managing $1 trillion in assets and expects to see average profit growth of 8.6% over the next three to five years. In February 2020, T. Rowe Price announced a 34th consecutive annual dividend increase of 18.4%. The company’s current dividend payout ratio is 40%.

Medtronic

Medtronic is one of the largest manufacturers of medical devices and has a current market value of $123.0 billion. The company increased dividend payouts for 43 years consecutively, and the stock currently has a dividend yield of 2.5%. In June 2020, the board approved the latest quarterly payout increase by 7.4% to $0.58 per share.

Automatic Data Processing

Automatic Data Processing is a prominent payroll processing firm that serves more than 810,000 clients in 140 countries. The company has paid dividends to shareholders for the past 45 years and increased dividend payouts every year without interruption since 1975. In November 2019, Automatic Data Processing increased the payout by 15% to $0.91 per share.

Procter & Gamble

Procter & Gamble generates $1 billion in annual revenues with 23 brands that include Gillette razors, Tide detergent, and Pampers Diapers. The company has paid dividends every year since 1890 and has increased its dividend payments annually for the past 64 years. Currently, the Procter & Gamble stock has a dividend yield of 2.6%.

Johnson & Johnson

Johnson & Johnson is active in various healthcare industry segments, including the manufacturing of surgical devices, pharmaceuticals, and consumer products. In April 2019, Johnson & Johnson announced a dividend hike of 6.3% to $1.01 per share and currently boasts a consecutive annual dividend growth streak of 58 years.

Kimberly-Clark

Kimberly-Clark owns several familiar brands that include Scott paper towels, Kleenex tissues, and Huggies diapers. The company has managed to pay dividends annually for 84 consecutive years. In January, the Kimberly-Clark board approved the 48th consecutive annual dividend increase of 3.9% to $1.07 per share.

Summary

Are you looking for a sustainable investment to add to your portfolio? If you are new to stock investing, buying dividends is a good starting point, especially if you want to build an income portfolio. Because dividend stocks allow for capital growth and regular earnings, it presents an excellent opportunity for building wealth.

You don’t have to be rich to start investing in dividend stocks. Don’t wait any longer. Open your online brokerage account today and start evaluating dividend stocks you can add to your portfolio.

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Chris Muller picture
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Chris has an MBA with a focus in advanced investments and has been writing about all things personal finance since 2015. He’s also built and run a digital marketing agency, focusing on content marketing, copywriting, and SEO, since 2016. You can connect with Chris on Twitter.