Since the market meltdown earlier this year, U.S. stocks have rallied hard and they have rallied fast. From March 23 lows, the Dow, S&P 500, and Nasdaq are up about 36.5%, 35.4%, and 38.3%.
It’s a stunning surge, and indicates how much investors anticipate a fast recovery once the coronavirus pandemic ends. The Fed has pumped trillions of dollars into the economic rescue effort, and bets are being placed that this will help outweigh weak corporate earnings.
But Wall Street’s quick turnaround fails to reflect the current dismal labor market (as well as other key economic factors). Another 2.1 million Americans filed for unemployment benefits last week, and initial claims have now topped 40 million since early March.
While we can’t predict what the market will do tomorrow, we can try our best to hedge against broader economic risks by investing in quality dividend-paying stocks.
But how do you find them?
Smarter Dividend Investing
There’s no perfect equation for stock picking. If there was, we’d all be living our best lives somewhere in a tropical paradise. So what we can do instead is rely on a few things: growth fundamentals, future (and past) performance, valuation, and a dash of gut feeling.
With dividend investing, goals will be a bit different compared to other strategies. Income investors are in it for the long haul, and are buying and holding stocks to receive those coveted quarterly payouts. Because who doesn’t love a little bit of extra cash, am I right?
Building a diverse, growing dividend portfolio, however, takes a little bit of savvy.
First, you should pinpoint what, exactly, you’re investing for. Is it for retirement, long-term savings, starting a new business, or general wealth building? Having a goal for your money will make you more attuned to your investments.
Once you have that locked down, you can start filtering for top performing dividend stocks.
Typically, you’ll find that mature, profitable companies are the ones shelling out stable dividends; these businesses—think utilities, telecoms, consumer staples, insurance companies—have hit a certain point in their growth cycle where they’re unable to grow at the rate they once did. Because of this, companies in these sectors are able to distribute their profits as dividends.
Sometimes, you’ll even be able to discover a dividend-paying stock in a flashier sector. Take Microsoft (MSFT), for example. The software giant began paying a dividend in 2004. At that point, the tech company was in a period of stagnation where it didn’t need to reinvest its earnings to fuel high growth. Now, of course, Microsoft is one of the sector’s leading cloud and software players, and pays a dividend with a yield of 1.12%.
As for fundamentals, there are key metrics that income investors should pay attention to.
The dividend yield is something that many investors, not just income, look at, since it tells you how much income you will receive relative to the price of the stock. While a high dividend yield will provide a good source of income, it could also signal that the stock may not make a good investment; the company’s financial health and future growth is likely in question if it’s paying an ultra-high yield.
Dividend investors should also look at what’s known as the “payout ratio.”
This ratio, which is the percentage of profits that a company spends on dividends, is going to tell you if a company is paying out too much of its profits on dividends. Generally, you should probably look at dividend paying stocks that pay out no more than 60% of their earnings, though if you are interested in investing in REITs, you’ll find their payout ratios to be at least 90%, as this is required.
What about growth?
Looking at a company’s annualized dividend growth rate, as well as its average annual dividend increase over a five-year period, will help show you how much a company is growing its dividend over time. Plus, future dividend growth will depend on earnings growth, so your stock picks will need to have strong year-over-year earnings growth rates, too.
You can also check out the list of companies known as the Dividend Aristocrats for portfolio inspiration. These companies have a strong history of profit growth, and have increased their dividends for at least 25 consecutive years.
When looking for dividend stocks, always remember this: companies aren’t obligated to pay dividends, and if a company cuts its dividend, that’s when you know there’s trouble on the horizon.
2 Dividend Stocks to Consider
With all of this in mind, let’s take a look at some dividend stocks that could make good “buy-and-hold” additions to your portfolio.
Seagate Technology (STX)
Seagate is a digital memory stock that designs, manufactures, and markets a range of rigid disc drive products that are used in mainframes, workstations, and enterprise-level servers.
It recently reported strong third-quarter results, and earnings and revenue jumped 77% and 18% year-over-year. Seagate’s strong HDD product lineup has helped keep net income, profit margins, and free cash flow on the rise for awhile now, and demand should remain strong as more and more people work remotely.
STX has a yield of around 5%, with a payout ratio of 58%. The stock is a #2 (Buy) on the Zacks Rank. Shares are cheap, trading at 11.6X trailing 12-month earnings compared to the broader Computer and Technology sector (roughly 25X). Plus, STX offers a much more enticing yield than what the S&P 500 Index would provide you.
Procter & Gamble (PG)
The consumer staples giant, Procter & Gamble is known for its large portfolio of household brands like Tide, Bounty, Dawn, Gillette, Crest, Charmin, Pampers, and many, many others.
For Q3, sales grew 5% year-over-year, with organic sales up 6% and gross margin rising to 49.4% compared to the prior year period. The company has begun to focus on maximizing its profitability, slimming down its portfolio to concentrate on its biggest money-makers. Management remains optimistic as well, despite any lingering uncertainty from the pandemic.
PG has paid a dividend for 130 years, and just announced a 6% increase back in April. Its dividend yields about 2.7%, with a payout ratio of just under 60%. The stock currently sits at a #3 (Hold) on the Zacks Rank. Shares trade at 23X trailing 12-month earnings compared to the S&P 500 (19.5X).
Disclosure: I own MSFT in the Income Investor portfolio. Follow me there for the latest economic updates and buy-and-hold-strategies.
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