Are you looking to maximize your dividend income? If so, good thinking. On the surface, one dividend payer may look as good as another, but if you dig deeper, you’ll find these names are not all the same. Picking the right ones and steering clear of the wrong ones can make a difference of thousands of dollars per year.
Here’s a closer look at three easy things any income-minded investor should do when hunting for new dividend-paying names to add to a portfolio.
1. Worry more about dividend growth and less about the yield
Don’t read too much into the message. Stepping in while yields are strong starts your position out at a distinct advantage. But there’s more to successful income investing than the present payout rate. Even more important, particularly if you intend to hold a dividend stock for years on end, is how well that company increases a dividend.
Take utility stock PPL (NYSE: PPL) as an example. It’s currently dishing out 5.7% of its stock price as annual dividend payments, which is one of the top yields among all major utility names at this time. Not bad.
But while its dividend grows reliably, it also grows minimally. The current quarterly payout of $0.415 per share is only 10% better than the $0.3775 per share from just five years back, translating into average annual growth of only around 1%. That doesn’t make it a bad company or a bad dividend stock. It’s just not exactly the sort of holding well suited to become a core income-producing asset. It’s not even keeping up with inflation.
In contrast, Texas Instruments (NASDAQ: TXN) boasts just a modest yield of under 2.2% right now. However, its current annualized payout of $4.08 per share is 150% better than the dividend payment from five years ago, and more than 600% higher than TI was serving up a decade back. Its strong pace of dividend growth — or just revenue growth — may or may not be sustainable for Texas Instruments, but that’s not the point. The point is, look beyond just what you can get today.
2. Stick with the pedigreed names
It’s forgivable that some companies curbed or canceled their dividend payments when the COVID-19 contagion was new. Even before the pandemic took root in the United States, some companies, including Ford Motor and Boeing, opted to suspend their dividends, already affected by what was happening overseas. More blue chips would follow suit as the potential fallout from the pandemic became clearer.
It would also be naive, however, to ignore the fact that some companies are more motivated than others to maintain dividend payments and payout growth just to retain their Dividend Aristocrat status, even to the point of making bad financial moves just to keep the growth going.
Dividend Aristocrats are companies that have paid a quarterly dividend and increased their payout annually for at least 25 straight years. And it’s an elite club. Only 65 of the companies in the S&P 500 qualify as Dividend Aristocrats. Though there’s nothing that requires a company to remain a Dividend Aristocrat, it’s the sort of accolade that helps keep a stock well-valued among a certain segment of investors.
3. Focus on businesses built to generate recurring revenue
Finally, some companies are better suited than others to maintain their payouts.
Recurring revenue is the key. Think utility names such as Consolidated Edison or consumer-goods names such as Procter & Gamble, both of which are Dividend Aristocrats. You pay your electric bill every month because you want to keep the lights on, and you buy laundry and dishwashing detergent over and over because … well, hygiene. So do other consumers.
But don’t be afraid to think outside the box a little. Microsoft (NASDAQ: MSFT) isn’t often a name that income-seeking investors consider. But maybe it should be. The yield of less than 1% is anything but thrilling, though the tech giant is in the midst of a sea change in how software is procured. One-time sales of CD- and DVD-based programs are being replaced by cloud-based access to programs such as Word and Excel, which are effectively rented out on a monthly or yearly basis. The same goes for Azure, Microsoft’s user interface for companies managing a cloud-computing platform. The company is even driving recurring revenue with its video gaming business, with a subscription-based product that offers ongoing access to a suite of games playable on the cloud.
This isn’t to suggest subscriptions and recurring revenue are outright required of worthy dividend stocks. One need only look at what happened to the dividends at Ford and Boeing, however, to appreciate the dividend risk linked to cyclical businesses.
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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. James Brumley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft and Texas Instruments. The Motley Fool has a disclosure policy.