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Buying low and selling high isn’t the only way to make money in the stock market. There’s also the more conservative approach of buying stocks that pay you to own them.
Dividend stocks have some great features beyond the income they provide, but they’re not right for every investor. Read on for a closer look at how dividend stocks work, plus popular dividend-stock picks for novice investors.
How dividend stocks work
Businesses typically use their earnings to fund growth initiatives. They might acquire other companies, expand their product lines, or update processes to be more efficient, for example. Those initiatives could lead to more sales, higher profits, or both.
Image source: Getty Images.
Dividend stocks can pursue the same growth opportunities as their growth counterparts, but they also distribute some of their earnings to shareholders as dividends. They pay them to reward current shareholders and attract new ones.
Companies that pay dividends are not always the most exciting investments out there. They tend to be large, mature organizations that achieve slow, steady growth by delivering products and services that people need. Makers and retailers of household goods like toilet paper and cleaning supplies, for example, may not strike you as innovative or fast-growing — but they do have advantages as investments:
You earn two ways. The total return of owning a dividend stock has two components: share-price appreciation and dividend income. Your gain on share-price appreciation will rise and fall until you sell the stock. But your dividend income, once received, is yours to keep.
Income. Cash dividends are like a small prepayment on the value that’s tied up in your stock shares. If a stock doesn’t pay dividends, you must sell it to access its value.
Quality. It takes a well-run company with a predictable business model to pay shareholder dividends for years on end. That’s not typically the kind of company that will experience a dramatic turn for the worse without warning.
Stability. Dividend stocks tend to be resilient in down markets. One reason is that it’s tough to sell a dividend stock that’s generating cash for you when all your other stocks are losing value.
Dividend reliability
No dividend is guaranteed. Any company can cancel or reduce its dividend at any time. So an important consideration in owning a dividend stock is whether the company will continue making payments to shareholders.
To assess the sustainability of a dividend, you can look at things like the payout ratio, the company’s debt level, and cash flow trends. You can also review the company’s history of dividend payments to gage the leadership’s commitment to shareholder payouts.
Many companies have a reputation for paying dividends reliably. Even better, some companies have a reputation for increasing their dividend every year. The ones that keep that trend going long enough can earn special titles — Dividend Achievers, Dividend Aristocrats, or Dividend Kings.
Dividend Achievers have increased their dividend annually for at least 10 years in a row.
Dividend Aristocrats have increased their dividend annually for at least 25 years in a row.
Dividend Kings have increased their dividend annually for at least 50 years in a row.
Once a company achieves one of these milestones, its leadership team is usually motivated to keep the dividend momentum going. If they don’t, investors are likely to respond negatively and drive the stock price down.
For those reasons, Dividend Achievers, Aristocrats, and Kings can be more reliable with their dividends than other companies with shorter track records.
Dividend Kings, Aristocrats for novice investors
Generally, it’s smart to invest in companies you know — that makes it easier for you to understand how your companies are performing and where they’re headed. In that vein, the table below includes five longtime dividend-paying stocks that are also recognized brand names.
Company
Dividend Yield
Status
Payout Ratio
Target
1.55%
King
38.2%
Johnson & Johnson
2.58%
King
52%
Procter & Gamble
2.45%
King
61.5%
Lowe’s
1.55%
Aristocrat
36.1%
Colgate-Palmolive
2.34%
King
58.8%
Table data source: MarketBeat.
For more dividend stock picks, see the full lists of Dividend Aristocrats and Dividend Kings.
Getting paid to invest
Dividend stocks won’t make you rich overnight. What they can do is take some uncertainty out of investing by paying a piece of your returns in cash. That can be a fabulous motivator for you to stay invested, especially when the market is going through a tough spell. And staying invested is one of the most powerful actions you can take to make money in the stock market.
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Catherine Brock owns shares of Johnson & Johnson and Procter & Gamble. The Motley Fool recommends Johnson & Johnson and Lowes. The Motley Fool has a disclosure policy.
