Dividend stocks are an exceptional way to generate a consistent stream of income while building wealth over time. But choosing which dividend stocks to add to your portfolio can be a moving target. There are some blue-chip stocks that investors can hold for a long time if not forever. But other dividend stocks look better at some times than others.
In this article, we’ll provide a brief overview of the benefits of owning dividend stocks and we’ll also provide some advice on how to choose the best sectors to invest in.
Why Should You Buy Dividend Stocks?
Buying shares of a company gives you an ownership stake, no matter how small, in that company. When a company pays a dividend it entitles you, as a shareholder, to a part of the company’s profits.
For example, at the time of this writing, Kimberly Clark (NYSE:KMB) pays a dividend that is equal to $4.64 on an annual basis. That means the stock pays shareholders $1.16 per share every quarter.
$4.64/4 = $1.16
The stock currently trades at $126.94 a share. Therefore, if an investor owns 200 shares of the stock, they would receive $232 as a dividend payment:
$1.16 x 200 = $232
Assuming the dividend was not increased and no more shares were bought or sold, the investor in this example would receive $928 on an annual basis from just a single stock.
Reinvesting Dividends Boosts Total Return
In addition to generating income for investors, dividend stocks can boost a stock’s total return. This is done when investors choose to reinvest the as opposed to receiving the dividend as income. This creates a growth spiral because the reinvested dividends go towards purchasing more shares. This in turn increases the value of those shares if there are capital gains to be made. And when the stock is underperforming, the addition of dividend income can smooth out the downside risk.
Using our previous example reinvesting the dividend would buy approximately 2 more shares of KMB stock:
$232 ÷ $126.94 = 1.82
Then the next quarter, the dividend would be based on 201.82 shares of stock. And if an investor continues to buy additional shares, it’s easy to see how, over time, reinvesting dividends is a way to increase the total return of a stock.
Understanding Stock Sectors
Selecting stock sectors can be as general or as specific as investors want it to be. For example, investors may look to buy energy stocks. But as a category energy stocks not only covers traditional oil and gas stocks, but it also covers renewable energy stocks. These two categories frequently work at cross purposes for investors.
Health care is another broad category that can encompass health care and social assistance, health services, or health technology. All of these carry different risks and benefits.
Using a stock screener can be a useful tool to help you find the stocks that match your specific investment objectives.
How to Choose a Dividend Stock by Sector
There are a few good guidelines to follow when choosing a dividend stock by its sector.
- Compare like with like. This is when it’s helpful to use a screening tool. This can help sort stocks by P/E ratio, market cap, by dividend payout, yield and many other metrics. This helps find stocks that possess similar financial attributes.
- Choose great dividend stocks not great stocks that happen to pay a dividend. Many investors have a portfolio for growth stocks and one for income (dividend) stocks. That doesn’t mean that growth stocks can’t be dividend stocks or that income stocks can’t provide growth. It just means that investors should pay attention to the stock’s primary purpose. For some investors, Apple (NASDAQ:AAPL) qualifies as a great stock that happens to pay a dividend. But it’s not a great dividend stock by any measure.
- Look for companies that are growing their dividends. Having a company that pays a dividend on a regular basis is good. But if they’re increasing the amount of that dividend, that’s even better. Many of the best dividend stocks belong to exclusive groups like the Dividend Aristocrats or Dividend Kings which include companies that have increased their dividend for 25 or 50 consecutive years.
- Have some flexibility to ride the hot hand. Many investors choose to take long positions in dividend stocks (i.e. hold them for at least 12 months). However, a key benefit to investing by sector is that you can choose to take a new position or perhaps increase an existing position depending on which sectors of the economy are the most robust at a given time. This can boost the amount you earn from a divided, but more importantly can allow you to boost your capital gains.
Don’t Overthink It
As you can see, it’s easy to get analysis paralysis when it comes to finding the best dividend stocks by sector. But the reality is that at any given time, it’s tough to say one stock is the absolute best.
The best strategy is to use a similar thought process as you do to pick stocks. That is find a few metrics that you really like and find the dividend stocks that fit those metrics. Second, don’t try to time the market. Good, quality dividend stocks will prove their value over time. And finally, diversify your dividend stocks across many sectors. This will give you a better opportunity to have some stocks that are showing growth even as others are underperforming.