One of the most enjoyable things as an investor is seeing periodic dividend income get deposited into your bank account from the businesses you have invested in. But if you are going to build a dividend stock portfolio, there are 3 types of dividend stocks can ensure your strategy is safe and sustainable.
Some dividend investors prefer DRIP stocks, and some prefer high yield dividend stocks. Others do not care about high dividend yields now and instead use a dividend growth rate investing strategy that focuses entirely on high dividend growth over a long period of time into the future.
All three of these dividend investing strategy concepts can be successful for investors and we will look at each one. We prefer to use all three dividend investing strategies to build a long-term dividend stock portfolio that will stand the test of time.
We have seen far too many investors reach for businesses that pay the highest yields today, without realizing that in many cases those dividends are not safe. Just selecting stocks that pay a high dividend is not an investment strategy, as more research is required to make sure the payment is sustainable for many years into the future.
In fact, often a high dividend yield on a stock is the market signaling that the dividend amount is in jeopardy of being reduced in the future. While you want to scrutinize all businesses before making an investment, you want to pay close attention to any stock yielding above 4% to help assure the safety of the dividend.
Dividend investors have many options to choose from when it comes to selecting companies for their dividend stock portfolio. They can select:
Regardless of whether you choose one or all three of the above-mentioned dividend investing strategies, here are some attributes to look for in businesses as you build your dividend stock portfolio:
Let’s dive deeper into each of the three strategies for investing in dividend paying companies.
The dividend yield on the average S&P index stock is approximately 1.6%. Although there is no hard and fast definition of a “high yield dividend stock”, we would say any business that yields more than 4% would be considered “high yield”.
Real estate investment trusts (REITs) and utility companies are two industries known for high dividend rates, so it is more likely that if you are looking for higher yielding stocks, those are two areas to focus on. But even with these two industries you want to make sure the yields are sustainable based on the payout criteria we’ve described above.
Two high quality companies that we like in this higher yielding space are WP Carey (ticker WPC) and PPL Corporation (ticker PPL).
WPC is a one of the largest REITS, investing mostly in single tenant commercial real estate. They are a high-quality company that operates primarily in the United States, but also have properties in Europe.
WPC is highly diversified by tenant and product type. They pay a dividend that yields approximately 5.9% and is increased regularly.
PPL Corporation is a high-quality utility company operating in the United States and United Kingdom.
PPL Corporation’s current yield is approximately 6%, which is high even for the utility space. They are a well-run company, but there is some uncertainty as a result of them being in the middle of divesting their U.K operations. Once completed they will be a simpler and solely U.S. based operation that should allow for some nice capital gains via price appreciation.
Not everyone needs a high dividend payment from their investment right now, particularly those who are far away from their retirement age.
Those in their 20s and 30s will buy shares in a dividend growth stock that pays a lower dividend now with the idea that over time that dividend will increase as the profits of the company increase. These investors are counting on the appreciation in the share price to drive much of their total return. As the dividend increases quickly, dividend income will drive more of the investor’s total return in the later years.
Two high quality companies with high dividend growth rates are Mastercard (ticker MA) and Microsoft (ticker MSFT).
Mastercard is a powerhouse of a financial technology company focused on processing payment transactions.
Mastercard is quite profitable with a very strong balance sheet. It currently yields just .5%, but this is because of the appreciation of its share price. It has a five year average dividend rate increase of 24%, so it takes its commitment to its shareholders very seriously.
Microsoft is also a very high-quality dividend growth stock.
With a market capitalization of more than $1.5 trillion and more than $90 billion of cash on its balance sheet, Microsoft has rock solid financial statements. It continues to grow nicely with iconic brands like LinkedIn, Xbox and Windows. And more recently its newer Azure division around infrastructure as a service has been turbo charging Microsoft’s growth. There is little doubt they will be able to increase their dividend nicely in the years ahead.
DRIP stocks are any dividend stock where you automatically reinvest the dividends to buy more shares at the then market price. This can be done by the business if you bought the shares directly from them where the DRIP offers automatic reinvestment. Or the reinvestment can be done by your broker if you bought the shares though them.
The key to DRIP stocks is to hold them for long periods of time to let the dividends get reinvested to buy more shares, which leads to higher dividends and so on.
Johnson and Johnson (ticker JNJ) is a great DRIP stock.
Johnson and Johnson makes products like Listerine and Tylenol that you use all the time. They pay a dividend that currently yields 2.6% and is increased like clockwork every year. The dividend is protected by a well-capitalized balance sheet and increasing annual profits.
JNJ is a great DRIP stock because you get a great return from the generous annual dividend and modest increase in share price. Reinvest the dividends to buy more shares, which in return will pay you even more dividends. This is a great way to build wealth, simply.
Summary
There are three ways to build great wealth with dividend stocks. Buying stocks with safe high yields, buying dividend growth stocks and investing in DRIP stocks.
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