Dividend stocks, part 3

First, let’s talk about dividend yields. The yield is simply the annual dividend payment divided by the stock’s current price. For example, if a stock is priced at $50 and pays an annual dividend of $2, the annual yield is 2 divided by 50, or 4%. You can see that if a stock’s price declines and the dividend stays the same, the yield rises. In the same way, if the stock’s price rises and the dividend remains the same, the yield falls.

Pros of high yields

Attractive income

High yields can mean more income. This can be especially appealing during retirement.

Potential bargain

Sometimes high yields indicate that a stock is undervalued, presenting a potential buying opportunity.

Cons of high yields

Risk of dividend cuts

A yield that’s significantly higher than average might be a red flag — it could indicate that the dividend isn’t sustainable and may be cut in the future. This will obviously decrease the yield and could also cause the stock price to decline. It may also mean that the stock price has already declined.

While a high yield can be tempting, it’s essential to dig deeper. Look at the stock’s price history and its forecasted outlook. Another important metric is the company’s payout ratio, which is the percentage of earnings paid out as dividends. A high ratio might indicate that the company is paying out more than it should, putting the dividend at risk.

Slower growth

Companies that pay high dividends may reinvest less back into the business, potentially leading to slower growth.

You can get dividend exposure from individual stocks, ETFs or mutual funds. Each strategy has its merits — your choice will depend on your goals and risk tolerance.

Dividend stocks

Pros

• Control – You have full control over your investments. You can choose companies that you believe in and understand.
• Potential for higher returns – If you pick the right stocks, you might achieve a higher return as compared to a fund.

Cons

• Research required – Choosing individual stocks requires a lot of research and ongoing monitoring. You need to stay on top of each company’s performance and any news that might affect its stock price.
• Higher risk – Investing in individual stocks is generally riskier than a diversified fund. If one company struggles, your portfolio can take a significant hit.

Dividend ETFs and dividend mutual funds

Pros

• Diversification – Most ETFs and mutual funds spread your investment across many companies, reducing the impact of any one stock performing poorly.
• Convenience – They’re easy to invest in and require less ongoing research compared to managing a portfolio of individual stocks.

Cons

• Fees – ETFs and mutual funds come with management fees, which can eat into your returns.
• Less control – You don’t get to choose the individual stocks within the fund, which means less control over your investment choices.

Company fundamentals

When choosing individual dividend stocks, look at the company’s fundamentals. This includes its financial health, earnings growth and industry position. A company with strong fundamentals is more likely to sustain and grow its dividends.

Dividend history

A company with a long history of paying and increasing dividends is often a safer choice. It indicates that the company has a stable earnings stream and a commitment to returning value to its shareholders. You might consider companies that are part of the “Dividend Aristocrats” — companies that have increased their dividends for 25 consecutive years or more.

Economic conditions

Consider the broader economic conditions. In a low-interest rate environment, dividend stocks can be more attractive because they offer better returns compared to bonds and savings accounts. Conversely, if interest rates are rising, dividend stocks and funds might lose some appeal as fixed-income investments become more competitive.

Tax considerations

In Canada, dividends from qualified Canadian companies benefit from a dividend tax credit, which can make them more tax-efficient compared to some other forms of income. However, dividends from foreign companies are taxed as regular income, which might reduce their attractiveness. Always consider the tax implications of your investments.

Dividend Reinvestment Plans (DRIPs)

At Investor’s Edge, you can set up your account with Dividend Reinvestment Plans that allow you to reinvest your dividends to buy more shares. This can help your investment grow over time without you having to actively buy more shares. It’s an efficient way to compound your returns, especially if you’re in it for the long haul.

Sector and geographic diversification

Don’t put all your eggs in one basket. Diversify your dividend stocks across different sectors — like technology, healthcare, consumer goods — and geographies. This helps spread risk and can protect your portfolio from sector- and country-specific downturns.

• Adding dividend stocks to your portfolio can be a great way to generate steady income and potential growth. But like any investment decision, it’s important to weigh the pros and cons. Consider the yield, but don’t get lured by high numbers. It’s important to consider whether the company can maintain the dividend yield, especially if it’s already high compared to similar companies in its industry.
• Decide whether you prefer the control of picking individual stocks or the convenience and diversification of ETFs and mutual funds.
• Look at the company’s fundamentals and dividend history, keep an eye on the economic environment, and don’t forget about taxes and diversification. By doing your homework and making informed choices, you can build a dividend stock strategy that aligns with your financial goals and risk tolerance.