Earn higher yields, more income, with dividend-paying stocks
With such terrible yields on CDs and savings accounts these days, dividend-paying stocks may be the only way you can earn a return on your money.
At a time savers are lucky to find CDs paying a measly 1%, there are many well-regarded companies paying dividends of 3% to 5%.
In fact, more companies in the S&P 500 are paying dividends than at any point since 1999.
With those companies sitting on an estimated $2 trillion in cash, many investment advisers believe we’ll see more of them reinstate or raise their dividends over the next year.
Dividends are the income-generating potential of a company. Think of it much like the interest you earn from a certificate of deposit.
Dividends are typically paid quarterly. So if the stock pays an annual dividend of $2, you'll receive four payments a year of 50 cents for each share you own.
But you'll want to focus on the dividend yield, which is stated as a percentage. The yield gives you a better picture of your expected return on investment.
It is the total amount paid each year in cash dividends divided by the current price of the shares, expressed as a percentage.
While 3.5% might not sound like a lot, it can add up over time, especially when you reinvest the dividends.
Of course, the big drawback is that the money you invest in stock isn't FDIC-insured like it is when you put it in a bank.
The value of your shares can go down, and we don't have to tell you how volatile the equity markets are. For all you know, the market could crash next week, and the value of your stock could fall by 5%.
But you can minimize the risk and anxiety by considering the beta value of the shares before you buy.
It's a common measurement of how volatile a stock is compared to the overall market.
A beta below 1 indicates that a stock's price moves less than the market average, while anything above 1 indicates the stock moves more than the market average.
So look for companies that have a long record of paying substantial dividends and a beta lower than 1.
They're not hard to find. Here are a few of the blue chip stocks in the Dow Jones Industrial Average you might want to consider:
- Verizon, the communications giant, is paying a whopping 4.54% dividend yield and a has beta of 0.51.
- Procter & Gamble, a huge maker of everything from laundry detergent to pet food, offers a dividend yield of 3.33% with the lowest beta of the bunch at 0.43.
- The Coca-Cola Co. pays a more moderate 2.72% dividend with a beta of 0.51.
- Exxon Mobil Corp. is the world's largest oil company with a dividend yield of 2.61% and a beta of 0.52.
Other possible picks include AT&T (with a dividend yield of 4.77%), Merck (3.88%), Pfizer (3.71%), Intel (3.67%) and General Mills (3.4%).
So what about this $2 trillion in cash?
Well, companies typically use cash to reinvest in their business or to reward shareholders.
Apple and Dell recently started paying a dividend. Caterpillar and Target also announced an increase in their dividend.
Moody’s expects a number of health care companies, including Life Technologies Corp. and Celgene Corp., to initiate dividends.
It’s good to be a shareholder before a company makes a dividend announcement.
When companies announce a new dividend or an increase in the dividend, it usually provides a bump in the share price.
Some companies, such as Proctor & Gamble, have been increasing their dividends every year for decades.
Be aware that share price and dividend yields move in opposite directions. So, as share price increases, the dividend yield will decrease.
That’s not such a bad thing because, while your yield may decrease, your shares will be worth more.
Companies can also cut their dividends anytime. Unlike a CD, there is no guarantee of that payment every year.
But solid payers, such as the companies mentioned here, have decades-long records of increasing dividends.
Investing in shares with high dividend yields also provides some protection against falling share prices.
If share price falls, hopefully your dividends will make up some of the difference.
You can add another level of protection against falling share prices by using stop-loss orders.
That's where you tell your broker, or set your computerized trading program, to sell your stock if the price ever falls to a predetermined amount.
Say you buy an attractive stock at $30 per share with a 5.5% dividend. You’re willing to take some risk, but you’re not willing to lose more than 10% of your principal.
Set a stop-loss order at $27, and you can fully protect 90% of your principal and limit your risk to a 10% loss.
Losing 10% hurts, but it's still better than losing 15% or 20%.
Once the stock price is up by a few percentage points, you can increase your stop-loss limit.
Hopefully at some point, you can use stop-loss orders to guarantee a profit rather than minimize losses.
Let's say you bought a great dividend-paying stock at $30 a share last year, and it's now $35 a share.
You're already up 16% in share price alone. There’s no point in risking principal now, especially since you bought with the intention of earning that 5.5% dividend.
So maybe you put in a stop-loss order at $32.50. Even if the stock nosedives one morning, you’ll still make 8% on the deal, plus all the dividends you’ve earned in the meantime.
Don’t set a stop-loss order too high, or it could sell quickly in regular market fluctuations.
If you buy a stock at $30 then immediately set a stop-loss at $29, it could hit that price by the end of the day. There would be no point in buying the stock in that case.
You don’t necessarily have to lock up your money for decades, but you should expect to hold onto these shares for a few years.
There is no such thing as a “risk-free” stock investment, but the companies above have a history of being more stable than most other stocks.
You can also potentially grow your earnings further by reinvesting the dividends. That’s when your dividend payments are automatically used to purchase more shares.
Because those new shares also earn dividends, you can get compound growth on your stock, just as you would with interest on a CD.
With the Federal Reserve determined to keep interest rates at record lows until at least late 2014, it will be years before CDs or money market accounts pay reasonable returns again.
If you take the plunge, we suspect you'll be thrilled to hold on to those dividend-paying shares — and to keep collecting your quarterly checks — for the foreseeable future.