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Dividend-paying stocks should be part of the portfolios of investors whose nerves are frayed by stock market volatility and even more adventurous types because they provide a guaranteed source of income.
Corporations pay dividends to shareholders as a way of showing their appreciation for holding their stock. They are usually paid every quarter, though firms also pay special dividends that are usually because of one-time events. The value of these payments is determined by a yield, which is a measure of the dividend in relation to its share price. (For more, see: Dividends: An Introduction.)
No Magnanimity
Don’t be fooled into thinking companies pay shareholders just to be magnanimous. At times, companies pay high dividends as a way to attract Wall Street’s attention because investors would otherwise ignore their stock. Cigarette company Altria Group Inc. (MO) is a case in point. During its most recent quarter, Altria reported net income of $1.39 billion, or 71 cents per share, on revenue of $6.49 billion — little changed from a year earlier. The results are hardly shocking given that tobacco use has been waning for years. In the most recent quarter, shipments of Marlboro cigarettes, its flagship product, fell 2.8%. Ordinarily, investors wouldn’t give a company with lackluster financials and anemic demand for its products a second look. Altria, though, has surged more than 28% this year thanks to its generous dividend.
Altria’s 52 cent-per share payout features a fat (meaning good) yield of 4.22%5. That’s outstanding given that the yield of the S&P 500, the most widely used measure of the strength of the broader market, is about 1.89%, and super-safe 10-year U.S. Treasury bills are paying 2.32%. In Wall Street Vernacular, that makes Altria a good “dividend play.”
Giveth, Taketh Away
But be careful. Corporations that give money to shareholders can also take away. Cliffs Natural Resources Inc. (CLF), a producer of iron ore and metallurgical coal used in steel production, cut its dividend in February by 76% to preserve cash in the face of declining prices. Exelon Corp. (EXC), which owns electric utilities serving Chicago and Philadelphia, slashed its dividend by 41% earlier this year. Many analysts were expecting an even bigger cut.
Companies sometimes pay dividends that they can’t sustain. Windstream Holdings Inc. (WIN), a network communications equipment provider pays a $1 per share in dividends, yielding 10%. Unfortunately, the company’s profits are puny. In the latest quarter, net income was $8 million, or 1 cent per share. That shows that far more money is leaving the company than it’s earning, a red flag that the dividend may not be sustainable. That’s why it pays for investors to be choosy when it comes to dividend stocks. TGT
Dividend Aristocrats
One helpful tool in picking divided stocks is the S&P 500 Dividend Aristocrats index, a list of 51 companies that have increased their payouts to shareholders for each of the past 25 years. Many of the companies are household names such as AT&T Inc. (T), Coca-Cola Co. (KO) and Target Corp. (TGT). The payouts vary somewhat. AT&T offers an outstanding yield topping 5%, while Coca-Cola and Target have payouts of less than 3%. (For more, check out: 10 Dividend Aristocrats.)
For those interesting in going the ETF route in dividend investing, there are many options. The biggest fund is the $20.1 billion Vanguard ProShares S&P 500 Aristocrats ETF (NOBL). It tracks the dividend aristocrats and is up more than 13% this year. Other options include the Vanguard Dividend ETF (VIG), which tracks firms that increase their payouts over time, and the SPDR S&P Dividend ETF (SDY). (For more, see: Invest in Dividend Aristocrats with this ETF.)
The Bottom Line
Dividend stocks should be a part of any well-balanced portfolio. A good place to start are the dividend exchange-traded funds listed above and the S&P 500 Dividend Aristocrats index. (For more, see: Why Dividends Matter and Dividend Facts You May Not Know.)
