This is a guest contribution by Hedge Fund Alpha
For nearly 100 years, dividends have accounted for 40% of total stock market returns, and in some instances, 54% of returns during times of high inflation. That’s what investors have been seeking with dividend stocks in recent years, following high inflation, rising interest rates, and geopolitical tension.
For a list of high-quality dividend stocks, investors should consider the Dividend Aristocrats. The Dividend Aristocrats are a select group of 68 S&P 500 stocks with 25+ years of consecutive dividend increases.
They are the ‘best of the best’ dividend growth stocks. The Dividend Aristocrats have a long history of outperforming the market.
The requirements to be a Dividend Aristocrat are:
- Be in the S&P 500
- Have 25+ consecutive years of dividend increases
- Meet certain minimum size & liquidity requirements
There are currently 68 Dividend Aristocrats. You can download an Excel spreadsheet of all 68 Dividend Aristocrats (with metrics that matter such as dividend yields and price-to-earnings ratios) by clicking the link below:
Investors continue to view dividend stocks generally as safer, and more stable compared to those that don’t provide dividends.
Now, as we approach the end of the year, investors might be on the fence regarding dividend stocks. Analysts at JPMorgan are predicting the S&P 500 will decline approximately 23% to 3,500 points by mid-2024.
Here are five important things investors should know before buying dividend stocks.
Table of Contents
You can instantly jump to any specific section of the article by using the links below:
- #1: Dividend Payouts Can Be Irregular
- #2: Dividend Stocks Are Not Risk-Free
- #3: Technology Stocks Can Pay Dividends
- #4: Non-Cash Dividends
- #5: Dividend Taxation
- Final Thoughts
#1: Dividend Payouts Can Be Irregular
While there is the shared understanding that dividends are commonly paid every quarter, at least in the United States, this is often not the case for all dividend-paying companies. Dividends can be paid at different intervals throughout the year, and largely depend on the company, and where the stocks are being traded.
Some companies can provide a monthly dividend to shareholders, which would allow them to generate substantial income from their investments. Receiving monthly dividends can be useful for investors counting their holdings, and using dividend returns as part of their monthly income.
Generally, companies that distribute a monthly dividend have a legal obligation to pay shareholders a portion of their income each month, and these investments are typically Real Estate Investment Trusts (REITs) or companies in the oil and natural gas sector.
Most well-known contenders that pay monthly distributions include Realty Income (O); LTC Properties (LTC); and Stag Industrial (STAG), among others.
Then there’s the more frequented option, which sees companies paying a quarterly dividend, based on broader quarterly performance. These companies are more frequented by investors looking to initiate a long-term strategy. On top of this, companies that pay quarterly dividends have become the norm on the stock market, providing a steady cash flow for investors quarter-over-quarter.
Some of the companies that provide the highest paying quarterly dividends include AT&T (T); Walgreens Boots Alliance (WBA); and 3M Company (MMM).
Then there is the third cohort which pays investors an annual dividend. Unlike shares that pay monthly or quarterly, investors typically receive their dividends once per year, in some instances this could be twice per year, and hold these stock options for longer.
Most popular companies that provide yearly dividends include Balchem Corporation (BCPC); Logitech International S.A. (LOGI); and Citizens Community Bancorp, Inc. (CZWI), among others. While some of these companies are traded on the U.S. market, a handful are often incorporated elsewhere and often provide investors dividends on an annual basis.
#2: Dividend Stocks Are Not Risk-Free
Often novice investors have a misconception that dividend stocks are risk-free, seeing that shareholders receive a portion of a company’s profits. Although dividend stocks are often lower in risk, especially for companies that have raised their dividends over the years and have continued distributing cash to investors, they’re not completely without any risk.
What investors need to keep in mind is that in some instances one could see a company paying dividends for several years, raising the margin each quarter, only to be hit by a financial downturn or market crash. In some instances, this would make dividends a safer option, but could also mean that companies could lower their dividend payouts as profits begin to sink.
Another thing to keep in mind is that these investments remain equities. This would make dividend stocks subject to frequent decreases, and the bigger risk of companies having to declare insolvent. And while a company may pay dividends now, this is not to say that it will continue doing so in the near future.
Some of the best-known companies that used to pay dividends include Rite Aid Corporation (RAD); Brinker International, Inc. (EAT); Abercrombie & Fitch Co. (ANF), and more recently, AMC Entertainment Holdings, Inc. (AMC).
Performance is a key characteristic to keep in mind. Although these companies experienced strong growth during the early dividend-paying years, slower demand, changing consumer behavior, and market volatility meant that companies had to cease their dividend distributions and redistribute profits toward business operations.
#3: Technology Stocks Can Pay Dividends
For quite some time, technology companies have remained an attractive investment choice, as these companies provide steady growth on the back of innovative technology and wider consumer and commercial demand.
During the second quarter, technology companies accounted for 14.87% of dividends paid on the S&P 500 index.
In a short time, at least from an investor perspective, technology companies have quickly climbed the ranks and now sit as some of the biggest companies globally by market capitalization.
The broader technology sector has remained a steady choice for many investors, mostly as these companies provide upside growth potential, and hold a forward-looking strategy that could help them navigate challenging market and economic conditions.
Although there’s a plethora of tech companies to choose from that do offer investors dividend distributions, investors tend to side with companies that have been around for several years and have continued raising their dividends.
However, it’s wise to remember that while many of these and other companies provide steady income for investors, their growth doesn’t always reflect on their bottom line. While they may experience steady growth, and pay dividends simultaneously, many often are left with a negative cash flow, and increase their quarterly net losses.
#4: Non-Cash Dividends
While companies have continued to embark on paying investors cash dividends, there are occurrences where investors might receive a non-cash dividend. Although this is less frequent today, compared to the earlier years of the stock market, there are times when companies opt to pay investors with additional stocks, or coupons instead of cash.
Take for example, a company might decide to pay investors in additional shares, instead of distributing cash. This would mean that investors would likely end up with more shares of the company, or any other public entity the company might own.
This is typically known as a stock split, meaning that for every portion of stocks an investor holds, they may receive a smaller distribution of shares, such as in the case where a company may offer an additional share or shares based on the amount an investor already owns. This would mean that the more you own, the better off you might be.
In other instances, companies have gone to pay investors in coupons or vouchers which they can use at their businesses or franchises. This is highly unlikely today, and in the past, companies used this special one-off dividend as a way to reward investors either with investor gifts or benefits.
Ultimately, a company will continue paying cash dividends, and would largely be regulated by an overarching dividend policy. Although there are instances where this might change, and investors might end up with less than they bargained for, this is perhaps less frequent today, than in the past.
#5: Dividend Taxation
Although dividends are a great way to increase your earnings, they may still be subject to income taxes, and the IRS recognizes any dividends earned or reinvested in the company that distributed the dividends as taxable income.
The tax on dividends is somewhat complicated, and would largely depend on the type of dividends you received, and how much thereof passed through your hands.
In most instances, a dividend-paying company will need to clarify whether dividends are qualified or non-qualified dividends, this will help to determine the taxes on these securities. In some cases, qualified dividends are subject to a lower tax rate, and can be as low as 0%, however, this would depend on how you are filing your taxes.
The current tax code lays the foundation for how qualified dividends are taxed. If a person’s taxable income is below $44,625 single or married filing separately, or a person is the head of household, with a taxable income below $59,750, or $89,250 if married or filing jointly or qualifying widow/widower, you may be subject to a zero percent tax rate.
Once your taxable income moves above this threshold, all qualified dividends may be subject to a 15% tax rate, and this may increase to 20% if your taxable income surpasses $276,925 if married filing separately, and so forth.
The amount of taxes on qualified dividends will depend largely on how much of your annual income is made up of dividends, and your annual earnings. For example, if your annual income is $175,000, and $20,000 thereof is dividends, then your dividends will be taxed at 15%, while your annual income will be subject to federal tax rates.
The case changes again for non-qualified dividends, and would generally follow the same federal tax guidelines for annual income.
It’s important to review your dividend holdings and to ensure that you are aware of how your dividends will be taxed, and how you will need to declare this income when filing your annual income tax returns.
Dividends are a unique kind of investment that allows investors to generate additional income and grow their portfolios. Typically, investors tend to look towards dividend stocks during times of market volatility, or in the event of high inflation or a recession.
Although dividends can provide substantial financial support for your portfolio, choosing the right options remains one of the most important factors that can influence the long-term outlook of your portfolio.
Knowing which companies provide steady and consistent growth, and align with your broader investment strategy would allow you to leverage dividend stocks for the near and long-term. Most importantly, dividends can help boost your earnings and give your portfolio a significant edge.
All-in-all, ensure that you are making the right choice when looking to purchase dividend stocks and look for companies that have a strong track record for raising their dividend payouts year after year, also known as Dividend Aristocrats.
Keep in mind that at the end of the day, dividend stocks are still equities, meaning that they will be subject to the broader performance of the market and the economy. Although it’s shown that dividend stocks continue to deliver positive returns, even during times of market decline, dividend stocks are not risk-free.
At Sure Dividend, we often advocate for investing in companies with a high probability of increasing their dividends each and every year.
If that strategy appeals to you, it may be useful to browse through the following databases of dividend growth stocks:
- The Dividend Kings List is even more exclusive than the Dividend Aristocrats. It is comprised of 54 stocks with 50+ years of consecutive dividend increases.
- The Blue Chip Stocks List: stocks that qualify as Dividend Achievers, Dividend Aristocrats, and/or Dividend Kings
- The High Dividend Stocks List: stocks that appeal to investors interested in the highest yields of 5% or more.
- The Monthly Dividend Stocks List: stocks that pay dividends every month, for 12 dividend payments per year.
- The Dividend Champions List: stocks that have increased their dividends for 25+ consecutive years.
Note: Not all Dividend Champions are Dividend Aristocrats because Dividend Aristocrats have additional requirements like being in The S&P 500.