Passive Income: Dividend Stocks
Most people who invest in stocks do so because they’re hoping that the share price will go up resulting in the opportunity to sell them later for a profit. However, as busy nurse practitioner professionals, you may not have the time to invest in knowing which specific companies to buy and when they should be traded exactly.
There is a subset of equities that pairs well with savvy investors who are looking to build passive income streams: dividend stocks. Dividend stocks are basically just regular common stocks that you can buy with any trading app with one key exception – they also pay you a “dividend” or distribution once per quarter.
By far, dividend payments are one of the most truly passive ways to make money! While I encourage people all the time to start a business or invest in rental properties, I’ve got to be honest – those initiatives take a lot of work to make them successful. I’m constantly always at risk of the business not growing or one of my tenants flaking out. However, I never have to worry about my dividend stocks. I can literally just sit back and wait for the payments to roll in without ever having to lift a finger.
Why Do Stocks Pay Dividends?
Dividends are a way for companies to share profits with investors. Typically, when a business has earnings, it can choose to:
- Reinvest that money back into the growth of the company
- Share those earnings with the owners (i.e. the shareholders)
Companies that do #1 exclusively are what are called “growth stocks.” Instead of sharing the money they’ve made with investors, they reallocate it into expansion or developing new product lines. While growth stocks can be a lot of fun while they’re making double-digit returns, they carry far more risk. Plus, since they don’t pay dividends, the only way to capitalize on them is to wait until the stock price goes up and sell your shares – so it’s not exactly passive.
Meanwhile, companies that do #2 or #3 are dividend payers. These stocks share the wealth by rewarding the owners with a yield of anywhere from 1 to 8 percent annually. For example, as of this writing, telecom giant Verizon (VZ) has a dividend yield of 7.67%. Although the dividend is never fully guaranteed, there are many companies that make it a priority to pay distributions to the shareholders – even if they’re not profitable in some quarters.
Other than receiving passive income, there are a lot of good reasons to invest in dividend-paying stocks.
For starters, they usually have good fundamentals. Most dividend-paying stocks are well-known blue-chip companies that are common household names. They also tend to be “value stocks” which tend to be more conservative in their approach to business. Hence, these companies will typically post regular earnings and have strong cash flow to support their operations. Equities like these are much less risky than companies that may not be profitable or take on excessive debt to function.
A good dividend-paying stock will also increase its dividend distribution over time. This is important for the shareholder because it’s a natural hedge against inflation that other assets (such as bonds) don’t offer.
Speaking of bonds, you may wonder how come you wouldn’t just open a CD or invest in bonds with interest rates as high as they are. The truth is that you could. However, because dividend stocks are stocks, they also offer the chance to appreciate in value.
This makes them a very efficient way to accumulate long-term wealth. According to Ned Davis Research and Hartford Funds, it was found that between 1973 and 2021 dividend-paying stocks grew at an average annual rate of 9.6 percent while non-payers averaged 4.8 percent.
One more notable advantage: Qualified dividends are subject to lower tax rates. Just like capital gains, dividends get taxed according to a more favorable marginal tax bracket system than regular income.
What Kinds of Stocks Should I Look For?
There are several characteristics to look for when trying to find good dividend-paying stocks. Start by pulling up the financial stats of any publicly traded company using your favorite stock screener (such as Yahoo Finance). Next, look at the following metrics:
- Dividend yield – The dividend amount divided by the current share price. Typically, the higher this percentage, the more money you’ll make. However, don’t get too caught up chasing after large yields alone. Some lesser-known companies may temporarily inflate their dividend payments just to attract new investors only to cut them shortly after.
- Dividend growth – How much the dividend payments have grown over time. Generally, you’ll want a company with a positive dividend growth trend. A good way to screen for these types of stocks is to look up a group called the Dividend Aristocrats. This is an exclusive list of companies that have increased their dividend payments consistently for at least the past 25 years!
- Positive earnings – Since dividends usually come from the company’s earnings, it will be important to look for businesses that have consistently posted positive earnings. However, keep in mind that a few negative quarters is not necessarily a deal breaker – especially if the economy has been hit hard.
- Low debt to equity – Avoid companies that are taking on too much debt to keep operations afloat.
Lastly, no matter how well a company looks on paper, I personally believe it’s important to only own stocks you believe in. These should be companies you know and trust. I can’t tell you how many times I’ve heard someone take a chance on some no-name stock that was rumored to 10X their money this year only to watch it come crashing down. Do your research and follow your gut.
Passive Income Opportunities
Here’s where dividend stocks become interesting. Instead of worrying about when to sell your shares or attempting to time the market, you don’t have to do this. You leave your principal alone and just sit back. Depending on how much money you have invested, those returns could be pretty juicy. Let’s assume you have a portfolio with a 4% overall yield. That means:
- $100,000 will generate $4,000 per year ($333 per month)
- $500,000 will generate $20,000 per year (1,667 per month)
- $1,000,000 yields $40,000 per year ($3,333 per month)
That’s a much cleaner approach than traditional investment or retirement strategies. With them, you usually have to sell off your shares to produce income – sometimes at a loss. Yet, with a dividend income portfolio, you can literally never sell a share and collect payments into perpetuity. That means no matter what the stock market is doing, you’ll be good.
In fact, there are retirement strategies and books based on using capitalizing off of just dividend yields. With a little bit of planning, you could structure your portfolio so that you’ll receive distributions every month.
Personally, I feel that dividend stocks have a place in most people’s investment portfolios. Getting those sweet distribution payments without having to lift a finger is truly the essence of passive income.