An Overview of Dividend Stocks and DRIPs

One of the ways that you can improve your investment portfolio is to include dividend stocks.

For some investors, dividend stocks make sense because they offer a degree of stability, as well as offer the opportunity to cultivate another source of income.

As you put together an investing plan, consider the possibility of including dividend paying stocks.

What are Dividend Stocks?

A dividend paying stock is one that periodically pays shareholders out of profits from the company. Many companies keep a portion of the profits aside, meant to distribute amongst shareholders. Your portion depends on how many shares you own.

If a company pays a dividend of $0.15 a share every quarter, then you would end up with $15 extra each quarter if you owned 100 shares of the company. That adds up to $60 a year. Some people spend a decade or so building up portfolios comprised of dividend stocks. After a time, the dividends offer another income stream that can be reasonably relied on.

It is important to note that companies can raise or cut dividends as they wish. An announcement usually precedes a cut or an increase, though. Companies that have raised dividends each year for more than 25 years.

Some of these dividend increases might be small, and the current dividend might not be great, but these are companies that can be reasonably (but not completely) counted on to provide stable dividends. This is true even during recessions and stock market downturns.

DRIPs

Instead of deciding to take a cash payout from your dividend stocks, it is possible to have the automatically reinvested, using what is known as a dividend reinvestment plan (DRIP). Instead of sending you a check each period, your dividend payout is used to automatically purchase more shares of the stock.

This is like getting additional shares for free. When you use dividend stocks in a long-term portfolio, or in a retirement account, DRIPs can be very helpful. You end up with more shares, so when you do decide to sell the stock, there is a chance that you will get even more for it — especially if it has done well.

Choosing Dividend Paying Stocks

There are some different criteria you can use as you choose dividend paying stocks. Some items to consider include:

• Dividend Yield: This is the amount the company pays out each year, as it relates to the share price. Many investors like to see a high dividend yield, but this can actually be deceiving. Sometimes a yield is high because the share price suddenly dropped, or because a company is trying to attract investors to help it get out of a financial spot. If you are looking for a stable dividend stock with reasonable returns, some recommend that you look for those with yields of between 3% and 6%.
• Dividend Growth: Consider the history of dividend growth from the company. Look at whether the company consistently raises dividends, or whether or not the company has been cutting dividends recently. A company with regular (although modest) dividend increases might be more attractive that a company with a choppy history.
• Company Fundamentals: It can also help to look at the fundamentals of the company. Management, cash flow, industry growth and market share can all be indications of whether or not the company will be able to maintain dividend payments over time.

Consider your investing goals, and whether or not investing in dividend stocks would help you meet them.