Upbeat music plays throughout.
Narrator:
No matter what stage of life you're in, dividend stocks can supplement your income or help grow your portfolio. Some investors make the mistake of chasing stocks with the biggest dividends, but you should arm yourself with more information about a company before buying. So, what should an investor look for? Let's take a look at a few commonly used metrics.
For many investors, the most important factor for a dividend stock is the return they're getting. That's called dividend yield, and it's a ratio calculated by dividing the annual dividend payment by the price of the company's stock. It's represented as a percentage and can give a sense of how dividend stocks stack up against each other.
Take two hypothetical companies that both pay $1 per share. Company A's share price is $30, which is a 3.3% yield. Company B's share price is $20, a 5% yield. Five percent makes Company B look like the better investment, right? Not necessarily.
Dividend yield can be misleading because it's based on the stock's price, which can move based on many factors. Investors can get caught up chasing a higher dividend yield, but it shouldn't be the only factor in deciding if a stock is worth your investment.
There's a reason that Company B's share price is at $20: It recently traded down from $30 after a negative earnings report. That would make its dividend yield look better, even though the company's not doing as well. Meanwhile, Company A's share price stayed steady after it delivered solid earnings.
While a stable dividend yield is valuable, remember that there isn't a number that's good or bad without context. Investors should understand what's driving the yield and focus on established companies with a history of both consistent earnings and growing dividends.
One approach investors sometimes take when screening stocks based on dividend yield is to compare the yield of a stock they're considering to a benchmark index. One example benchmark is the average dividend yield of stocks in the S&P 500®, which in 2023 was 1.5%.
Finding stocks that have a history of paying dividends over the long term can also be valuable. One way of trying to gauge that is by researching a stock's payout ratio, which tells you the percentage of earnings that go towards the dividend.
Higher payout ratios are typically a cause for concern. Paying too much towards dividends can limit a company's ability to grow. Companies exhibiting a low ratio of dividends to earnings suggests they're retaining some earnings, making it less likely they'll reduce dividends in the future. A healthy range might be percentages between 20 and 60.
Next, many investors seek dividend stocks that have a track record of increasing the dividend over time. You can find that information through the company's dividend growth rate, typically shown over three years, five years, and 10 years. Companies that increase their dividends at regular intervals—say, once per year—tend to outperform their peers over time. A range you might consider is between 5% and 20%.
Outside of dividend related information, investors can examine a company's overall financial strength and whether the stock is trading at a fair price.
After all, it's probably a good idea to know whether a company you're investing in is making money or not. The company's cash flow per share can answer that question. It's a ratio that shows how good a company is at generating after-tax earnings for every common share of stock, a useful metric when you're comparing stocks with widely different prices. It's okay for this number to be high but look beyond a single month or quarter to try to ensure it's consistent instead of an outlier.
Next, knowing how much debt a company has is almost as important. The debt-to-equity, or D/E ratio can show what a company owes relative to what it owns. It's calculated by dividing total debt by total shareholders' equity, or the amount of money that would be left to shareholders if the company liquidated.
Lower debt-to-equity ratios are better because debt burdens can eat into future earnings. However, they can vary depending on the industry. For example, big industrial energy and mining companies tend to carry more debt than other industries. That's why investors typically compare debt level of companies in the same industry.
Finally, it's helpful to know whether or not you'd be getting good value by investing in a company. The price-to-earnings, or P/E ratio tells you how much you're paying for each dollar of earnings. To get it, divide the price of a share by the company's earnings per share.
Low or high P/E ratios aren't inherently good or bad. When a P/E ratio is low, it could mean that investors are losing confidence, selling shares and driving the price down—while earnings hold steady.
If nothing has changed with a company's earnings but investors are buying the stock for another reason, it'd drive the share price and the P/E ratio up. Of course, that high P/E may be justified if the company is poised for growth.
The P/E range most investors look for is between 20 and 30 but you can consider looking at companies beyond that range, especially if other criteria are met.
You can search for stocks based on criteria like these using Schwab's Stock Screener. You'll find it by logging into Schwab.com, selecting Research, then Stocks, and then Stock Screener. Type the metric you'd like to review in the search bar or scan the lists for other ideas.
If you've already got a stock in mind, or you'd like to check on one you've previously invested in, you also can find similar metrics for an individual stock on Schwab.com.
Stocks aren't the only way to get the benefits of dividends; dividend-focused ETFs or mutual funds can offer some dividend benefits. Some of them conduct the analysis we've discussed for you, though they are typically subject to management expenses and other fees. Also, there's no guarantee those funds will continue generating dividends because stocks held by the funds may discontinue their dividend payments.
Dividend stocks can potentially benefit your portfolio by providing a stream of income and increasing your portfolio's growth potential. To help maximize those benefits, make sure you look beyond dividend yield for companies with good fundamentals and consistent, growing dividend payments. Keep in mind that dividend payments are not guaranteed. A company may choose to reduce or stop paying dividends altogether.
For more investing education, subscribe to our YouTube channel and check out schwab.com/learn.
On-screen text: [Schwab logo] Own your tomorrow®
