There are more than 1000 publicly listed companies that trade on the New York Stock Exchange, the Nasdaq and the American Stock Exchange that pay dividends. In fact, the list of dividend-paying stocks is so large and diverse that your biggest challenge is going to be choosing the best for your portfolio. Fortunately, dividend stocks can be categorized to narrow the field of options for your own investment needs. The groups are not exclusive, so some companies may be in multiple categories.
Dividend Growth Stocks
Companies that have consistently increased their dividend payment have not only outperformed the general market, but they often do so with less risk. That is why many investors look specifically for companies with strong cash flow and a commitment to returning cash to shareholders.
Dividend Aristocrats is a term often used for a group of stocks that have consistently increased their dividend payment per share over a certain period. The most well-known is the S&P 500 Dividend Aristocrats, composed of the largest U.S. firms that have increased their dividend every year for at least 25 years. To March 2014, the S&P 500 Dividend Aristocrats posted an annual return of 10.3% over the last ten years compared to a return of 7.4% for all the companies in the S&P 500 over the period.
Because of the requirement for consistently increasing dividends over a long period, the group tends to be over-weighted to a few sectors of the economy. Shares of consumer staples companies make up nearly 25% while shares of technology companies make up less than 2% of the index. Based on current trends those numbers could change over the next 10-15 years. Whether you invest in a fund replicating the Aristocrats or just use the index as a source for potential investments, the list is a good place to start when trying to find strong dividend-paying companies.
More Information Here: Dividend Growth Stocks List
Some stocks pay dividend yields so high that it seems like an easy decision. Unfortunately, like that notorious offer you can’t refuse, you are better avoiding some of these stocks. There are two issues you need to be aware of when searching for high-yield dividend stocks.
First, is the high dividend yield simply a function of poor price performance? If the shares pay an annual $0.25 per share dividend and have a price of $15 per share, the dividend yield is just under two percent. Now if the price of the shares plummets to just $2.50 per share, the dividend yield vaults to 10%. Of the 181 stocks trading on the NYSE with dividend yields over 8%, nearly half (81) have seen their stock price fall by more than 8% over the past year with the top ten posting losses of more than 20%. A dramatic price drop is usually a sign of tough times for a company and the dividend may have to be cut to protect the business.
Another reason you need to be cautious of high-yielding stocks is that many of these companies keep little back for growth. They pay out nearly all their cash as dividends and must constantly raise money for new projects. Dividend payments from these stocks are usually extremely inconsistent with very high payments in some quarters and low payments in others. That high yield you think you are getting may not be so high in the near future.
Despite the risks, some companies do a very good job of paying a high dividend yield and still protecting future growth. We will discuss more about how to select stocks in the next section. For now, just remember that the stock market is like anything else. If it looks too good to be true, it probably is.
More Information: High Yield Stocks List
Shares of utility companies are popular with dividend investors because of their consistent payments and low risk in the business model. Utilities are a special type of company, with a sort of protected status. They trade the ability to increase rates as high as the market will bear for the protection of being one of the few suppliers. This also makes them one of the most predictable returns in the market.
Within the group, investors generally categorize companies by the service provided (electric, water and natural gas) or by whether the company is regulated by a local municipality or not. Each category will mean different risks and rewards. Unregulated providers may be able to raise rates more quickly but will probably not enjoy monopoly protection from competitors. The different service providers may be at risk to prices or shortages for their respective commodity.
One risk to utility companies that you will want to watch out for is increasing interest rates. Since the power of the company to raise rates is often limited, their cash flow and dividends are relatively fixed compared to other stocks. This means that the investment may behave more like a bond than a stock and the share price may fall when interest rates rise. The drop is usually not too bad with a gradual rise in rates and the safety and yield in these companies is still pretty enticing.
Companies providing staple goods, or things that are seen as necessity products, are also a common favorite for dividend investors. Like utilities, these companies are typically in very mature industries with stable sales and cash flows. Since sales are so consistent and opportunities for growth are relatively fewer, these companies can afford to pay out more cash as dividends.
Consumer staples may also be referred to as consumer non-cyclical because their products are not generally prone to the rise and fall of the business cycle. Within the group, you find industries like: Beverages (both alcoholic and non-alcoholic), food processors, personal & household products, and tobacco. While you may not agree that alcohol or tobacco products are necessities, those that buy the products generally buy a consistent amount through good times and bad and the companies’ sales are relatively consistent.
New Breed of Technology Dividend-Payers
Just twenty years ago, no one would expect a technology company to pay a dividend on its common shares. The tech bubble was just inflating and companies like Oracle (ORCL) and Intel (INTC) needed every penny to pay for their tremendous growth. Talking about how a new era has begun just makes me feel old but there is a growing list of tech giants that are paying strong and sustainable dividends.
Slowing opportunities in growth projects and a huge stockpile of cash has driven some of the bellwether technology names to issue dividends over the last few years. Microsoft (MSFT) started paying out cash in 2003 and Intel offers a yield stronger than many of the consumer staple companies. While growth might have slowed for these companies in developed markets, many still have longer to run on emerging market convergence. Economies of scale mean they can acquire new startups to help drive sales growth as well.
Of course, dividend payments are still the exception rather than the norm among tech companies. Of the approximate 1,800 technology companies listed on the U.S. exchanges, only 219 pay a dividend and only 105 offer a yield of 2% or higher. The addition of dividends means a strong complement to shareholder returns and a great way to diversify your portfolio from the traditional dividend-paying sectors.
Dividend Exchange Traded Funds
Mutual Funds have been around for nearly two centuries but their publicly-traded counterpart, the Exchange Traded Fund (ETF), is still a relatively new concept for some investors. ETFs are basically mutual funds that can be bought and sold like a regular stock. The funds hold a collection of investments, usually stocks in other companies, and sell their own share ownership. ETFs have a defined investment mandate that guides the kinds of investments they hold and can offer a way for investors to buy a diversified basket of stocks with one purchase.
There are more than 40 funds with a defined dividend strategy and hundreds of others that pay dividends. Most dividend-focused funds pay between 2% and 5% but there are also those with higher yields. One of the most attractive benefits of dividend investing through ETFs is that it opens your portfolio to assets and stocks in which you might not otherwise have access like bonds and foreign companies.
Investing in ETFs can be similar to investing in stocks but there are also some important differences that you need to watch. First, while fees are normally lower than investing in mutual funds, you will be charged a percentage of assets every year. The fee is fairly small for most funds but can be high for some actively-managed funds. You may also be concentrating your portfolio and do not even know it by combining some funds with the rest of your stocks. Since most funds invest along a specific idea or mandate, often their holdings will not be well-diversified across sectors or industries. Combine a portfolio of high growth stocks with a biotechnology ETF and you could be getting a lot of the same stocks.
Monthly dividend stocks
What is better than getting your dividend checks every quarter? Getting your dividend checks every month!
A few companies, mostly finance and REITs, pay dividends on a monthly basis. The fact that payments go out twelve times a year instead of four does not necessarily mean the yield will be higher but getting frequent payments may help to smooth out your income if you rely on your investments for extra cash.
The list of funds that pay dividends monthly is fairly extensive and might be a good place to start for those looking for monthly payments.
More information: List Of Monthly Dividend Stocks
Real Estate Investment Trusts (REITs)
As for real generational wealth, there are few assets that have made more people rich than real estate. A survey by Fidelity notes real estate as the top source of generational wealth and more than three-quarters (77%) of millionaires own property. Not only does ownership provide long-term returns through appreciation and rents but also an attractive tax shield from the deduction of depreciation.
Until the 1960s, this asset class was largely the domain of the rich with pockets deep enough to diversify themselves across different property types and different regions. Then President Eisenhower signed the REIT Act into law and a new world of investment was opened to people like you and me.
REITs hold and manage real estate property and issue shares on the stock exchanges. If the firm passes at least 90% of profits to investors it does not have to pay corporate income taxes so it is an extremely tax-efficient way to manage assets. Without the millions to diversify across different property types and geographic locations, REITs are the best way for retail investors to get access to the market.
And besides the benefit of diversification into another asset class, REITs have provided great returns over the long-term. The National Association of Real Estate Investment Trusts (NAREIT) monitors sector returns and shows that its index of equity REITs has outperformed the S&P 500, the Russell 2000 and the Barclays Aggregate Bond index in the 10-, 20- and 30-year time horizon. In fact, over the forty years to 2010, the NAREIT index has provided annualized income returns of 8.3% and an annualized price return of 5.5%.
As with other fund investments, a REIT usually follows a mandate as to the types of property it holds. Investments are usually built around a property-type or a geographic location. Different property types offer different investment characteristics due to different supply and demand throughout the economic cycle. There are primarily four commercial property types: office, retail, industrial and multi-family. Combine these types with a vast array of geographic mandates and you can start to see the opportunity to invest in real estate in almost any market.
In a recent twist, not all REITs necessarily operate real estate. Though the IRS may change the rules in the future, there are a handful of companies that have been granted REIT-status for tax purposes but in industries like: data-storage, cell phone towers and mortgage notes. Most REITs pay a dividend yield between 3% and 5% though some that invest in mortgages offer much higher yields at higher levels of risk.
Like ETFs, REITs trade like regular stocks but there are a few differences that you need to remember. Since real estate is a depreciable asset, there is often a huge expense on the income statement for REITs. This reduces earnings per share but unlike machinery, most real estate actually increases in value with age, so the earnings reported by the company may not be a good measure of the stock’s value. To measure REITs, investors use Funds from Operations (FFO) which adds back depreciation and deducts other property-related sales. FFO for REITs is used like earnings to measure how expensive or cheap the stock is compared to peers and history, i.e. price-to-FFO.
REITs are more heavily exposed to rising interest rates than other stocks for several reasons. Because rent increases may be fixed for long contract periods, the cash flow from REITs is much more like a bond investment. When interest rates increase, the value of bonds decrease because the fixed coupon payment is less attractive against higher-yielding investments.
REITs may also be exposed to rising rates because of high financing costs needed to run the companies. Since they pay out almost all of their income every year, REITs finance growth through loans or by issuing shares. When the cost of debt increases as rates rise then the companies might issue shares instead and current shareholders could see their ownership diluted.
While REIT weakness when rates rise might be true in theory, history has shown that it is really only a problem when interest rates increase quickly over a limited period. Generally, the companies are able to manage their rate exposure and still provide solid returns to investors.
More Information: REIT List
Master Limited Partnerships (MLPs)
Master Limited Partnerships are another unique structure of business to take advantage of taxes on certain investments. Companies that own certain assets, primarily oil and gas transportation and storage infrastructure, are allowed to pass on their expenses and profits to owners without paying corporate income taxes. The opportunity to avoid double taxation, at the corporate and individual level for other companies, is a huge advantage and many oil & gas conglomerates spin off their infrastructure assets and pay a transaction fee to the partnership for pipeline or storage needs.
There are two types of MLP owners, the general partner and the limited partner. The general partner operates the company and usually owns some of the limited partner shares as well. The limited partner issues shares that trade like regular stock and pays a distribution from cash flow. Since fees are based primarily on the volume of energy products through pipelines or in storage, the partnership’s cash flow is not as exposed to commodity prices as with other energy companies. Owners of shares in the limited partnership are technically called “unitholders” instead of stockholders.
Previously, the pipelines and storage were seen as relatively mature industries and growth was relatively weak. With the boom in U.S. energy production, these companies have seen a huge rise in demand for traffic along their infrastructure and have ramped up capital spending to increase the size of their network.
MLPs tend to offer higher yields than REITs or other dividend stocks, usually around a range of between 5% and 7% a year. As with all dividend investments, it is important to watch the yield and the company’s ability to sustain a higher dividend payment. A special metric is used for MLPs called Distributable Cash Flow (DCF) and is similar to FFO for REIT investments. DCF is the companies operating earnings (EBITDA) with capital expenditures added back to arrive at a measure of the cash available to pay out distributions.
The coverage ratio is just the DCF divided by the current distribution and is a strong tool to measure how well the partnership can sustain or grow distributions, i.e. if the partnership is paying out more than its DCF (a coverage ratio above 1.0) then cash flow will need to be increased or the distribution cut.
As with REIT investments, MLPs pay out a lot of their income as distributions so they may issue shares or debt to fund future growth. Shares issuance will dilute current investors while too much debt means higher rates and less distributable cash flow after interest expense.
Beyond the tax-advantaged status at the corporate level, individual investors receive a tax break as well. Many distributions are not classified as income, but as a return of capital. The distributions reduce the cost basis in the investment and are not taxable until the asset is sold. Once the investment is sold, a portion of the difference between price and cost basis is considered long-term capital gain and the rest is taxed as income. That means that you only pay taxes on much of the dividends when you sell the shares.
Of course, these benefits come at a cost. MLPs issue a K-1 tax document each year that details the profits, expenses and distributions in the partnership. As a unitholder, you will need to file a special form for these investments on your income tax returns and keep track of your basis in the shares.
More Information: MLP List
Very thorough article!
Wow! A ton of great information in this article. Amazing job Dividend Ladder. I would definitely recommend that all new dividend investors stop by and read this article to learn about the dividend growth investing game. Thanks for taking the time to put this all together!
There are some great High yielders like O that I wouldn’t hesitate buying when i have enough funds:) Great job on breaking down on all these types, I love some REIT!