The Dow Jones Industrial Average dropped some 800 points on April 26, and the S&P 500 has been down more than 11% since the start of the year. This would put the stock market in correction territory, which is a drop of more than 10%. That means most stocks are in negative territory year to date, as are most of our portfolios.
Long-term investors shouldn't make any rash decisions as long as they believe in their holdings and nothing has materially changed for a particular stock or its industry. Corrections don't historically last as long as bull markets, and selling now would only lock in your losses before the market has a chance to come back.
But it may be good to know that there are some stocks out there that pay you to own them, regardless of the market environment -- dividend stocks. They are particularly important in markets like this as they can boost your total return and provide you with some income.
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Dividends 101
Dividend stocks are simply stocks that pay out a regular dividend, or cash distribution, to their investors, usually every quarter, but sometimes once a month. Roughly 84% of the stocks on the S&P 500 pay dividends, while only about half of small-cap stocks pay dividends.
Typically, the best dividend stocks are those of large, blue-chip, well-established companies with a history of steady, stable earnings. Because dividends are paid out of earnings, the best dividend stocks are those with consistent earnings. This is why many smaller companies don't pay dividends or pay lower dividends. The same is true for younger growth companies, which are heavily investing capital in their future growth.
When assessing dividend stocks, there are a few different indicators you should look at. One is how long the company has consistently increased its dividend. Companies that have boosted their annual payouts for 25 years in a row or more are called Dividend Aristocrats. Some of the companies with the longest streaks are pretty familiar -- Procter & Gamble (65 years), Coca-Cola (59 years), and Johnson & Johnson (59 years).
The other key metric is the yield. The yield is the percentage of its stock price that it pays out in dividends. The average yield on the S&P 500 is about 1.37%. So, a yield over that would be considered good. Some companies have yields of 4%, 5%, or higher. The nation's largest bank, JPMorgan Chase, for example, has a 3.25% yield. Based on its price of roughly $122 per share, it paid out a quarterly dividend of $1.00 per share this quarter.
So, if you owned 50 shares of JPMorgan Chase, you'd earn $50 per quarter in dividend income, which you could either pocket or reinvest into the stock. For the year, the stock would produce $4 per share or $200 for 50 shares.
Payout ratio and total return
Another factor you should consider is the payout ratio, which is the percentage of quarterly earnings that is allocated to pay the dividend. This metric tells you if the company is paying out too much or too little to its dividend. Generally speaking, a stock with a payout ratio over 50% or 60% may be paying too much to its dividend, as those earnings might be better deployed in growing the company.
On the other hand, a payout ratio below 50% is generally a good indicator that the company is maintaining a robust dividend without sacrificing some other investment or growth opportunity. A payout ratio of 25% to 40% might be considered a sweet spot. One that's under 20% might be low, but it indicates that the company could be raising its dividend.
As mentioned, dividends can be kept as income or reinvested back in the stock. When they are reinvested, they contribute to a stock's total return, which is a combination of capital appreciation -- or the rise in stock price -- and the reinvested dividend.
According to a recent report from Fidelity Investments, dividends have accounted for 40% of the S&P 500's return since 1930. But during times of high inflation, dividends account for a higher percentage of the return. For example, in the 1970s, a period of high inflation, dividends accounted for 71% of the S&P 500s total return. In the 1940s, another period of high inflation, it was 65%. Conversely, during the 2010s bull market, it was only 16%.
Inflation is as high now as it's been in about 40 years, so it is a good time to seek out some good dividend stocks to offset some of your losses.
