If you follow the lead of many Wall Street investors -- including portfolio managers, equity strategists, chief investment officers, and other experts -- then you might want to consider adding some dividend stocks to your portfolio.
A decent CNBC survey of 500 Wall Street investors revealed that 42% are most likely to buy dividend stocks right now, given the sluggish state of the market. It was by far the most of any investment type, as mega-cap technology stocks were second at 18% followed by financials at 16%.
Why dividend stocks and why now? For starters, in a market that's down some 13% year to date, they are stocks that pay you to own them.
What are dividend stocks?
Dividend stocks are those that distribute a quarterly, or sometimes monthly, payout, or dividend, to investors. Most dividend payers are large, established companies with a history of solid earnings, as dividends are paid out of a company's earnings. Not all large companies pay dividends; roughly 400 of the S&P 500 stocks distribute them. But the percentage is far lower among mid-cap and small-cap stocks.
And among those stocks that pay dividends, not all offer great yields -- which is the percentage of a company's share price that it pays to dividends annually. The average dividend yield on the S&P 500 is currently about 1.69% -- so anything over that would be considered pretty good. A dividend yield over 3% is generally considered a fairly high dividend.
Right now, a lot of banks are paying high dividends, including Citigroup, which has a 3.98% yield. A 3.98% yield results in a dividend of $0.51 per share each quarter, based on its current $51 share price. If you own 50 shares of Citigroup, that dividend would result in a $25.50 dividend payout per quarter. For a full year, a $0.51 per-quarter dividend would come out to $2.04 per share per year. So, if you owned 50 shares, you would have $102 per year in dividend payments.
Now, you could take that money and put into your bank account, or you could reinvest it back into the stock, growing your position.
Watch the payout ratio
In addition to the yield, you also want to watch the payout ratio. The payout ratio is the percentage of earnings that go toward the dividend. As an investor, you want to look for a dividend that has a payout ratio, ideally, below 50%. If the company has a payout ratio that is too high, say over 60% -- then it may be stretching too far to make the dividend payment. That could result in the payout not being sustainable or the company sacrificing other investments, which could hurt its growth. This is often called a dividend trap.
Generally speaking, a payout ratio in the 25% to 50% range is pretty good but it really depends on the company. And then there are some companies -- namely real estate investment trusts (REITs) and business development corporations (BDCs) -- that are required by law to pay out 90% of their earnings to dividends, so consider investing in those types of companies.
Also, a good way to identify a company that is committed to sustaining its dividend is the length of time it has raised its annual dividend. Those that have boosted their annual dividends for 25 years in a row or more and meet other requirements of S&P Dow Indices are called Dividend Aristocrats, while those that have done so for 50 or more straight years are known as Dividend Kings. Coca-Cola, for example, would be considered the latter as it has raised its dividend for 60 consecutive years.
Why dividend stocks are popular right now
Investors tend to flock to dividend stocks in bear markets or down markets for a couple reasons. One, they are typically stable, blue chip companies that have been around a long time, are well capitalized, and have weathered recessions and downturns in the past. The market downturn brings down their valuations and makes them an attractive buy for many investors.
Also, the dividend, if reinvested in the stock, can boost its total return. Since 1930, dividends have made up 40% of the S&P 500's total return, according to an analysis by Fidelity Investments. But that percentage goes up during difficult markets. In the 1970s, for example, when the market was down, the economy was sputtering, and inflation was high, dividends accounted for about 71% of the S&P 500ʻs total return. Conversely, during the 2010s bull market, they accounted for only 16%.
Or, of course, you could take the quarterly distributions and save them or use as spending money. Either way, these are stocks that pay you to own them.