If you’re interested in making an investment outside of bonds, consider dividend stocks. Understanding dividend stocks can help you make a more informed decision regarding this type of investment. Read on to learn more about dividend stocks and the investment process.
What Are Dividend Stocks?
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Dividend stocks are profit distributions made by a company to its shareholders via shares in the company itself. They’re important to investors because they provide several benefits such as steady income and tax advantages and allow for dividend reinvestment. Some drawbacks include double taxation, diluted earnings per share, and the possibility of dividend reinvestment.
What Is a Dividend Yield?
The dividend yield is a ratio that shows a company’s dividend distributions to shareholders related to its stock price. To calculate it, divide the dividend per share by the price per share. Overall, knowing the dividend yield gives you a greater indication of the company’s financial health and overall stability.
How Do You Assess a Dividend-Paying Stock?
You can evaluate a dividend-paying stock through four different dividend stock ratios. They are as follows:
- Dividend Payout Ratio: This ratio refers to the total amount of dividends paid to shareholders related to the company’s net income. It’s calculated as dividends paid divided by net income.
- Dividend Coverage Ratio: This ratio lets you know the number of times a company can pay dividends to its shareholders. Start by dividing a company’s net income minus the required payments to preferred shareholders by the dividends to common stockholders.
- Free Cash Flow to Equity Ratio: This ratio lets you determine how much cash a company can distribute after taking care of expenses and debts. To calculate it, take the net income and subtract net capital expenditures, debt repayment, and the change in net working capital from the company’s net income. Then, add the net debt.
- Net Debt to Earnings Before Interest, Taxes, and Depreciation (EBITDA) Ratio: This lets you assess the company’s leverage and how well it can meet its personal debt. Start by taking a company’s total liability and subtract cash and cash equivalents. Then, divide by its EBITDA.
What’s the Difference Between a Bond and a Stock?
Bonds are loans made by an investor to a borrower. They’re often made to a corporation or government entity. Stocks, on the other hand, are securities or stakes in a company that signify a fraction of ownership.
How to Invest in Dividend Stocks
If you’re interested in investing in dividend stocks, you can do so through exchange-traded funds (ETFs) or individual stocks. Here are the steps for investing through ETFs:
- Open a brokerage account.
- Find ETFs and compare the costs.
- Make sure you have a diversified ETF portfolio.
- Purchase the ETF.
Here are the steps for investing via an individual dividend stock:
- Look for dividend-paying stocks.
- Assess a dividend-paying stock by comparing the dividend yields and the stock’s payout ratio.
- Evaluate the company’s industry and finances.
- Determine how much stock you want to purchase.
- Buy the stock.
Now that you know what dividend stocks are, you can determine if they’re a wise investment choice. Make sure to review the benefits and drawbacks and consider your financial future.