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6 Tips For Buying The Right Dividend Stocks

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Steve Pomeranz

I get a lot of questions regarding the purchasing of stocks that pay high dividends and I think there are some misconceptions regarding the meaning and process of owning a high dividend paying stock.

First, ask yourself how high should the dividend be?  Some company’s pay 2%, some 4% and some pay 10%.  Is 10% really the best?

 6 Quick Tips

  1. Look at the ratio of the dividend to actual earnings….if a company earns 1 dollar and pays .80 cents. That could be a warning sign. Even though the dividend yield is 8%. It might not be sustainable.
  2. Sometimes a lower dividend paid by a company with increasing earnings and high a dividend growth rate can be better.
  3. Think of a dividend as a bond with an increasing coupon. What is 3% today could be 6% in 7 years.
  4. The excess of earnings that the company retains is your true yield.  If a company earns a dollar, pays .30 cents and retains .70 cents. The intrinsic value of the company could be rising by .70 per year. On a 15 dollar stock that is an crease of about 5% in intrinsic value per year. Add the 5% to the 3% you are getting in dividend and at that price, you could have an average 8% appreciation per year.
  5. Stock price movements won’t affect the intrinsic value, so that is what you want to focus on.
  6. Low prices allow you to buy a set of earnings and cash flow for less, thereby increasing your future return. High prices do the opposite.

The Bottom Line

Dividends are only part and generally a small part of the strategy to create wealth. The best and most extreme example is BRK.

BRK has never paid a dividend and has increased from 15 per share to $150,000 per share. It has done this be keeping its earnings and reinvesting those earnings back in itself.  A dividend would have dissipated the earnings.

Think twice and do your homework before investing in stocks purely for the dividend. There is a right way and a wrong way, so don’t make those classic mistakes.

I've been an investment strategist and adviser for over 35 years, leading with a mission of unbiased advice to educate and protect listeners on my weekly radio show on NPR affiliates nationwide. I have been named a “Top 100 Wealth Advisor” by Worth Magazine and “Top Advisor” by Reuters.