How To Choose Dividend Stocks

When we cover dividend stocks, The Juice goes over lots of basics. Because they’re important when differentiating between different types of dividend payers within the context of larger, well-diversified, long-term portfolio. 

To balance income and growth, you need to have a handle on the basics. However, a little bit of common sense — a grasp of what should be obvious — also helps. 

Today, The Juice hits you with a little bit of both. 

On the basics — 

One of the key metrics to look at when assessing the strength and sustainability of a company’s dividend payment is payout ratio.  

With its earnings, a company can do several things. Among the two most popular: 

• It can reinvest its earnings back into its business to fund future growth. 
• It can reward shareholders by paying a dividend, usually quarterly, but sometimes annually or just once. 

Payout ratio is how much in dividends a company pays relative to its net income (dividend divided by net income, multiplied by 100 to get a percentage). 

If a company earns $50 million in a year and pays $25 million to shareholders via dividends, its payout ratio is 50%. Is this good or bad? It sort of depends. 

Generally, the higher the payout ratio, the more concerned you should be. If that $50 million a year company pays $45 million in dividends, it has a payout ratio of 90%. It’s probably safe (we can use that word here!) to say that’s never a good situation. Or, at the very least, it’s not a sustainable situation. 

A 50% payout ratio, however, might be perfectly fine for one company, but not great for another.

Let’s consider some examples. 

At the moment, Microsoft (MSFT), which is the third most searched dividend stock in our Trackstar database, has a payout ratio of 22.4%. This indicates that the company can comfortably not only pay, but likely continue to increase its dividend annually, as evidenced by its current 22-year streak. 

Meanwhile, Meta Platforms (META), number five on today’s Trackstar list, has a super low payout ratio of 8.6%. This isn’t uncommon, given that Meta just instituted a dividend and remains a high-growth tech company, similar to, but also earlier on in the process than Microsoft. 

Just as Microsoft, Meta and other companies have to balance growth (as in, reinvesting for growth at the company) and income (as in, rewarding shareholders with income via a dividend), individual investors must do the same at the individual stock level. 

To this end, Procter & Gamble (PG) has increased its dividend payment for a pretty incredible 69 years in a row. While MSFT and META both have dividend yields of less than 1.0%, PG yields about 2.4%. While nothing to write home about in this high-interest rate environment, it’s not too shabby either. 

At least not at first glance. Until you run the numbers on growth and income from an investor perspective. Growth, as in stock price appreciation. Income, as in how much you can expect to collect and have your overall return amped up by a consistent dividend payment.  

As these three dividend stocks go, PG is obviously the most mature, followed by MSFT and relative dividend newcomer META. We fully expect MSFT and META to continue increasing their payout. PG will probably do likewise. However, as stocks for a long-term (or even somewhat near-term) portfolio, they’re not equal. 

Let’s compare a $1,000 initial investment in July, 2022, followed by additional monthly contributions of $100, in each of these stocks, factoring in dividend reinvestment: 

The chart more than speaks for itself. 

An investment in META, which has only made two dividend payments in its life, beats perennial dividend payers MSFT and PG by leaps and bounds. While PG pays a superior dividend, it’s not a superior stock. By almost any means. 

Of course, there’s the element of risk. 

If you’re 70 years old and need your money now, you might want to milk PG’s yield (though why not just live off of 5% in a savings account at the moment if you’re risk averse?) and worry less about the stock price cratering. If more volatile MSFT or META takes a dive, the loss of capital might sting more and not be quite as offset by the dividend as it can be in a stock like PG. 

This said, it’s easy to get caught in the dividend stock cult. As much as we love dividend payers here at The Juice, we’re not fools. We’re not blind loyalists to one style of investing. Check out some of the dividend investor forums online and you’ll find people who are. 

These people live and die by dividend stocks. They literally won’t invest in a company that doesn’t pay a dividend. And they’ll only buy the names with the longest increase streaks and other (seemingly) impressive metrics. This makes no sense. 

The difference between overall returns in META and PG for the last two years is more than $3,936. That’s a lot of money. This isn’t to say PG is a bad stock. Or that you shouldn’t own it. But it is to say that you shouldn’t own simply because it pays a better dividend than META. This doesn’t make it a “better” stock. 

Choosing between dividend stocks actually has to do with a lot more than its actual dividend. 

The Bottom Line: If you’re assessing a stock on the existence and subsequent strength of its dividend alone, we hate to break it to you, but you could be a better investor. We don’t like seeing zealots on the internet trying to convince people that it’s their dividend growth way or the highway. Again, this is a 100% illogical approach. 

Obviously, The Juice likes and sees the value in dividends. But we consider them as part of a well-considered, diversified portfolio that doesn’t only include dividend stocks. Most investors need some growth. And many can generate income from other, sometimes better sources.

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