Learn how to find good dividend stocks to invest in by quickly filtering through available dividend stocks for ones that offer a great yield as well as capital gains potential. This dividend stock strategy can be utilized by investors, or day or swing traders seeking to put unused capital (currently sitting in a bank account, or other low yielding financial product) to work for a higher return.
For investors, and even active traders, dividends provide an alternative stream of income and help maximize market returns; a Guinness Atkins Funds report showed stocks that grow and initiate dividends had a 9.6% average yearly return between 1972 and 2010, while the S&P 500 averaged 7.3%. Dividend paying stocks tend to perform better, in terms of total returns.
A report from Dreyfus shows similar findings. When the total return for each decade is broken down into price and dividend returns, dividends make a significant contribution to the total return in each decade. Figure 1 shows the steady decline in dividends over the long-term though. That makes it even more important for investors to find a few good dividend stocks to invest in. There are good dividend stocks out there, offering great income potential and capital gains. Below is one strategy for finding them and capitalizing on them.
Figure 1. Dividend Yield of the S&P 500 (as of March 2015)
The dividend strategy below is not for everyone. It’s not a completely passive approach and requires some research (spending about 20 to 30 minutes each month so you always have other trade candidates in case one of your current positions closes). The approach is designed to utilize capital, achieving returns greater than a typical passive, buy-and-hold, or savings (collecting interest) strategy…through the use of dividends and capital gains.
A New Approach to Finding Good Dividend Stocks
I’m an active trader. I day trade and swing trade, yet but like many investors I face the issue of getting nearly zero percent interest on any capital that is sitting in a bank–a problem faced since 2009 by investors holding cash. Investing in some dividend stocks utilizes that capital, producing a return. While there is always a risk of losing on individual trades, not utilizing capital also has a downside: the purchasing power of those dollars, sitting in a bank and doing nothing, continually decline. A dividend approach that utilizes that capital, creates a return and only takes about 30 minutes a month implement (and results in about 5 to 15 trades a year) is worth considering.
Dividend stocks give you a basic idea of your income potential from capital invested — this is called the dividend yield.
The dividend yield is the dollar amount of the yearly dividends received, divided by the purchase price of the stock (then multiply the result by 100 to get a percentage). If you make multiple purchases of the same stock at different prices, then the dividend yield is yearly dividends divided by the average purchase price.
The price of the dividend stock fluctuates daily, going either up or down. Regardless of the direction of the price you have some reasonable assurance that you’ll be making something on your money from the dividend stock you bought. When you buy matters though. If a stock is fluctuating between $11 and $15 over the course of several years, why buy it at $15 when you can buy it at $11 or $11.50? If a company pays a $1.24 yearly dividend, the price you buy the stock at makes a significant difference in your dividend yield (your return on your capital invested).
- Dividend yield when buying at $11.5: $1.24 / $11.5 = 10.78%
- Dividend yield when buying at $15: $1.24 / $15 = 8.26%
Would you prefer to make 10.78% on your money, or 8.26%? In this example it may not seem like much of a difference but the former return is actually 30% higher than the latter! For more volatile stocks where you buy it makes a huge difference in your dividend yield. Even a calm stock can move big during years where the overall market is volatile…like 2008/2009. Buying at $50 is a lot different than buying at a $100. Buying at the lower price means more upside potential as well (assuming we are buying near the bottom of a market cycle where the price typically rebounds from), providing possible capital gains when the stock is sold.
The goal then is to buy only a few good dividend stocks at a good price which offer a good yield. “A good price” is subjective. There are no guarantees that the price won’t drop after we buy it, but if we wait for a price that offers us a yield we are happy with, then even if the price drops a little it doesn’t matter. If we bought the stock above at $11, and it falls to $10 before starting to move higher, that isn’t a major concern. We couldn’t know it would fall to $10; it was moving between $11 and $15, so $11 was a good place to buy.
What about diversification? Warren Buffett said:
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
If risk is controlled on each trade (discussed shortly), diversification isn’t required.
Buy a few dividend stocks at a good price with a good yield, and then control the risk on them. Buy them near the lows of their long term price ranges. Don’t try to catch a falling knife though. The stock may be moving into the support zone, but make sure it stabilizes there before buying. A stock in rapid descent should be left alone until it stabilizes and shows evidence that an uptrend could be beginning. You don’t need to pick the exact bottom to make money.
I look at about 5 to 10 years of price action, and try to include the most recent major market crash. I look at the chart see what price area the price has typically bounced off of. That’s the area I want to buy. Making this assessment takes practice, and is subjective. The price could still drop, but at least you got one of best price seen in the last several years. This approach requires patience, although there are always good opportunities out there. The Good Dividend Stocks to Consider Buying column highlights several stocks each month which are in a favorable spot in terms of yield and price.
The chart below shows an example of this approach. Trading at $7.83 offers a 12.77% dividend yield. This price also happens to be near the low of its multi-year range. Whether this range will continue to hold in the future is unknown, but what we do know is that buying near the range low has provided some of the best price seen over the last several years. Buying opportunities occurred in 2009 and 2015, as by that time the range was established. Buying near the first support level at $7 or lower support level near $5.50 provided a great dividend, and also provided upside potential as the stock has bounced to at least $11 each time it reached support. Note that the dividend yield is actually much higher if the stock was bought for $6 or $5.50 as opposed to $7.83 at the time of writing. If purchasing at $5.5 the dividend yield is 18.17%.
Figure 2. Buying a Dividend Stock Based on Dividend Yield and Favorable Price
Dividend Stocks: Controlling Risk and Taking Profits
The easiest way to control risk is by position size. That means don’t invest more than 5% in any single stock. If you have a $50,000 portfolio, then you buy $2,500 of each stock you want. If the stock goes to zero you have only lost 5%. If you research the companies, the likelihood of it going to zero is small, which is why we are willing to risk 5% of our capital. This percentage can be adjusted to suit your preference. This is the preferred method, as it is the most simple, works well and keeps you in the trade until the conditions no longer favor the trade (when what got you into the trade is no longer present, consider getting out).
Risk can also be controlled using a stop loss order. It gets you out of the trade if the price moves too much against you. In the case of Figure 2, the price hit a low of $5.73 in 2008. Giving the stock a bit of room, if I buy in this region, I place a stop loss at $5. Your risk per share is the difference between your entry price and stop loss price; this is called the Trade Risk. If I bought at $5.75, my trade risk is $0.75 per share.
I recommended traders don’t risk more than 2% of their capital on each trade, but in this case, since we do have income potential, I am comfortable risking up to 3%. Yes, this is different than the 5% risk discussed in the position sizing risk management strategy above. Risk less when using a stop loss because you are likely to have more a few more losing trades with a stop loss.
Let’s use 2.5%. If you have $50,000 to invest, and risk 2.5% on each trade, you can lose up to $1,250 on a single trade (2.5% of $50,000).
That is the maximum risk (per trade) to the account allowed, also known as your Account Risk.
Divide your Account Risk by the Trade Risk. The result is your position size: how many shares you should take on this trade so you are only risking 2.5% of your account.
In this case, the position size is Account Risk / Trade Risk = $1250/$0.75 = 1666.67 shares. Buy 1666 shares at $5.75 (or whatever you entry price is). Place a stop loss at $5. You may also opt to place an exit order at a target price. Figure 2 shows a possible exit point based on prior price action. The stock has shown a tendency to stop rising between $11 and $12. Be conservative, and place an exit below this, at $10.75. By getting out near where the price has a tendency to reverse, you make $5 profit per share (almost doubling your money), in addition to collecting dividends while you hold the trade.
Profit Potential Of a Good Dividend Stock, with Controlled Risk
In our example, with a $50,000 account, risk is capped at $1,250 (on this single trade). It’s possible that with slippage (when an order doesn’t fill at the price expected) the loss could be a bit larger. This isn’t typically a problem in stocks/REITs/ETFs with lots of volume (discussed in a moment).
Our position size is 1666 shares, and at a price of $5.75 per share that means we’ve used $9,579.5 in capital. Lots of capital is left over for several other dividend paying stock trades.
If the position is held for one year, dividend income is $1 x 1666 shares = $1,666 ($1 is the yearly dividend of PSEC at the time of writing). The income completely offsets the potential loss of $1250 if the trade goes sour after a year.
If the price reaches our profit target, which it did on several occasions in Figure 2 (usually taking about a year), we also reap $5 profit per share (assuming the $10.75 exit). The capital gain equals $5 x 1666 shares = $8330. Assuming the trade takes about a year, the total profit is $9,996 (capital gains + dividend income). This is almost eight times as much as the risk ($1250), and a 104% return on invested capital (the $9,579.5 used to buy the shares).
Use all the account capital in this way, and it’s quite possible to attain 20%+ returns (often much higher) on the total account equity ($50,000 in this case). Since each trade only risks 2.5%, if holding 5 positions the account is only exposed to a 12.5% loss. Of course not all trades will be winners. Some trades will hit our stop loss, resulting in a loss. Since we are using longer-term charts though, usually it will take at least a few months for the price to hit our stop loss. During that time we collect dividends, reducing our total risk. If we originally risked $1250 on the trade, but receive a quarterly dividend of $0.25 before the stop loss is reached, the $416.33 in income ($0.25 x 1666 shares) helps offset that risk. Therefore, our losses are often smaller than our maximum risk, and the longer a trade is held the higher the income potential (while still having the possibility of collecting a capital gain at some point).
In order to use this strategy, we need to find multiple good dividend stocks. “Good” means good price and good yield. The section below shows you how to find such stocks. You don’t need to find them all at once though. Only buy when great stocks are trading at the price you want. Over time you will accumulate a great stocks, with great dividends for your portfolio.
You may also choose to simply invest up to 5% (or a percentage you are comfortable with) of your capital in each stock. If you have $50,000, buy $2,500 worth (5% of $50,000) when the price reaches your entry point. If the stock goes to zero, you only lose 5% of your account. But if the stock reaches your target you make the dividend and capital gains. In this case you spent $2500 at $5.75 per share, and bought 430 shares. Yearly dividend income is 430 x $1 = $430. If the price reaches our $10.75 we make an additional 430 x $5 = $2150, for a total return of $2580. There is a big difference between this return and the “stop loss” method return because with the stop loss method the position size was much bigger, and therefore required more capital to initiate it. Also, in this example our risk and capital invested are the same ($2500); in the stop loss example above they were not the same.
How to Find Good Dividend Paying Stocks
There are thousands of dividend paying stocks. We need to filter out most of these stocks so we’re only left with higher yielding stocks which have decent volume (so we can get in and out of positions with ease) and that meet certain minimum criteria. When using a stock screener, such as Finviz.com (which is free to use), use the following criteria to find good dividend paying stocks. Adjust the criteria to suit your personal goals.
- Click on Screener.
- Input Dividend Yield, Over 5%
- Average Volume, Over 500K, Over 750K preferred
- Price criteria, over $5
- IPO Date, More than a year ago
- Under the Industry drop-down, select Stocks Only or Exchange Traded Funds. Leave blank to see both stocks/REITs and ETFs that match your criteria.
- Under the “Fundamental” tab input personal filters based on the type of stocks you want to own.
- Consider including a Payout Ratio criteria, less than 100%
- Price/Earnings, greater than 0 (company has positive earnings)
- You may also opt to look for only stocks that are trading at low P/E levels, such as below 5 or 6 (but above 0)
- Operating Margin, over 10% (company can likely pay its bills)
- If you are looking for ETFs, note that some criteria will interfere with the search results. For example, including a Payout Ratio criteria will block ETFs from showing up in the sceener results. If your ETF scan produces zero ETFs, try removing the criteria (one at a time) which may be interfering with the results.
- View results in “Financial” mode (click on “Financial”)
- Click Dividend twice so the list is ranked from highest to lowest in terms of Dividend (yield).
- Change view to “Charts” mode (they are still ranked highest to lowest dividend yield).
- In chart mode, if a stock is trading near the high on the time frame (chart) shown, leave it alone. If a stock is trading near the low, it deserves a look.
- Manually go through the stocks on your list. Have your chart platform open (such as FreeStockCharts.com) and view a 5+ year chart of the stock. In order to consider it for purchase, it should be trading near a major support level over that time frame. See How to Get the Most of FreeStockCharts.com When You Start Trading for a basic tutorials on the major features the site offers.
This is the bare minimum of criteria that should be looked for. There are definitely more criteria that can be added in if looking to only buy solid companies. For some books on investing and what to look for, check out Best Trading and Investing Books.
The following video shows how to find good dividend stocks — with high yields as well as long-term capital gains potential — using Finviz.com. The criteria above is used, along with a basic explanation of the types of stocks and price action we are looking for on the charts. To become proficient, research and practice your method. Reading this article won’t make you an expert, it just lets you know what to look for. It is up to you to implement it profitably in the future; doing so requires practice and research.
Video on How to Find Good Dividend Stocks to Invest In
The video is best watched in full screen mode, so you can see what’s happening. Click the full screen button on the bottom right of the video. Allow about 10 seconds for the video to clear up after doing so (may be a bit fuzzy for a few seconds). To exit full screen mode and return to the article, hit Escape on your keyboard.
Dividend Stock Pitfalls
There is a risk that a company may stop paying their dividend or reduce it. Since the dividend can be an attractive feature to investors, a negative change in the dividend can also have a negative effect on the stock price…a double whammy. It is also possible a company may increase their dividend though, this will have a positive effect on yield.
When doing your manual screen through the stocks, look for stocks where the company has a stable history of dividend payments.
When screening for dividend stocks in this manner you are relying on third-party data providers that may not always be posting accurate information, or the information may be outdated. Before making any purchases make sure the data, mainly the dividend information you have, is accurate. Occasionally Finviz, and other sites such as finance.yahoo.com, may not immediately adjust the dividend information when the company changes it or there is a stock split. Check the website of the company you want to invest in for current dividend payment information.
Summary: How to Find Good Dividend Stocks to Buy
Dividend stocks are great for passive investors and active traders alike. For investors, dividend stocks tend to produce better long term returns than their non-dividend paying peers. For active traders like me, dividend stocks provide a way to create an alternate stream of income and put dormant capital to work.
A good dividend paying stock has a good yield, but can also be bought at a good price, based on the price history of the stock. If you can’t get it at the price you want, wait, or look for another opportunity. New opportunities arise every few months and weeks as stock prices constantly fluctuate. Screen for stocks that meet your desired dividend criteria. Using a free stock filter like the one available at Finviz.com can help.
The dividend policy of companies may change over time, affecting both the yield and the price of the stock. These things happen. In the case of a negative event, move on and look for other opportunities. Always double-check that the dividend information you receive from third-party vendors is accurate before acting on it.
By Cory Mitchell, CMT