Many companies pay a dividend fro holding their stock. They do this to attract longer term investors that are more interested in parking cash in the company rather than flipping shares on a daily basis. In layman's terms a dividend is simply a dollar amount (or penny amount) per share that the company pays to share holders at a set date every quarter.There are many great reasons for investors to search for dividend paying stocks. The extra cash is the most obvious but there are other great reasons which we will explore further.
Liquidity is number one! When searching for a high dividend do not just look for the highest yield. This can be a recipe for disaster. Investors will always want to make sure that the stock trades enough volume. For example Ladder Capital Corp. (NYSE: LADR) pays an astronomical dividend (more than 20%) but barley anyone trades The stock. never sacrifice liquidity for yeild. I prefer to search through known, liquid names in the S&P 500 or Nasdaq 100.
So lets take a look at the S&P 500's current list of top dividend paying stocks and weigh the pros and cons of an investment based on dividend. In first place we have HCP, Inc. (NYSE: HCP) with an 8.45% yield. Second is one that everyone likely knows, its AT&T, Inc. (NYSE: T) with a 5.27% yield. Then we have Chevron (NYSE: CVX), 5.15%, Abbvie (NASDAQ: ABBV), 4.32%, and finally Emerson Electric (NYSE: EMR), at 4.15%.
The above company's all pay respectable dividends and one could argue that they are somewhat diversified. So why wouldn't everyone want to invest in these names for the long haul and pocket the high yield? After all, the S&P 500 is down 15% so far this year so wouldn't it be helpful to collect the extra yield? Yes and no...
While it is advantageous to have that extra edge you are taking a bit of a gamble that the company will remain stable. If this happens then every quarter, theoretically your cost basis will be reduced should you choose to reinvest your dividend (and you should choose to do that), but what if the company has a bad earnings announcement or cannot weather the market downturn? Let's use HCP as an example.
HCP is paying a healthy 8.45%. If you bought the stock first thing this year and held all year you will at least make the 8.45% but further analysis reveals that HCP has already dropped 30% this year! Now its early, and maybe it makes a comeback but what if it doesn't? You see, companies also offer dividends to attract investors in tough times. You want to be sure that you are investing in a company that has a history of high yields not a company that is desperate for new investors. AT&T is a company that has this long history of nice dividends, and its performance is quite the contrary to HCP. AT&T is up almost 7% for the year. Now assuming that stays like that AND you can hold for the 5% yield you have a nice play on your hands.
So there you have it. The number one "strategy" if you will, for investing in dividend stocks is to look for those companies that have a solid history of paying dividends, not the desperate ones that are struggling.