Investing in individual dividend stocks is fun. Do you know how to invest in individual dividend stocks? The process itself is easy. There is an inherent risk, though. If you’re looking for a shortcut to wealth this is not the way.
I follow a simple process when choosing stocks. There still is a residual risk after running stocks through my financial sausage grinder.
Investing in individual dividend stocks successfully requires a process and patience. I evaluate the following to determine if a stock fits my long-term goals, risk appetite, and faith:
- Dividend yield between 3% and 7%
- Dividend payout percentage less than 60%
- Current assets greater than long-term liabilities
- Increasing annual dividend payout of at least five years
- P/E Ratio Less Than 20
- No Unethical Implications
- Profitable for the most recent five years
Disclosure: Buying and selling stocks is a risky business. This article is simply my way of doing it. Copying what I do could be detrimental to your financial health. If you’re unwilling to develop and follow an established process stick with mutual or exchange-traded funds.
You’ve been warned.
What Is A Stock
A stock is a fractional ownership in a publicly traded company.
The market determines stock prices. After an initial public offering, a stock price will increase or decrease based on supply and demand and other factors.
Here’s an article I wrote with dozens of basic financial terms.
Where Can Stock Shares Be Purchased
Stocks are purchased through a broker or through an online company. I use Fidelity for my individual stock purchases (just a link, not an affiliate).
Many people love Vanguard.
Both offer easy-to-use and inexpensive tools.
Minimizing Taxes
I keep all of my individual stock purchases inside of a Roth IRA. This keeps me from calculating a ton of tax information at year-end. Paying taxes is neither patriotic nor a sign of advanced spirituality.
Jesus never encouraged the paying of taxes to a corrupt government in Mark 12:17. Most interpretations of that particular verse are superficial and lazy.
When buying stocks consider the tax implications.
Stock Day Trading — Beware
Day traders come and go. Many begin day trading because it’s easy to start. Most go because it’s an unprofitable business.
What’s a day trader? A day trader is a person who buys and sells stocks daily. They attempt to buy low and then sell at a profit. That’s an extremely difficult task.
The stock market is a capricious beast.
Day traders lose about 95% of the time.
If you’re interested in losing money just go to Vegas and put $1,000 on the Cubs.
Dividend Yield Between 3% and 7%*
What is a dividend? A dividend is a monetary distribution of a company’s profits to shareholders. Not every company pays dividends.
What is a dividend yield? A dividend yield is the percentage of income a company pays relative to its stock price.
Let’s use Starbucks as an example. Starbucks currently has an annual dividend yield of 2.28%. Its current stock price is $84.69. A stockholder will get about $1.94 in dividends for every share they own. Dividends are typically paid quarterly. The dividend payment would be about $.48 per quarter.
Rightsize Risk
Why do I desire a range between 3% and 7%?
The S&P 500 dividend yield is currently about 1.5% and my high-yield savings account is currently paying 1.784%. Single stocks are inherently risky. A dividend-paying S&P 500 fund would minimize the risk and give me a decent yield. My savings account is essentially risk-free.
If I am assuming additional risk there better be some additional reward on the table.
The 3% basement is double the average S&P yield. Why not double the savings account rate and create a basement of 3.56%? Great question. There are still capital gains opportunities in buying stocks. If I buy Starbucks at $84.69 I might be able to sell it at a later date for $100. The difference, $15.31 is a capital gain.
Plus the savings rate is directly tied to the Fed Funds rate. For many years the yield was less than 0.50%.
Why a ceiling of 7%? The riskier a company becomes the more they need to pay higher yields to attract investors.
I begin to get uncomfortable at 5% but make exceptions for REITs. REITs are required to pay higher dividends by law.
Dividend Payout Less Than 60%
Cash is king. Companies must learn to manage cash flow well. Certainly, shareholders should be rewarded for their risk. However, when a company pays excessive dividends other areas of the enterprise suffer.
Investors should be in for the long haul. Businesses need to fund research & development. Capital expenditures need to be scheduled. Employees must be paid well.
I only buy individual stocks in a company that keeps its annual dividend payout below sixty percent.
Current Assets Exceed Long-Term Liabilities
This is a simple way of testing a company’s balance sheet. If a company collected the entirety of its accounts receivable and liquidated all of its inventory could it pay off the company debt?
This metric will eliminate many companies. I invest in companies that have debt on a proper leash.
Increasing Annual Dividend Payout For 5 Years
As an owner (shareholder) of a company, I want to know that the company appreciates me. The only way I can feel that appreciation is by paying me a dividend and increasing it each year.
Employees expect pay raises each year. It’s the same with shareholders of a company.
A company that has a fluctuating dividend could also have cash flow issues. It’s better, in my opinion, to start with a small dividend and continually and incrementally increase it.
Starbucks was mentioned previously. Their yield is currently 2.28% but it has increased steadily for the past 10 years! It won’t be long until Starbucks eclipses my arbitrary basement of 3%.
P/E Ratio Less Than 20
The P/E ratio measures the current share price relative to its earnings per share. Let’s stick with Starbucks.
P/E Ratio = Market Cost Per Share / Earnings Per Share
Currently, Starbucks’ market cost per share (asking price) is $84.69. Its earnings per share are $3.55.
$84.69 / $3.55 = $23.85
The P/E ratio of Starbucks is currently 23.85.
What does the P/E ratio tell us? It helps us determine if a stock is undervalued (cheap) or overvalued (expensive).
The S&P 500 has a current P/E ratio of 21.06. Historically the median P/E ratio of the S&P 500 is 14.90. Historically, investors have paid $14.90 for $1.00 of earnings.
Investors are currently paying $23.85 of earnings for Starbucks.
Using a P/E ratio smaller than 20 weeds out stock market darlings like Starbucks, Apple, Walmart, and Mcdonald’s.
It also keeps us from overspending on stocks.
No Ethical Implications
This one is less quantifiable than the previous financial metrics. It also requires a person to be a bit judgy and to think through what is important to them.
Many dividend investors buy solely because the financials are strong and the dividend is high. I take things a step deeper.
Is the company experiencing a scandal of some type? Does the company produce a product that violates your conscience?
While we certainly will not know of every ethical violation we can still do some research. Our government already forcefully extracts too much money for nefarious causes. I don’t want to willingly support a company that is intentionally harming people or violating my faith.
Profitable For the Past 5 Years
This is a simple way to test a company’s income statement. Companies will have challenging times. However, a well-managed business can navigate difficult market conditions and remain profitable.
One could easily dig deeper than this but I find this adequate for me.
Which Companies Should Be Bought
Let’s review three well-known companies (Starbucks, Twitter, and VF Corp (maker of Van’s and The North Face). Do they pass this simple 7-question review?
P = Pass and F = Fail. I need 7 passes to signal a buy.
| Company | Yield 3%-7% | Dividend Payout <60% | CA > LTL | Dividend + | P/E Ratio <20 | Ethical | Profitable | Buy? |
| SBUX | F | P | P | P | F | P | P | No |
| TWTR | F | P (none) | P | F | F | F | N | No |
| VFC | P | P | P | P | P | P | P | Yes |
Finding valuable and affordable individual stock investments is challenging. Most investors should stick with mutual funds and exchange-traded funds.
Unless you are fully funding an available 401(k) you should strongly consider steering clear from individual stocks.
Caveat emptor.
What would you add or remove from my list of seven criteria?