Dividends are one of the two primary ways through which investors reap rewards on their stocks. The other is capital gain. While a dividend is the portion of a company’s profits that it distributes to its shareholders, a capital gain is an increase in the value of the capital invested in the shares of a company as a result of a rise in their price.
Dividend stocks are stocks of companies that regularly pay out dividends. They are the darlings of income investors. Those are investors whose objective is to create a consistent source of income from stocks. As dividends are paid four times a year, quarterly, income investors get returns on their investments all year round.
Warren Buffett, the greatest investor of our time and CEO of Berkshire Hathaway (NYSE: BRK-A; NYSE: BRK-B), a holding company of 41 securities of which 31 pay dividends, seems on track to receive a massive $3.8 billion in dividend income this year.
Which Dividend Stocks to Buy?
Dividend stocks are highly recommended for aspiring income investors. But to be a successful income investor, you need to know the best of those stocks to buy. You can by looking out for the following metrics:
- Dividend Yield: This is calculated by representing the annualized dividend as a percentage of the share price. For example, if Company ABC with a share price of $50 pays out $5 in dividend yearly, the dividend yield will be 10%. Although the higher the dividend yield, the better, a good dividend growth history and sustainable dividend payout ratio are more important.
- Payout ratio: What percentage of its earnings does a company pay its shareholders as dividends? If Company ABC, in net income for a business year, earns $2 per share and pays $0.50 per share in dividends, the payout ratio will be 25%. As a rule of thumb, for dividend payments to be sustainable, the payout ratio has to be modest. If a company has a very high payout ratio, you should ask: how sustainable is it? Any company that pays out too much (anything higher than 100%) of its operating cash flows or reserves in dividends might just be some steps away from a financial crisis.
- Earnings per share (EPS): The earnings per share (EPS) metric compares a company’s earnings to its shares. It is calculated by dividing its profit by its outstanding shares. The higher it is, the higher, it means, the company is earning per share. A company with increasing earnings per share (EPS) can afford to pay more of its cash flows as dividends.
- Return on Equity (ROE): A company’s equity is its assets minus its liabilities. It is the value that will be left if it were to sell its assets today and settle its liabilities with the proceeds. The return on equity (ROE) is net income over equity expressed as a percentage. For a dividend stock to be worth your buy, it should have an above-industry average, stable (for at least 5-10 years) ROE. In short, the company must be growing its ROE year after year.
- A high dividend yield is good but it is not everything. Data by Mellon Capital has indicated that actual or realized dividend yields tend to be much lower for supposed high-yield stocks than their expected yields. Often, except during general market downturns, low-priced stocks are seemingly high dividend yielding stocks because they are low-performing companies. Thus, stocks with yields between 2-6% but with very strong fundamentals are the best.
- Yes, it is good if a company’s dividend payout is high. However, it is better if it is sustainable. A company should not be disbursing all its earnings as dividends; it should also be reinvesting into its business. Hence, a payout of 30-100% is ideal.
- Is the company profitable? How much does it earn per outstanding share? Without healthy cash flows, no company can pay dividends. Also, avoid companies that are neck-deep in debt. An excessively indebted company will rather funnel its cash flows into debt repayments, rather than dividend payout. Moreover, is the stock fairly valued? Dividend stocks are best bought during market downturns: a lower price, a higher yield.
- Check the dividend stock’s return on equity (ROE). The ROE is a reliable indicator of the quality of the company’s management and its effectiveness in using shareholders’ equity to create income. ROE varies between industries and sectors, but the standard is to use the S&P 500’s ROE of around 14% as the average for all. However, importantly, do not consider anything less than 10%.
Based on those valuation metrics, the following are some of the best dividend stocks for the 2021 US stock market that you should consider.
Shell Midstream (NYSE: SHLX)
Shell Midstream Partners, L.P., operates as an oil and gas asset management company, developing, acquiring, and operating pipelines and other midstream projects. You might wonder: is an oil company a good pick now considering the growing interest in green energy? Well, do not worry. The company plays the forward game by focusing on diversified assets to ensure a steady income for its investors.
As a result, its cash reserve is always substantial. No wonder that for five successive years now, it has grown its dividends, at an average rate of 22.2%. As of March 31st 2021, it had a dividend yield of 13.79%. Although the earnings per share (EPS) declined in 2020 amidst falling oil price due to the pandemic, it is expected to rebound this year.
Shell Midstream lost about 47% of its share price in 2020 despite the S&P 500 gaining 17%. So, the stock is now trading about 15% away from its 52-week high of $16.18. Hence, now may be best time to buy at a bargain before the market fully recover.
Coca-Cola (NYSE: KO)
Coca-Cola’s extensive global distribution and deep penetration continues to make its stock an investors’ darling. Although it may no longer have the massive growth potential it once had, Coca-Cola has continued to deliver impressive returns for its investors through effective management and expansion into new terrains.
In the last 13 years, the company has had an ROE range of 49.61% to 6.22%, with the median being 27.13%. In the last quarter of 2020, its ROE was 30.73% – far higher than over 90% of its peers. Coca-Cola has paid dividends since 1919 when it made its initial public offering (IPO). And for the last 57 years, it has increased its dividend payments – one of only 16 companies to have done so. Presently, its dividend yield is 3.16%.
Coca-Cola is a stock of huge dividend value. Warren Buffett began buying its shares after the 1988 stock market crash at a bargain (he now has 400 million of its shares through his holding company, Berkshire Hathaway). Since then, it has grown at an annualized rate of 11%. Buy Coca-Cola also and become a joint owner with him.
Johnson & Johnson (NYSE: JNJ)
A multinational company, Johnson & Johnson is one of the largest manufacturers of medical, pharmaceutical, and consumer products in the world. Being well-established, the company operates in over 60 countries and has its products sold in virtually all. By revenue, it is the 37th largest according to the Fortune 500 list.
Johnson & Johnson has traded within a modest 52-week range of $125.50 to $173.65. Presently, it hovers around $162.83. Thus, while you stand the chance of realizing some capital gains, you can also expect a dividend yield of 2.48%. The company has an ROE of 24% and 59 years of consecutive dividend growth. Currently, its payout ratio is 46.54%.
For three years, Johnson & Johnson has also grown its dividend by an average of 19.88%. Moreover, it is one of two U.S-based companies with an AAA prime credit rating, an indicator of high creditworthiness.
AbbVie (NYSE: ABBV)
AbbVie is a research-driven biopharmaceutical company established in 2013 as a spin-off of the Old Abott Laboratories. In August 2019, RINVOQ, a drug the company discovered and developed was approved by FDA for the treatment of severe-to-moderate rheumatoid arthritis in adults. In May 2020, it acquired Allegan, a leading pharmaceutical company with specialization in medical aesthetics.
AbbVie (NYSE: ABBV) has a 52-week range of $72.55 to $113.41. Presently, it hovers around $108, having delivered more than 44% over the last one year. It has an annual dividend yield of 4.79% and a 42% payout ratio. Its ROE is 69.7% – a substantial drop from its 5-year peak of 220% in December 2018. Despite the drop, compared to its peers in the healthcare sector, the company is still in the 96.7% ROE percentile. Impressive!
Iron Mountain (NYSE: IRM)
Iron Mountain deals in data and records management. It provides data backup and recovery and information destruction services to its clients. The company has as customers at least 90% of Fortune 1000 companies. Using security technologies and background checks, it helps its customers in more than 50 countries and over 225,000 organizations all over the world safeguard their information and assets.
Iron Mountain’s share price has ranged between $21.00 and $41.32 over the past 52 weeks. It has a dividend yield of 6.67% and based on cash flow, a payout ratio of 57.41%. Since 2015, its ROE has averaged 13.81% – greater than our baseline standard of 10%. And if you consider that the average is 5.4% for the REIT industry it operates in, you would realize that the management, indeed, has put the company’s equity to good use.
Here, you have learned what dividend stocks are, why you should invest in them, and the important valuation metrics to consider before doing so. The best dividend stocks for 2021 US stock market that you should consider are Shell Midstream, Coca-Cola, Johnson & Johnson, AbbVie, and Iron Mountain. In addition, though, you can also consider Equitrans Midstream Corps. (NYSE: ETRN) Cardinal Health, Inc. (NYSE: CAH) and AGNC Investment Corp (NASDAQ: AGNC).