Tired of working for pay? Do you want to earn money while you sleep? One great way to earn money effortlessly is by creating passive income with dividend stocks. Holding dividend stocks can provide reliable income and long-term growth with absolutely no work on your part. I love dividend stocks to balance out my portfolio’s growth stocks so that I have a reliable source of extra cash when the market is going south. In this article, I’ll be going over all you need to know to get started creating passive income with dividend stocks.
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Table of Contents
What are dividend stocks?
Dividends are profits that a company pays you for owning their shares. Most dividend are paid quarterly, though there are some that are paid monthly. Dividend stocks are stocks that pay out regular dividends to their shareholders. These are great stocks to get invested in early on because they pay you regularly in cash and are usually well established companies. You can use this cash for whatever you want such as reinvesting it in the market or paying your bills.
How do I choose dividend stocks?
Many people choose dividend stocks based on two factors: dividend yield and payout ratio. The dividend yield is a ratio of the dividend to the price of the stock.
$latex Dividend Yield = \frac{Annual Dividends Paid Per Share}{Price Per Share}$
A good rule of thumb for most stocks is to carefully analyze any stock that has a dividend yield of over 4% as the payout could be unsustainable for the future.
The dividend payout ratio is the ratio of the dividends paid by the company over the net profit. This is less commonly used but is also an important factor to gauge whether a stock is worth purchasing for its dividends.
$latex Dividend Payout Ratio = \frac{Dividends Paid}{Net Income}$
When choosing dividend stocks, it’s important to not just go for a high dividend yield but also a reasonable dividend payout ratio. According to dividend.com, a dividend payout ratio should be judged as follows.
Dividend Payout Ratio | Rating | Reasoning |
Less than 0% | Loss Making | Only possible if analyst's estimates for next year end are negative. Companies may continue paying dividends to "look good." |
0-35% | Good | Typically when company just starts a dividend. For "value investors" rather than people who are looking for nice passive income. |
35-55% | Healthy | Well established companies and leaders of their industries. Healthy ratio of reinvesting and payout shareholders. |
55-75% | High | Higher dividends but less potential for company to grow dividends in the future. |
75-95% | Very High | Almost all money going toward dividends and therefore risks cutting its dividends in the future. |
95-150% | Unsustainable | Poor earnings estimates and dividend will likely be cut or eliminated altogether. |
150% and more | Very Unsustainable | As bad as a company that has negative payout ratios. Payout more to shareholders than they are earning. |
Good dividend stocks for 2021
What makes a good dividend stock? You should take into consideration dividend yield, consecutive years of dividend growth, dividend increase per year, and payout ratio. A balanced combination of these is important for creating reliable passive income with your dividends.
While there’s no magic formula to determine what makes a “good” dividend stock, stocks listed in Dividend Aristocrats are generally a good place to start. Dividend Aristocrats are stocks which have had consecutive dividend growth for at least 25 years. These are generally large and established companies, recession-proof, and reap steady profits.
Below are some of my favorites from Dividend Aristocrats with their track records.
Company | Dividend Yield | Consecutive Years of Dividend Growth | Average Dividend Increase Per Year | Payout Ratio | Annual Dividend Amount |
Clorox Co. (CLX) | 2.39% | 45 | 9.78% | 60.33% | $4.44 per share |
Abbott Laboratories (ABT) | 1.40% | 49 | 10.75% | 55.56% | $1.80 per share |
Johnson & Johnson (JNJ) | 2.43% | 59 | 6.23% | 46.54% | $4.04 per share |
Coca-Cola Co. (KO) | 3.24% | 57 | 3.48% | 77.73% | $1.64 per share |
In order to be paid dividends, you must be holding shares of that company by the ex-dividend date. If you sell your share(s) after that date, you will still be paid dividends for that particular quarter. If you aren’t holding shares by that date, you won’t be paid.
As an example, if I were to purchase 100 shares of JNJ at its current price ($166.58), I would earn around $101 in passive income each quarter to total about $404 each year! As long as I’m holding my JNJ shares, I would be consistently paid in dividends. Remember that this amount that I regularly receive is in addition to the inherent value of the shares that I am already holding. Creating passive income with dividend stocks is an amazing way to make your money work for you.
Conclusion
Dividends are one way of generating passive income and a great supplement to a growth focused portfolio. Remember that dividend stocks are generally for long-term investments. Don’t pay too much attention to their day to day movement and focus on the dividend returns.
Now that you know all about how to start creating passive income with dividend stocks, what dividend stocks will you invest in? Comment below! In future posts, I’ll be talking about other ways of diversifying your income streams. If you haven’t already, learn the basics of how to start investing in the market here.
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Hello, I’m Chloe! I’m the primary author of Off Hour Hustle. Currently, I work as a software engineer, sell products through eBay, Etsy, and OfferUp, have 26+ credit cards, and am always working to diversify my income streams. In my spare time, I enjoy climbing, hiking, and other outdoor activities.