If you have read my previous posts you know that I am currently focusing on growth stocks. However as time goes by my plan is to eventually transition into dividend stocks and use the dividends as a passive income source while leaving my principal alone. This is why I went with dividend income daily for the name of the site, even though dividend income is really only going to be a portion of my overall passive income stream. That said, I’d like to take a minute and point out that all dividend stocks are not created equal.
When I first started looking into dividend stocks last year the first ones to jump out at me were utilities and pipelines. Some stocks in these industries are currently paying a substantial dividend. For example, if you take a look at Magellan Midstream Partners, L.P. (MMP), you will see that it’s dividend is currently over 9%. So one retirement plan might be to simply put $1,000,000 into this stock, leave the principal alone, and you would walk away with $90k / year in passive income. If this seems like it’s too good to be true, it’s because there’s a good chance that it might be. In this case, the overall price for MMP has dropped about 40% over the last 5 years (as of today). In addition to that the new president of the U.S. has also indicated he wants to focus on renewable energy, and he has already revoked the permit needed to finish the Keystone XL pipeline.
I’m personally not suggesting you buy, hold or sell MMP. I didn’t start this site to recommend individual stocks, and there are plenty of other sites out there that you can explore if you are looking for assistance with that sort of thing. I do want to point out that generally speaking, if a stock has a really high dividend it might be a red flag. For most industries, a dividend payout ratio of 50-70 is good while anything above 80 might actually be a bad thing. Having said that, dividend payments in some industries (ie. oil and utilities) are typically higher. You should also look for consistent EPS and dividend payments that grow or at least stay the same over time when you are evaluating a dividend stock. Dividend cuts are especially worrisome, since there is a good chance the stock price will also go down when a company cuts its dividend.
High dividend yields might be a red flag, but there may be times where investing in a stock with a high dividend makes sense. For example if you think a particular industry is due for a comeback it might make sense to buy a stock in that industry. You could also buy one stock that has a 10% dividend even if the price is going down, and then balance it out with another stock whose price is going up and pays a 3% dividend. With this scenario you would get a 6.5% return and hope that the growth in the second stock is enough to offset the decline in the first one. I’m personally going to stick with growth stocks for the time being. The name of the site may be dividend income daily, but I’m still going to need a high principal in order to receive substantial dividend payments.