Imagine your favorite companies paying you without having to work. Did you know this is possible? Instead of just spending money on these companies, you can also receive income from them. This is possible if you invest in their stocks, and they pay dividends. Dividends are periodic payments that companies offer to their shareholders and are an excellent way to earn money in the U.S. Stock Market.

Are you interested in learning how to invest with a dividend strategy? In this article from Hapi, we explain what dividends are, how to analyze them, and why to invest in dividend-paying stocks.

What are dividends?

Dividends are payments made by a company to share its profits with its shareholders. They are paid periodically and are one of the ways investors get a return on their stock investment.

Dividend payments and amounts are determined by the company's board of directors. However, it is not mandatory for a publicly traded company to pay dividends.

There are key dates to remember when investing in dividend stocks:

The first is the declaration date when the board of directors approves the amount of dividends to be paid and sets the payment date. The second is the record date, which determines which shareholders are entitled to receive a dividend. Finally, the third important date is the payment date, when dividends are paid to all shareholders who invested before the record date.

Why do companies pay dividends?

Companies in an early growth stage with a high growth rate usually do not pay dividends, as they prefer to reinvest most of their profits to sustain higher growth and expansion.

On the other hand, well-established companies often pay dividends regularly to reward the loyalty of their investors. For example, Coca-Cola has paid dividends every quarter since 1920 and has increased its dividend payment every year since 1963.

This impressive track record has attracted major investors like Warren Buffett, who now earns over $600 million annually in dividends from Coca-Cola.

How to analyze dividend stocks?

To understand the potential benefit of investing in dividend stocks, the first step is to determine the company's Dividend Yield. This number shows what you will receive in dividends expressed as a percentage of the stock price. It can be easily calculated using the following formula:

Dividend Yield = dividends per share / price per share

A [very high Dividend Yield](https://www.investopedia.com/articles/investing/071715/risks-chasing-high-dividend-stocks.asp#:~:text=High Dividends Can Be Fool's Gold&text=The yield is high because,an effort to conserve cash.) might indicate that investors suspect the dividend will soon be reduced due to various business problems. On the other hand, if that number is too low, it may not be worth considering it as a dividend investment.

To make the Dividend Yield concept easier to understand, let’s look at a simple example. Microsoft pays a dividend of $2.27 per share, and its share price is $225.41. By dividing 2.27 by 225.41, you get a result of 1.21%. This is the Dividend Yield of Microsoft (MSFT) as of the market close on Tuesday, October 11.

There are several indicators to evaluate the quality of dividend stocks. Three key ratios are:

1. Dividend Payout Ratio: This measures how much of a company's net income is paid out in dividends. A lower ratio is preferred over a higher one, as a high ratio might indicate the company could have difficulty maintaining dividend payments long term. You can calculate it as follows:

Dividend Payout Ratio = dividends per share / net earnings per share

1. Dividend Coverage Ratio: This measures how many times a company can pay dividends to shareholders over a year. It is the inverse of the Dividend Payout Ratio:

Dividend Coverage Ratio = net earnings per share / dividends per share

1. Net Debt to EBITDA: This shows a company’s ability to reduce its debt, indicating how many years it would take for the company to cover its net debt. In general, this ratio should not be too high to avoid significant investment risk:

Net Debt to EBITDA = [Debt - cash] / Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

Why invest in dividend stocks?

Investing in dividend stocks through an investment app is just one of many strategies available, with pros and cons.

One key point to remember is that dividend stock investing is a long-term strategy. You must buy and hold the stocks to receive dividend payments over a significant period. In the short term, you won’t be able to get the expected cash flow.

There are many positives to investing in dividend stocks in the U.S. Stock Market. The most important is that you can receive passive income. In other words, you will get a steady cash flow simply for owning a stock. Once you receive that money, you can use it however you want.

Another way to benefit from this income is to reinvest it in the same stocks and enjoy the compound interest that grows. This works in a straightforward way: dividend income is reinvested in more shares, increasing the amount invested, which generates more dividends than before, and so on year after year.

Also, consider the overall returns of dividend stocks. By the end of July, the year-to-date return for the entire S&P 500 was -15%, while dividend stocks showed little variation. This happens because, in bear markets, investors tend to seek more conservative stocks and secure cash flows.

Examples of dividend-paying stocks

• Altria (MO) - Dividend Yield 8.65%
• AT&T (T) - Dividend Yield 7.45%
• Newmont (NEM) - Dividend Yield 5.2%
• Citigroup (C) - Dividend Yield 4.84%

How to start investing in dividend stocks?

Investing in dividend stocks is a great long-term strategy, as it allows you to earn passive income to achieve your financial goals. To do this, you need to evaluate different indicators in-depth, starting with Dividend Yield and Payout Ratio.

If you prefer diversification, you can also opt for a dividend ETF. Some examples include VIG, VYM, SCHD, DGRO, and SDY.

Hapi offers a simple way to start investing in dividend-paying stocks and ETFs. Open an account today to get started.