These are historic times for the stock market. At the time of writing this, the S&P 500 has a dividend yield of nearly 2.3%. The 10-year Treasury is under 1.8%. It is downright incredible that the S&P 500 yields 50 basis points more than the 10-year Treasury.
Not only that, but the S&P 500’s dividend yield is largely taxed at 23.8% (the maximum Federal rate), while Treasury notes are taxed at a maximum rate of 43.4%. So not only does the S&P 500 yield a lot more than the 10-year Treasury, it is taxed a lot less.
If you’re looking to add high-quality dividend stocks on the dip, now is an excellent opportunity. However, as with investing in general, higher potential returns come with increased risk. As I mentioned in yesterday’s blog post, if you chase dividend yields in the energy sector, you’ll likely find yourself stuck with struggling companies that will cut or eliminate their dividends going forward.
So if there’s one thing I want you to take away from today’s blog post, it’s this: When selecting dividend stocks, you must look beyond its annual dividend yield. While high dividend yields can be attractive, that shouldn’t be the only thing you’re looking for. With some companies, a high dividend yield isn’t always a good thing: Sometimes a high yield is actually caused by a drop in stock price.
As a starting point, you should use my Dividend Grader tool to assess how strong a dividend stock is. Dividend Grader focuses on four characteristics that are essential to identifying healthy dividend stocks…
The Dividend Grader Formula
The first is a strong Dividend Trend. What I look for in dividend stocks is their ability to increase their dividend payments. So, my Divided Trend grade looks at the last four quarters of payments to see if the payments are growing, unchanged or decreasing. It is generally a bad sign if a company has to cut its dividend payments.
The second is Dividend Reliability. This is looking at how consistently the company has paid a divided. Have they been paying for years without missing or have they had some gaps during times of trouble? Consistent payments is a great sign for the company and plays a big role in making buy, sell or hold decisions for a stock. The third grade is Forward Dividend Growth. There’s a lot that goes into this particular rating. It involves looking at growth estimates for the company and the divided. You certainly don’t want to own a company that isn’t on track to increase your dividend payments over time.
The fourth grade is Earnings Yield. This is one measure used to help gauge earnings quality. A higher positive number can possibly indicate future dividend increases or at least companies with the ability to pay dividends. A falling or negative earnings yield can indicate a possibility of lower future dividends or possibly a stopping of dividend payments.
All of this comes together to deliver you the Total Grade. This is where I blend the results of the four dividend grades and make the final buy, hold or sell recommendation. I also provide the Fundamental Grade and Quantitative Grade from Portfolio Grader for your reference.
The Portfolio Grader Formula
Speaking of which, I also recommend you run any prospective dividend stock through Portfolio Grader, which screens stocks based on their profit potential, providing a “Fundamental Grade” that measures a company’s health and a “Quantitative Grade” that indicates whether institutional investors are buying this stock.
Now, you’ll notice that the same ticker entered in Portfolio Grader and Dividend Grader may result in conflicting grades and buy recommendations, and that’s because Dividend Grader focuses primarily on a stock’s income generating potential, while Portfolio Grader pins down a stock’s capital appreciation potential.
Easy as A-B-C
While a vigorous amount of number-crunching goes on behind the scenes, Dividend Grader and Portfolio Grader are both designed to give you my analysis in easy-to-interpret A to F letter grades.
In both of these rating systems, all of the individual grades are taken into account and create the final rating which gives you my current buy, sell or hold recommendation. A=Strong Buy, B=Buy, C=Hold, D=Sell and F=Strong Sell.
Get Started With These Three Dividend Stocks
To get you started, I’ve run the top dividend stocks in the S&P 500 through my stock screening tools and have come up with three dividend stocks that rate highly in both Dividend Grader and Portfolio Grader.
So it just goes to show that dividends alone won’t ensure profits in this market—we all need to pay attention to fundamental metrics as well.