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Want to Become a Better Dividend Investor? Follow These 5 Tips

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In 2021, U.S. stocks have rallied hard and they have rallied fast, with the Dow, the S&P 500, and the Nasdaq each looking to notch another double-digit gain for the year.

It’s an incredible surge, and indicates how confident we’ve become as the economy reopens and recovers. The labor market continues to improve as well, with initial jobless claims now falling close to pre-pandemic levels and October’s jobs report showing a strong snap back in payrolls. And consumers, despite feeling the pressure of inflation and the supply chain crisis, continue to be resilient.

While we can’t predict what the market will do tomorrow, we can try our best to hedge against broader economic risks by investing in quality dividend-paying stocks.

But how do you find them?

Smarter Dividend Investing

There’s no perfect equation for stock picking. If there was, we’d all be living our best lives somewhere in a tropical paradise. But what we can do instead is rely on a few things: growth fundamentals, future (and past) performance, valuation, and a dash of gut feeling.

With dividend investing, goals will be a bit different compared to other strategies. Income investors are in it for the long haul, and are buying and holding stocks to receive those coveted quarterly payouts. Because who doesn’t love a little bit of extra cash, am I right?

First, you should pinpoint what, exactly, you’re investing for. Is it for retirement, long-term savings, starting a new business, or general wealth building? Having a goal for your money will make you more attuned to your investments.

Once you have that locked down, you can start filtering for top performing dividend stocks.

Typically, you’ll find that mature, profitable companies are the ones shelling out stable dividends; these businesses—think utilities, telecoms, consumer staples, insurance companies—have hit a certain point in their growth cycle where they’re unable to grow at the rate they once did. Because of this, companies in these sectors are able to distribute their profits as dividends.

Sometimes, you’ll even be able to discover a dividend-paying stock in a flashier sector. Take Microsoft (MSFT - Free Report) , for example. Microsoft began paying a dividend in 2004, which at that point the tech company was in a period of stagnation where it didn’t need to reinvest its earnings to fuel high growth. Now, of course, Microsoft is one of the sector’s leading cloud and software players, and pays a dividend with a yield of 0.73%.

As for fundamentals, there are key metrics that income investors should pay attention to.

The dividend yield is something that many investors, not just income, look at, since it tells you how much income you will receive relative to the price of the stock. While a high dividend yield will provide a good source of income, it could also signal that the stock may not make a good investment; the company’s financial health and future growth is likely in question if it’s paying an ultra-high yield.

Dividend investors should also look at what’s known as the “payout ratio.”

This ratio, which is the percentage of profits that a company spends on dividends, is going to tell you if a company is paying out too much of its profits on dividends. Generally, you should probably look at dividend paying stocks that pay out no more than 60% of their earnings, though if you are interested in investing in REITs, you’ll find their payout ratios to be at least 90%, as this is required.

What about growth?

Looking at a company’s annualized dividend growth rate, as well as its average annual dividend increase over a five-year period, will help show you how much a company is growing its dividend over time. Plus, future dividend growth will depend on earnings growth, so your stock picks will need to have strong year-over-year earnings growth rates, too.

You can also check out the list of companies known as the Dividend Aristocrats for portfolio inspiration. These companies have a strong history of profit growth, and have increased their dividends for at least 25 consecutive years.

When looking for dividend stocks, always remember this: companies aren’t obligated to pay dividends, and if a company cuts its dividend, that’s when you know there’s trouble on the horizon.

2 Dividend Stocks to Consider

With all of this in mind, let’s take a look at some dividend stocks that could make good “buy-and-hold” additions to your portfolio.

Seagate Technology (STX - Free Report)

Seagate is a digital memory stock that designs, manufactures, and markets a range of rigid disc drive products that are used in mainframes, workstations, and enterprise-level servers.

Seagate recently reported strong fiscal first-quarter results. Revenue jumped 35% year-over-year to $3.12 billion, while adjusted earnings more than doubled compared to last year. Seagate’s HDD product lineup has helped keep net income, profit margins, and free cash flow on the rise for a while now, and demand should remain strong—especially now that STX launched new technology that integrates its HDDs with the PCIe interface—as more and more people work remotely.

STX has a solid yield of 2.65%, with a payout ratio of 40%. Seagate is a #2 (Buy) on the Zacks Rank. Shares are cheap too, trading at a forward P/E of 13.3X compared to the Technology Services Market (roughly 70X). Plus, STX offers a more enticing yield than what the S&P 500 Index would provide you.

JPMorgan Chase (JPM - Free Report)

JPMorgan is the biggest bank in the U.S., and was the top-performing large bank over the past decade. Additionally, JPM outperformed its peers during the pandemic recession last year, falling only 5% in 2020 while other banks experienced double-digit percentage drops.

There are two key things that set JPMorgan apart from other banks, the first being its “fortress balance sheet,” according to CEO Jamie Dimon. The company ended 2020 with capital reserves above $200 billion, which will provide the means to both invest in its business and return money to shareholders. The second factor is JPMorgan’s diverse revenue stream, which helps offset any tough economic periods.

JPM, a #3 (Hold) stock, is about as stable as it gets in the financial sector. It has a forward P/E of only 13.4X, trading competitively below peers in the Finance Market (17.5X) considering its short- and long-term growth potential. Additionally, JPM has one of the best dividends in the space, with an annual yield of 2.45% and a payout ratio of 23.4%.

See More Zacks Research for These Tickers

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JPMorgan Chase & Co. (JPM) - free report >>

Microsoft Corporation (MSFT) - free report >>

Seagate Technology Holdings PLC (STX) - free report >>

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