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5 Ways to Profit from Dividend Stocks

Quick, tell me something—when’s the last time you reviewed your stock portfolio? Do you know how many, if any, of your shares pay dividends? Or what sectors they’re in?

The traditional dividend holdings approach is to include some utilities or consumer staples stocks in your portfolio. One problem is that these typical dividend-paying sectors may fare poorly when interest rates rise. Investors who limit their equity income portfolio to the usual suspects are overlooking some companies with great dividend-growth potential.

Here are five ways you can update your dividend strategy and one caveat:

  1. Don’t just look for the highest yields. Some investors have been buying higher yielding stocks, which in turn makes them pricier. But instead of focusing solely on high current yields, income-focused fund managers look for future dividend growth. Some of the sectors that offer better dividend-growth potential are technology, energy and materials, versus the typical utility sector. 

  2. Focus on steady dividend growers. Part of Pinnacle’s Equity Income fund’s strategy is to include stocks that regularly boost their dividends over time. They don’t necessarily pay the highest dividends now, but current income isn’t the idea here. You want to target companies whose share prices will rise as they increase their dividends. But your yield, based on your purchase price, will grow over time. 

  3. Invest in companies that are restoring their payouts. This can be a sound long-term strategy: If you buy shares that pay a small dividend, the yield on your original investment may soar if the firm boosts the rate. Rebuilders formerly paid high dividends, so you can be confident that management will share the wealth when they’re able. Many financials are in redevelopment mode.

  4. Keep an eye out for first-timers. A company initiating a dividend yield usually indicates that business is good and they have enough extra money to give back to shareholders. They’re not always small companies, either. Apple started paying a dividend as recently as 2012. Just know that a dividend launch isn’t always good news—sometimes it means that a company’s growth has slowed and that’s the best place for it to stash some cash.

  5. Cautiously venture overseas. Foreign stocks tend to offer more enticing dividend yields than U.S. companies. However, many countries withhold taxes, anywhere from 10-20 percent, on dividends paid to U.S. shareholders. You can recover that money through the foreign tax credit if you hold the shares in a taxable account but not if you hold the shares in an IRA or other tax-deferred account.

The caveat: avoid “overpayers.” Sometimes a company’s dividend is too good to be true. If a company pays out too much of its earnings to boost or maintain its dividend, they leave themselves little or no earnings to generate future growth. Compare the dividend payout ratio of companies and be wary of those paying out 70, 80 or even over 100 percent of their earnings.

You may want to consider a dividend-focused fund instead of hand-picking your own stocks. Some funds focus on higher yields, while others look for more moderate yields with future dividend-growth potential. The two approaches likely will have very different portfolios, so knowing which strategy you’d rather pursue—high current yields or future growth—will help you choose.

Ralph Lehman can be reached at 865-766-3019 or by email at ralph.lehman@pnfp.com.

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