Dividend Stocks: Port in a Storm? (2024)

With stocks in a bear market, inflation running hot, and recession risks rising, you might be wondering if any part of your stock portfolio is likely to generate returns in the coming months—or if preserving your capital is the best one can hope for in this environment.

There are no guarantees in investing, of course, but investors looking for potential ports in the storm for their stock allocations could consider focusing more on steady dividend payers.

"Dividend payers tend to be big, well-established companies that have an abundance of cash," says Steve Greiner, vice president of Schwab Equity Ratings^®. "In this market, it can make sense to focus on measures of quality—those with good cash flow, low debt-to-equity rations, good earnings, and a record of profitability—particularly if they're in more defensive sectors."

Here's what to know about dividend stocks, and how to pick appropriate ones for you.

Dividends, when reinvested, can significantly boost total returns over time, making dividend-paying stocks an attractive option for older and younger investors alike.

For example, if you invested $1,000 in a hypothetical investment that tracked the S&P 500^® Index on January 1, 1990, but didn't reinvest the dividends, your investment would have been worth $11,687 as of September 2022. If you had reinvested the dividends, you would have ended up with just over $20,000—nearly double.

"Of course, dividend-paying stocks are generally much riskier than bonds, something income investors in particular should consider when weighing their options," Steve says. "Especially now that you can find decent yields on Treasury bonds."

What's more, dividends aren't guaranteed, unlike the interest payments from Treasuries. Companies can trim or slash their dividends at any time, a risk that was realized in 2020 after 68 of the roughly 380 dividend-paying companies in the S&P 500 suspended or reduced their payouts.

"Fortunately, companies generally only cut dividends when they're in distress," Steve says, "so favoring those with sound financial metrics can help mitigate this risk."

"There's a reason—and not always a good one—that a security is offering payouts that are well above its peers or the broader market," Steve says. "Before jumping at a big yield, try to determine why it's so high."

Dividend yield is calculated by dividing a stock's total annual dividend payouts by its current share price. If a high or rising yield is due to a shrinking share price, that's a bad sign and could indicate that a dividend cut is on the horizon.

If a rising dividend yield is due to rising profits, on the other hand, that's a much more auspicious sign. "When net profits rise, dividends tend to follow suit, so just be sure you know what's causing the increase before buying the stock," he says.

This metric—which is calculated by dividing dividends per share by earnings per share—tells you how much of a company's earnings are going toward the dividend. "A ratio higher than 100% means the company is paying out more to its shareholders than it's earning," Steve says. "In such cases, it may be able to cover its dividends from available cash, but that can last only so long."

If a company whose stock you own is losing money but still paying a dividend, it may be time to sell. "Dividend payers in financial straits may try to stave off a dividend cut—which can drive away shareholders—by funding payouts with borrowed funds or dwindling cash reserves," Steve says. "It's rare that such measures turn things around, though. They're usually just delaying the inevitable."

High levels of debt represent a competing use of cash. "If push comes to shove," Steve says, "the company is going to pay its creditors before it pays its dividends."

A good rule of thumb is to favor companies with a "current ratio"—a measure of the company's current assets versus its current liabilities—of 2 or higher, which is a good indicator of its ability to cover its short-term obligations.

Some sectors offer a more attractive combination of dividends and growth than others—but they also offer different risk characteristics that you should consider when researching dividend payers for your portfolio. Stocks from the banking, consumer staples, and utilities sectors, for example, are known for steady dividends and lower volatility, but they also tend to offer less growth potential. Dividend-paying tech companies, on the other hand, could offer attractive dividends along with the opportunity for larger price gains, but they also tend to be much more volatile.

"If you're a long-term investor, you might be willing to accept tech's higher volatility in exchange for its growth and income prospects," Steve says. "But if you're nearing or in retirement, you might want to stick with dividend payers from less-volatile industries."

When not to reinvest

How to research dividend payers on schwab.com.

Log in to schwab.com/stockscreener to research dividend stocks by:

• Payout ratio: Select Dividends under the Choose Criteria menu, then select Payout Ratio - TTM and choose a range.
• Current ratio: Select Financial Strength under the Choose Criteria menu, then select Current Ratio and choose a value.
• Sector: Select Basic under the Choose Criteria menu, then select Sectors and Industries and choose a sector.

To review a stock's dividend growth, log in to schwab.com/research-tools, search for the company name or ticker symbol, and select the Distributions tab on the stock's research page.

To research dividend-paying stock funds, log in to schwab.com/ETFscreener (for ETFs) or schwab.com/fundscreener (for mutual funds), select Distributions under the Choose Criteria menu, then select Distribution Yield and choose a range.