The Motley Fool

Dividend stocks: why a high yield may not be the best way to make a million

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Stack of new bank notes
Image source: Getty Images.

While a high dividend yield may be appealing when it comes to investing in dividend stocks, focusing on it in isolation may not be the most effective means of increasing your overall returns.

Certainly, a high income return today can lead to improving financial returns in the long run. But other aspects of dividend stocks, such as their financial strength and the potential for dividend growth, may be equally important.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

Therefore, it may be prudent for income investors to take a holistic view of their investments, rather than just focusing on a high yield.

Financial strength

One key area to focus on when buying dividend stocks is their financial strength. Doing so could increase the chances of an investor’s income being sustainable over the long run.

Therefore, it may be worth checking a company’s balance sheet, with lower debt and higher interest cover suggesting that they may be in a relatively strong financial position. It may also be worthwhile focusing on the track record of the company when it comes to making dividend payments. Should they have been able to pay a rising dividend during more challenging economic periods, it may indicate that they have a strong platform for future dividend growth.

Of course, some stocks are more cyclical than others. For investors who desire a strong and robust income over the long run, it may be prudent to concentrate their capital on mature companies that operate in defensive sectors. Otherwise, should there be an economic downturn, they may see their income levels decline to some degree.

Dividend growth prospects

As well as checking the sustainability of a dividend, it is a good idea to determine the growth potential of a company’s payout. A high rate of dividend growth could turn a modest income into an appealing level within a matter of a few years.

A company that has a low dividend payout ratio, which is calculated by dividing dividends paid by net profit, could indicate that there is scope for it to raise dividends. Likewise, a business which has a sound strategy and that is forecast to deliver strong earnings growth may be able to increase shareholder payouts in the medium term.

A high rate of dividend growth may suggest to investors that the company is experiencing an improved financial period, and that its management team is confident in its prospects. This may increase demand for the stock, and lead to a higher valuation. In turn, this may boost an investor’s capital gains over the long run.

Takeaway

Focusing on a dividend yield in isolation may not be the best way to make a million from dividend stocks. Instead, considering their dividend growth potential and dividend affordability may allow an investor to find the best income stocks that are able to have the biggest impact on their financial future.

5 Stocks For Trying To Build Wealth After 50

Markets around the world are reeling from the coronavirus pandemic…

And with so many great companies trading at what look to be ‘discount-bin’ prices, now could be the time for savvy investors to snap up some potential bargains.

But whether you’re a newbie investor or a seasoned pro, deciding which stocks to add to your shopping list can be daunting prospect during such unprecedented times.

Fortunately, The Motley Fool is here to help: our UK Chief Investment Officer and his analyst team have short-listed five companies that they believe STILL boast significant long-term growth prospects despite the global lock-down…

You see, here at The Motley Fool we don’t believe “over-trading” is the right path to financial freedom in retirement; instead, we advocate buying and holding (for AT LEAST three to five years) 15 or more quality companies, with shareholder-focused management teams at the helm.

That’s why we’re sharing the names of all five of these companies in a special investing report that you can download today for FREE. If you’re 50 or over, we believe these stocks could be a great fit for any well-diversified portfolio, and that you can consider building a position in all five right away.

Click here to claim your free copy of this special investing report now!

Our 6 'Best Buys Now' Shares

Renowned stock-picker Mark Rogers and his analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply click below to discover how you can take advantage of this.