Updated: Aug 5
As a beginner investor you should be aware there are 2 types of investment:
1. investment for capital gain (the usual buy low – sell high type of investment)
2. investment for passive income.
Investors looking to generate regular passive income buy assets that provide them with cash on a regular basis (monthly, quarterly, or yearly). Having acquired enough of these assets they may live on passive income without worrying about making money. The idea here is simple. Let’s say you would like to have 100,000 USD a year as you figured this is just enough to live the life you want. If you can find a group of assets that generate a regular fixed income of 5% per year this would mean that with $2,000,000 investment you reached your goal:
$2,000,000 * 5% = $100,000 a year.
If you haven’t yet reached your goal you can always choose to reinvest the income you get into buying new assets until you reach the desired asset amount.
There are a few assets that can provide passive income: buying real estate to rent it out and collecting monthly rent, dividend mutual funds, saving accounts, bonds, and dividend stocks.
Let's look closer into stocks paying dividends.
Stocks with dividends are a great choice for those who want to invest to generate passive income. Dividend stocks distribute a portion of the company's earnings to investors on a regular basis. Most American dividend stocks pay investors a set amount each quarter, and the top ones increase their payouts over time, so investors can build an annuity-like cash stream.
With the COVID stock market meltdown, many of the stock prices decreased substantially. Most of the stocks that pay dividends were also impacted as investors fear that the dividend payout ratio will decrease or worse, the company will stop paying dividends for some time. However, this is the best time to buy those stocks at a discount. When COVID becomes a new norm, or people develop herd immunity, or the vaccine is finally here the companies will go back to normal business. At this moment they will go back to paying the dividends they were paying before. This will benefit you 2 ways:
1. You will be receiving a higher dividend payout for your stocks than those who will buy later as you paid less for each stock.
2. Your stocks are likely to appreciate with time.
3. A general benefit of stocks with dividends is the increasing dividend payout. If you pick a good company that keeps growing its earnings, over time it will be paying bigger dividends. This means your personal yield is increasing with time and can go above 10% or even 15% which is a very good return even comparing to some of the best mutual funds.
Let's take a look at one of the Canadian stocks that pay dividends. I like some of the Canadian stocks for stability and high dividend yields. This is Toronto-Dominion Bank (TD), the second-largest bank in Canada.
Let's say you started to buy TD stock in 2003. At that time the stock price was around $18 and the bank was paying a quarterly dividend totaling $1.12 per year.
Fast forward to 2008-2009. Despite the stock price for TD declined, the bank did not stop paying dividends and actually slightly increased vs. 2007. Annual dividends at that time stood at $2.44.
Fast forward to 2019. The stock price is $78 (before COVID). The annual dividend is $2.22.
This means that if you would have bought shares at $18 in 2003 they would yield 12.33% in dividends. And this does not even count in the effect of reinvesting the dividends. In addition, your stock would have appreciated 340%.
The story repeats again (as in 2009). The stock is trading at a 25% discount from the high level just before COVID. Yet, TD again increased dividends in 2020.
What we can learn from this case:
Investing in strong dividend stocks can provide for an increasing return.
Dividend-paying stocks that increase their dividends also appreciate with time.
Good companies can withstand crisis well without stopping their dividends.
Below are the key points to investigate when selecting the best dividend stocks to invest in:
The company is financially stable and can withstand another year or 2 of COVID.
The company has a good history of generating earnings that were increasing over time.
The company, in addition to dividend payout, also invests in its future growth. The rule of thumb is that its dividend payout ratio is below 60%. This means that at least 40% goes into further growing the business. In this case, you will benefit in the future 2-way: 1) your dividends will grow 2) stock prices will grow as well.
Below is the list of stocks with the highest dividend yield:
Canadian stocks with the best dividends
As promised above below is the list of Canadian stocks with very good dividend yield. I like Canadian stocks for a few reasons:
in Canada, everything is very simple. They have 5 key banks that are considered Tier 1. They are the biggest banks in Canada and are heavily regulated and protected by the government. There are like 3-4 biggest insurance companies. Manulife (in the table below) is the biggest of them. Then, there are monopolies around natural resources.
Canada showed great prudence and stability during the 2008-2009 banking and financial industry meltdown. Due to strict regulations, Canadian banks were not at all impacted.
Many Canadian stocks have high dividend yields (as you can see below).
I particularly like the Canadian banks. All banking is divided between 5 key banks (as mentioned above), but Canada adopts around half-million new immigrants who arrive in Canada. This is a natural growth for banks as the immigrants must bring cash with them and they have to do banking somewhere.
Below is the list of Canadian stocks with the best dividends
Even if you are mostly engaged in stock trading for capital gain watching when dividend stocks are trading at a discount could be a good strategy. Eventually, as you make enough money is trading stocks you might want to retire. At this moment dividend stocks may be a great way to retire and let your life collecting dividend passive income.