Not all dividend strategies are the same. How to choose the best one for you

Published Wed, Apr 24 20242:18 PM EDT

Investors looking for income often turn to dividend stocks. Yet there are different dividend strategies, depending on what you hope to accomplish. Some stocks can pay dividend yields in the double digits. Others can pay less than 1%. Some investors turn to dividends to earn income to live on, while others look at dividend growth as an indicator of future share price appreciation. "Understand what you need from your investments," said investor Jenny Harrington, CEO of Gilman Hill Asset Management. "You need to very clearly define what you're looking at those dividends for — a sign of corporate strength or looking for a source of significant income to support your investment portfolio or lifestyle." She considers herself a dividend income investor, looking for names that provide a healthy payout for her clients. Her portfolio typically generates a 5% dividend yield or better. On the other hand, Kevin Simpson, founder and chief investment officer of Capital Wealth Planning, looks for names that have consistently boosted their dividends every year. Total return is his objective, not just the income the portfolio is generating today. Yet, it is more nuanced than just buying names with the highest yield or those that are dividend growers. Here is how Harrington and Simpson each manage their particular investment strategy and where they see opportunities Dividend income investing Harrington looks for companies whose management and boards have a high commitment to the dividend. They also have earnings growth, although "it doesn't need to be a whopper," she said. The companies should also have a sustainable payout ratio, meaning the dividends are well covered by earnings or, in the case of real estate investment trusts, funds from operations. Stocks should also have rational valuations and strong balance sheets, as well as a favorable industry environment and quality management. In addition, Harrington looks for those with "relatively low economic sensitivity so that they can deliver the dividend through any disease and any environment." Here are some of the names she owns in her portfolio. Kinder Morgan , which yields 6.1%, will benefit from increased demand for liquefied natural gas and artificial intelligence, Harrington said. During the earnings conference call last week, the pipeline company's co-founder and executive chairman, Richard Kinder, said there is tremendous expected growth in the need for electric power. "This growth is being driven by a number of factors, most prominently by the increasing demand of new and expanding data centers, especially those required to support AI," he said. Kinder Morgan's growth in its distributable cash flows is allowing the company to boost its dividend, while maintaining a payout ratio of about 50%, Harrington pointed out. She also likes Organon , which has a 6.1% dividend yield. The women's pharmaceutical company spun off from Merck almost three years ago is expected to generate cash flow that is three times its annual dividend outflow, Harrington said. Lastly, Verizon offers an essential service across the United States, she said. Despite the competitive market, Verizon has grown its dividend annually and is now paying a 6.8% yield. It has a payout ratio of less than 60%, she said. Dividend growers By contrast, Simpson looks for companies that have consistently grown their dividends for the last five years. Yet it isn't just about increasing payouts. Simpson also looks at valuation, because he doesn't want to overpay for something just because it has an attractive history of boosting its dividend. Diversification among sectors is also important, he said. However, the most important criteria is that the dividend is increasing as a result of the company having the earnings growth to support it, Simpson said. That will translate to an appreciation in total return, he said. "Total return is the focal point," Simpson said. "We believe that great companies that are increasing their dividends because of increasing earnings will see share price appreciation over a full market cycle." His firm serves as sub-advisor to the Amplify CWP Enhanced Dividend exchange-traded fund, which has a 30-day SEC yield of 2.02% and an expense ratio of 0.56%. DIVO 1Y mountain DIVO's one-year performance Among Simpson's top picks are TJX Companies , Honeywell International and CME Group . TJX , which has a 1.6% dividend yield, is his firm's newest position and one that he sees as a beneficiary of consumers trading down to lower-priced goods. Its five-year annual dividend growth rate is 11%, he said. Earnings per share grew 20% last year and is forecast to grow 6.5% this year, he said. The company's price-earnings multiple over the last few years has ranged between 20 and 30 and is currently at 24x, he said. Meanwhile, Honeywell, which has a 2.2% yield, also trades at a reasonable valuation, Simpson said. "There is a strong lean into aerospace because of some of the problems Boeing is having," he said. Honeywell has a 6% five-year annual dividend growth rate, he said. Gross margins have ramped up to all-time highs at 37%, while free cash flow is re-accelerating to $4.5 billion, according to Simpson. Lastly, CME Group not only has a 2.2% dividend yield, it tends to pay a special dividend once a year that's posted strong growth, he said. CME paid $4.50 per share at the end of 2022 and $5.25 a share at the end of 2023. CME has five-year annual dividend growth of 15%, and a flawless balance sheet, he said. It grew earnings nearly 20% last year, he added. Earnings growth is projected to slow this year, he said. However, political and geographical uncertainties, as well as transaction fee adjustments, will likely boost profitability through increased trading volumes and revenues, he said