When you think about dividend paying stocks, you usually think of well-established businesses such as Procter & Gamble, Caterpillar or Coca Cola. There are actually many other types of dividend stock you can buy, simply because there are different types of companies which issue dividend stocks. In the next few sections of this post, I will give you a list of some major types of dividend stocks that you might choose to invest in.
These companies produce or sell products that consumers buy every (or almost every) day, such as tobacco, household products or beverages. Procter & Gamble (PG), Philip Morris (PM) and Coca Cola (KO) are just a few examples of such companies. These companies sell non-cyclical products, which means that customers will still buy these products during recession. The result is that such companies have consistent earnings and they usually have large market caps: calculated by multiplying the price of a stock by its total number of shares.
Many large banks like Wells Fargo & Co (WFC) were established dividend payers that offered relatively high dividend yields before the Great Recession (3%-5%). In 2008 and 2009 they had to dramatically cut their dividends. After that, they slowly started increasing their dividends, but be prepared that they will most probably cut them again at some point.
Energy companies such as Royal Dutch Shell (RDSA), British Petroleum(BP) and ExxonMobil (XOM) have a history of paying high dividends. When energy prices are low, these companies will increase their dividend payments. When energy/oil prices increase, their dividend yields will decrease to their historical range (3%-5%).
Royalty Trusts invest in assets in energy sector. They generate income from the production of natural resources (e.g. natural gas). They don’t have actual employees or operations of their own – they are simply a form of financing in the energy sector which allows energy companies to lease natural resource assets. Royalty Trusts are operated by banks who manage their finance, take care of the paperwork and distribute earnings to shareholders. The biggest downside of investing in this type of dividend stocks is that their dividend yield is very volatile and the shareholder has no way of knowing how much he will earn from such stock. The largest royalty trust in the US is the San Juan Basin Royalty Trust (SJT). They own oil and natural gas resources in the San Juan Basin of northwestern New Mexico.
Utilities companies are usually very stable businesses with consistent earnings. Their customers will always need water, electricity and natural gas, so they tend to keep their stability during the recession. They don’t have a lot of competitors because they already have huge infrastructure and it would be almost impossible for a new company to build such infrastructure from scratch. Stocks issued by these companies have stable price and they tend not to increase their dividend payments. Utilities usually offer limited dividend growth, but since they payout up to 80% of their earnings, they tend to offer very high dividend yields (up to 6%) to attract investors. Examples of utilities companies are Duke Energy Corp (DUK) and American Electric Power (AEP).
Real Estate Investment Trusts (REITs):
REITs are companies who own income producing real estate(hotels, shopping malls, warehouses etc.). REITs give investors the opportunity to invest in commercial real estate, but they can also sell their shares on public markets at any time. The law requires them to pay out 90% of their earnings as dividends, so they usually pay above-average dividend yields. REITs can make long-term profits because their commercial tenants often have multi-year contracts with exactly defined payment schedules. Few examples of REITs are Realty Income Corp (O), Public Storage (PSA) and Simon Property Group (SPG).
Business Development Companies:
BDCs are special type of companies which invest capital into small and medium-sized businesses similar to venture capital funds. However, VC funds are usually accessible only to investors who have a lot of money to invest. BDCs, like REITs, have to distribute 90% of their income to shareholders, but some BDCs distribute as much as 98% to avoid taxation. Some of them offer extremely high dividend yields (up to 20%), but they are also very volatile and they can blow up at any time. Because of this, many dividend investors avoid investing in BDCs. If you think that this kind of stocks are attractive to you, please make sure that you don’t invest more than 5% of your capital in such companies. One example of BDC is Apollo Investment Corp (AINV).
I hope this post will help you decide which stocks to buy. Feel free to use it as a guide to evaluate individual companies.