How to Make $3000 Using Dividends in 2023 – 5 Pillars You Need To Master Today
One of my most favorite passive income ways other than selling premiums is Dividend Investing.
Living off dividends means your portfolio generates a passive income stream that can cover your expenses indefinitely. No more punching the clock to earn a paycheck or worrying about your portfolio’s fluctuating value as long as the dividends keep rolling in.
Like clockwork, and requiring no effort on your part, the dividend stocks and funds you hold deposit recurring dividend payments into your brokerage account throughout the year.
How Dividends Work:
Before we get into the strategy, let’s first explore how dividends work with an example.
Bank of America’s Dividend:
Bank of America is one of the world’s leading financial institutions, providing individual consumers and businesses banking products and services.
If you owned 100 shares of Bank of America today, the bank would pay you a dividend of 48 cents per share on the number of shares you own. In other words, you would be paid $48 annually for owning the shares. Since dividends are paid quarterly, you would receive a $12 payment per quarter.
The dividend yield would be 1.6% annually for owning Bank of America stock. The dividend yield is merely the current stock price of $30 divided by the annual payout of 48 cents. The yield is the annual percentage return you can expect to receive for owning the company’s stock.
With a dividend income strategy, a portfolio is constructed containing shares of companies from various industries that pay quarterly dividends. The goal of the strategy is to create a steady income stream from the portfolio’s overall dividend yield to cover your living expenses in retirement.
What’s a Realistic Dividend Yield?
Once you’ve determined how much you want to spend each year, you’ll need to determine what type of dividend yield you can realistically expect. While your mileage may vary, you can normally expect a dividend return of 1% to 6%.
The overall dividend yield of your investment portfolio will be determined by its composition. For your reference, below are some samples of typical historical dividend yields on several popular assets:
- Vanguard S&P 500 Index Fund ETF: 1.85% long-term average
- Ford Stock: 4.88% average over the last five years
- Schwab US Real Estate Investment Trust (REIT) ETF: 2.67% over the last five years
To figure out the amount of money you’d need to invest to live off dividends like this, you’ll need to define two variables:
- The amount you plan to spend per year
- The dividend yield of your intended portfolio.
Say you plan to spend $20,000 a year to support yourself and your family in the future. If you believe you could achieve a portfolio with a dividend yield of 5%, divide $20,000 by 5% to find a minimum portfolio value of $333,333.
$20,000 / 0.05 = $333,333
$20,000 might seem small for a $300K investment. But here’s what you need to rethink,
- Steady Income — You make steady $20,000 per annum through dividends monthly/quarterly
- Start Small — Always use DRIP to compound it annually. In 2002, a $5000 investment in $HD would yield a $100,000 portfolio in 20 years. Compounding has that kind of power.
- Sell Premiums — Option strategies such as covered call and cash secured put can also be used to sell premiums and earn extra money. If you have a $100,000 portfolio and sell premiums on QQQ, you may easily earn $150 x 3 = $450 every week. You may earn $23,400 per year merely by selling premiums. You may now earn an extra $23K. You can also sell premiums even if you don’t own shares. I teach the strategies on how I make steady 25–30% a month in my book here.
That’s why people say, dividend investing is always the KING!
How to Evaluate Dividend Sustainability
All of the videos and articles I read online would give me a full breakdown analysis and tell me what to invest in, but it was difficult for me to pull the trigger because they didn’t explain the reasoning behind why they did what they were doing.
The “why” is one of the most important parts of investing. If you know why you chose a company, you can be confident with your portfolio. This is what I was searching for as a beginner investor.
Before I started investing, my greatest mental barrier was if I had enough cash to make investing in the stock market worth it. I quickly realized, after some trial and error, that it’s not about how much money you start off with, but about how you invest it.
Any investor can take $100,000, put it in a dividend paying stock and generate a decent return. A great investor can take $100, make it compound on itself and turn it into $1,000.
Below are the 5 Pillars to Master for a Sustainable Dividend Investment:
#1 Cash Flow: The Cash Flows Statement (CFS) is a financial statement that gives a general overview of the amount of cash and cash equivalents entering and/or leaving a company.
The cash flows statement measures how effectively a company manages its own cash position. There are different components of Cash flow like Operational Cash Flow, Investing Cash Flow, Financing Cash Flow. But the most simple and important one that you must consider checking is Free Cash Flow. This is the bread and butter when it comes to analyzing the cash flow statement, and it is equal to:
Free Cash Flows = Net Cash Flow from Operations — Capital Expenditures
As investors, we are looking for companies that will be in business for years to come, so having a positive free cash flow can attribute to many years of successful growth.
#2 Earnings Per Share (EPS):
EPS is calculated using the below formula,
EPS = (Net income — Preferred Share Dividends) ÷ Average Number of Outstanding Shares
EPS measures the amount of net income earned per share of stock outstanding in the market. This ratio is extremely important and, in my experience, a strong indicator of a company’s profitability.
Investors love to analyze EPS because it highlights how profitable a company is on a shareholder basis. It provides a level playing field of comparison, so you can see how a larger company’s profits per share differ from a smaller company’s profit per share.
Keep in mind that this ratio depends on the average number of shares outstanding in the market, so generally larger companies like Apple (AAPL), who currently has approximately 4.455 billion shares outstanding would have to make considerably more income than a company like Boeing (BA), who currently has approximately 562.79 million shares outstanding in order to have similar EPS ratios.
A higher EPS is always better than a lower EPS because it signals that the company is more profitable, as they are generating more income in comparison to their outstanding shares. It also indicates that the company can distribute more of its profits to shareholders if it wishes to do so. As a dividend investor, I love seeing a higher EPS as this means there’s more possibility of dividend increases in the future.
#3 Price Per Earnings Ratio (P/E):
P/E ratio, which stands for price-to-earnings ratio, couples well with a company’s earnings-per-share (EPS). It helps investors to evaluate a company’s stock price in relation to its EPS. This is a powerful tool because it allows us to determine the value of a stock.
Buying a stock that’s “undervalued”, according to the P/E ratio, means that the company’s price is likely to increase in value over time, and vice versa for those that are “overvalued”.
It’s important to understand that a number at face value doesn’t give us much information. P/E ratios are used against industry benchmarks to determine if the company is in fact undervalued or overvalued within its respective sector.
#4 Dividend Yield:
The dividend yield is a formula expressed as a percentage used to measure the amount of cash flow you’re getting back in return for every dollar you invest in a company. In more simple terms, it’s how much “bang for your buck” you’re getting from your money.
You may be wondering what makes a good dividend yield? Well, the answer isn’t quite that simple because general stock market conditions can always have an impact on the yield, but I like to stay within a range of 3–6%.
#5 Payout Ratio:
Many people overlook the payout ratio although it’s a great indicator for predicting the future growth or decline of dividend payments. Let’s breakdown the formula:
Payout Ratio = Annual Dividend Per Share / EPS
Companies continue to pay dividends due to two main reasons:
- They don’t want to look bad in the eyes of their shareholders if they cut dividends, which can have a significant impact on their share price.
2. Paying out dividends is a matter of pride for many companies as it signifies an act of giving back to the shareholder for placing their trust in the company. Some companies have been paying out dividends for years. Cutting or eliminating them altogether could have a tragic impact on shareholder confidence.
Refer to this guide next time you are looking to do a deep analysis of an investment opportunity. If you can check off all of these boxes, you are looking at a strong investment that will pay you increasing amounts over time.
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