How to invest in dividend stocks to build quick passive income - financial independence

If you’re looking to generate income through investing then doing some research in good dividend paying stocks will help you to develop another stream of income as well as capital growth of the stock. What most investors are interested in is the dividend yield; these investors usually neglect company fundamentals.

By neglecting company fundamentals you run the risk of investing in a company which has poor financials and any money that you do make trough dividend income could be undone by loss of capital. The best way to generate consistent income is by investing in good dividend paying stocks that have a reasonable sustainable yield and good underlying fundamentals.

Finding Good Dividend Paying Stocks
Looking at the Financial History of Stocks

Before you invest your money into dividend paying stocks you need to research the entire market to find the best companies to invest in. One of the best places to do your research is MSN Money where you can find the underlying financial numbers for every dividend paying company for the last 10 years.

Looking at the Bigger Picture When Investing in Dividend
How Long Do You Want to Invest Your Money?

Before you invest in dividend paying stocks you should have clearly defined goals, one of the most important decisions you need to make is the length of your investment, the longer you leave your investments the greater the chance of making money. If you’re planning on investing for a year then dividend stocks might be the wrong option and you should consider deposit accounts.

Dividend stocks should be a long term investment in a company that you really believe in; if the company has had strong earnings in the past then the chances are it will have strong earnings in the future. Your task is screen stocks that pay excellent dividends and then check the company’s financial history to determine the fundamental strength.

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The Screening Process for the Best Dividend Paying Stocks
Screeen To Find Quality Stocks

If you go to Dividend.com you’ll be able to screen for the highest paying dividend stocks and then download the results on an excel spreadsheet. This list will contain stocks that pay dividends up to 20% or more! Your next step is to then go to MSN Money and check the financial history of the stock for the last 10 years.

You should look at the following financial indicators to determine financial strength: PE Ratio, Return on Equity, Return on Capital, Debt, and Stock Buy Back. You should also check to see if the stock has a durable competitive advantage, this means the stock has a strong brand presence and does not need to engage in price wars now does it have to invest large sums of money to remain the market leaders, such companies would include Coca Cola (KO) and H & R Block.

PE Ratio: You need to check the PE Ratio for the last 5 years. The price earnings ratio is simply the price of the stock divided by the earnings per share, the PE Ratio tells you how much you need to invest in order to get a $1 in earnings. If the company has a PE Ratio of 60 this means that you need to invest $60 to earn $1, if the company has a PE Ratio of 10 this means that you need to invest $10 to earn $1. The lower the PE Ratio the more valuable the company as you’ll get a higher return on your investment. High PE Ratios represents a company which is overvalued through possible speculation; a low PE ratio shows the stock to be undervalued possibly through extreme pessimism.

Return on Equity and Capital: If a company was making $10 profit a year and had assets of $100 and liabilities of $50 then the Return on Equity would be $10/($100-$50)= 20%. The return on capital would be $10/$100=10%. What you should look for is consistently high Return on Equity and Return on Capital for the last 10 years.

Debt: Another important measure of a company’s strength is long term debt, you should look for companies that have little or no debt, when the company does have debt you need to know how long it would take to pay it off from earnings; the quicker a company can pay off its debt the stronger it is financially. If a company has $150 billion in long term debt and only earns $3 billion per year then it would need 50 years to pay off its debt. If another company earns $50 billion a year then it would take 3 years to pay off the debt.

Stock Buy Back: You should also look companies that actively engage in stock buy backs, if you own shares in a company and the stock has a history of buying back its own shares then your holdings become more valuable, if a company has a history of issuing more shares then your holdings will become less valuable.

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Buying Good Dividend Paying Stocks
Once you’ve analyzed every stock in the list you should be left with a handful that strikes a balance between dividend yield and financial strength. You next step is to find the best prices to buy into the stock using technical analysis indicators. You should also try to find the best brokers with the lowest commission when placing your trades and then be patient and wait for your analysis to be rewarded. You should re-evaluate your holdings every six months and replace companies that have become weak with stronger companies.

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