Value investors like to buy cheap stocks of good companies that can grow over time. Dividend investors like to buy stocks that pay a reliable, steady and safe dividend. Some investors like cheap dividend stocks that have the best of both worlds.
Cheap dividend stocks can offer both a great dividend and the potential for the stock price to rise over time. If you can pick the right cheap dividend stocks, you can increase your total return. Total return doesn’t just look at dividend yield or rising stock price. It looks at both.
For instance, if you buy a stock for $100 at the beginning of the year and it rises to $110 by the end of the year, your return is 10% ($10 price increase / $100 investment). On the other hand, if the stock also paid $5 in dividends during the year, your total return is 15% ($10 price increase + $5 dividend / $100 investment).
Finding cheap dividend stocks is the tricky part. Fortunately, there is a good way to find them. Though it may seem like a tough pill to swallow, dividend-paying stocks that have fallen can be a good source of cheap dividend stocks.
For example, if you have a list of companies, you would like to invest in, wait until the stock price falls below your stock valuation. When the stock is down, its dividend yield goes up. If the stock eventually recovers, you will be rewarded by the stock rise. But where can we find them?
Cheap Dividend Stocks to Buy
Specific sectors of stock typically pay a higher dividend yield than average. For example, many bank, utility, oil and gas, cigarette, real estate, healthcare and consumer staple stocks can be reliable sources of dividends. Sometimes stocks in these sectors can be hit by things that cause them to fall temporarily. The key is to be patient.
Take oil and gas stocks, for example. Many times, oil and gas stocks rise and fall along with the price of oil and gas. Rises and falls in oil and gas can be caused by supply and demand imbalances. Oil prices in 2014-2016 fell dramatically. A significant increase in the world’s oil supply causes oil prices to fall. Astute investors could have bought cheap dividend oil stocks, which eventually recovered.
Over the years, cigarette stocks have paid some of the highest dividend yields of the sectors. Readers are probably aware that smoking is bad for your health. In addition, smoking has slowly decreased year after year. Sometimes these factors cause cigarette stocks to sell-off. Because smoking is addictive, the stocks usually recover.
If you don’t like buying cigarette stocks for personal reasons, that is perfectly fine. There are plenty of other stocks out there. Readers may want to do a stock valuation on the stocks in their favorite sectors and wait patiently until they become cheap. Patience is a virtue!
Best Cheap Dividend Stocks
It’s best to cast a wide net by finding as many stocks as possible that could potentially become the best cheap dividend stocks. Then keep an eye on your stocks until you’re ready to buy. In the meantime, here are a few stocks to consider.
- Merck (NYSE: MRK): Merck is one of the largest drug companies in the U.S. Merck’s drugs treat cancer, HPV and animal health. The company also has many drugs awaiting approval. Merch has grown sales and earnings per share over the last several years. In addition, it has a P/E ratio of just over 16x. The stock pays a healthy dividend yield of about 3.26%.
- The Home Depot (NYSE: HD): Home Depot is one of the leading home improvement chains in the US. Customers range from DIY folks to construction crews. Though the stock rose dramatically during COVID-19 stay-at-home restrictions, the stock has pulled back so far in 2022. Currently, the stock pays a dividend yield of about 2.5%, and it has a P/E ratio of less than 20x.
The Risks
There are risks to investing in cheap dividend stocks along with every stock. For instance, stocks can be down for temporary reasons, but they can also be down because of permanent problems. It may be difficult for investors to distinguish between the two.
Take cigarette companies, for example. Cigarettes are inexpensive to make, and companies sell them for a high price. Therefore, companies have large profits to pay dividends. If smoking continues to decrease as it has in the past, profits may decrease.
Same with oil and gas companies. Oil and gas have been a major energy source for countries around the globe. Environmental concerns about oil and gas usage have caused an increase in renewable energy sources. Though renewable energy sources are currently expensive and only supply a small percentage of the world’s energy, there is a chance that oil and gas profits will decrease over time.
When profits fall permanently, the risk is that companies decrease or even eliminate their dividend. If that is the case, your total return could be severely harmed by a decreasing dividend yield and a falling stock price.