A great way to boost your income is by investing in dividend stocks. Investing $10,000 in a stock yielding 10% would result in $1,000 in annual dividend income. But investing in high-yielding stocks is generally risky. Companies usually don't offer yields that high. If a company's stock is suddenly yielding that much over a short period of time, it'd mean the share price has been falling over that period (usually over 18 months or less). That could mean underlying problems or concerns with the business and the market is less confident about the company's outlook.
For those reasons, it can sometimes be difficult to determine how much you should expect to earn in dividend income while keeping your portfolio safe. Below, I'll look at the types of dividend stocks you should target, and what a safe yield might be.
3 healthcare stocks with 3 different yields
The S&P 500 has a dividend yield averaging 1.7%. If your primary objective is to collect a dividend, and you aren't looking to just invest in the S&P, you should target a rate higher than that, since investing individually in stocks is riskier than holding a broad index, and you should be compensated for that risk.
A high-yielding stock that could grab investors' attention today is Medical Properties Trust (NYSE: MPW). At over 10%, it initially looks as though it may be too good to be true. The real estate investment trust (REIT) has more than 430 healthcare properties in its portfolio (its focus is on hospitals), spanning several countries.
Through the three-month period ending Sept. 30, the REIT has reported funds from operations (FFO), a key metric for REITs, of $0.42 per share, down slightly from the $0.44 it reported in the same period last year. A dividend of $0.29 per quarter translates to a payout ratio at 69%.
Let's compare this to another healthcare stock, CareTrust REIT (NYSE: CTRE). Its dividend yield of 5.7%, while nowhere near Medical Properties' level, is still considered relatively high. The REIT also invests in healthcare properties, with a focus on senior housing and skilled nursing facilities. It's smaller in scale, with around 200 properties, and it is less diversified, focusing on the U.S. market.
For the period ending Sept. 30, CareTrust's FFO per share was $0.28, almost identical to the $0.27 it reported a year ago. That doesn't leave a huge buffer over the $0.275 it is paying out in quarterly dividends right now. It serves as a good example of simply having a lower yield not necessarily resulting in a dividend stock that is a safer option.
Next, let's assume you aim for an even lower yield, going instead with a healthcare stock like Johnson & Johnson(NYSE: JNJ), which yields 2.6%. The company makes medical devices and pharmaceuticals that people around the world use and rely on. It's not a REIT, so it doesn't use FFO. Investors can simply look at its net income figure to see how well the business is doing.
Its diluted per-share profit of $1.68 for the period ending Oct. 2 was sufficiently higher than its quarterly dividend payment of $1.13, putting its payout ratio at a more modest 67%. Johnson & Johnson is also a Dividend King, having increased its dividend payments for 60 consecutive years.
Here's a summary of the three stocks:
| Company | Forward Dividend Yield | Payout Ratio |
|---|---|---|
| Medical Properties Trust | 10.2% | 69% |
| CareTrust REIT | 5.7% | 98% |
| Johnson & Johnson | 2.6% | 67% |
Table by author. Payout ratios for MPW and CTRE are based on funds from operations.
Investors need to look past the yield
As the table above demonstrates, a yield on its own won't tell you that a dividend is safe. While Johnson & Johnson's payout ratio suggests it is the safest, the higher-yielding stock Medical Properties doesn't look much more dangerous at first glance. However, one of the added risks with REITs is that they carry significant debt, and that can make them unappealing investments to own in a rising interest rate environment.
Data by YCharts.
Johnson & Johnson is undoubtedly the safest of these dividend stocks to own, as its payout ratio is the lowest, and its debt-to-equity ratio is also the best. While Medical Properties is a bit higher than CareTrust, the difference may not be enough to suggest that it's a much riskier buy, given that it has a better payout ratio.
What yield should you target?
If you're a risk-averse investor, a stock like Johnson & Johnson would serve as a relatively safe investment to own. That means that, on a $10,000 investment, you could expect to earn approximately $260 in dividends on an annual basis. But over time, that amount is likely to rise given the company's track record for paying dividends and its strong financials. The healthcare giant is also the only investment on this list to be in positive territory this year (it's up 3%).
Although there isn't a percentage that will guarantee you safety, generally, once you look at yields of more than 5%, you can expect a bit of risk to come with those payouts. Medical Properties' 10% yield is certainly appealing, but with the stock crashing more than 50% this year and having the highest debt-to-equity ratio on this list, those payouts would be of little comfort to investors who have incurred significant losses on the stock.
Investors are better off targeting a modest yield above the S&P 500 average but below 5%, buying shares of a solid business like Johnson & Johnson that's likely to do well regardless of the state of the economy. Swinging for the fences and targeting high yields could lead to some mammoth dividend income, but it could prove to be moot if you lose big on the stock or the company reduces the payout.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.
