I've been trading and investing in stocks for over 20 years and use them as a source of side income. I was also a Motley Fool blogger.
How to Make A Passive Income Through Online Stock Investing
If you haven’t yet started investing in stocks, you’re missing out on a tremendous opportunity to collect extra money each month, save towards your next big purchase or vacation, and even boost your retirement savings. Stocks not only appreciate but pay out dividends, and these two cash-generating realities are what keep many people and retirees in the green long after they’ve resigned or retired from their jobs. The best news is that you don’t need thousands of dollars to start investing in the stock market. Many online stock brokerages let you invest for as little as $4/month. Many other brokerages now offer trades for free!
How Do You Begin Trading Stocks?
Overall, the quickest way to becoming a stock investor is to purchase stock using an online brokerage. There are several different ‘no frills’ online brokerages that offer fast trades and promise low commissions; several such example brokerages are listed below.
Ally Invest (formerly TradeKing): This site offers free (self-directed) stock trades, with no minimum account balance. Plus, you gain access to its Trader Network, where you can research stocks and obtain investment information from other community members.
Betterment: If you’re not sure which stocks to buy, Betterment’s “set-and-forget” purchase model may work for you. With Betterment, you select your risk tolerance and let the site pick your stocks and bonds. In essence, you buy into a mutual fund, but without the requirement of having $10,000 or more to invest. Unlike typical money managers that charge a 1% or higher annual fee for picking your stocks, Betterment charges only 0.25%.
Charles Schwab: This online discount brokerage free online trades, with no account minimum amount required. Also included, for no extra fee, is the brokerage’s “proprietary and third-party research.”
E-Trade: This tried and true online brokerage offers online stock trades for $0, plus loads of free webinars, articles, and courses to make you an informed investor. It also runs frequent promotions like cash bonuses for funding new accounts or adding money to existing accounts.
Now that you’ve found a way to buy stocks cheaply, how do you buy the ones that will make you a passive income?
Making a Passive Income With Dividends
Many stocks pay monthly, quarterly, or yearly dividends to their shareholders. These dividends are declared a few weeks or even months ahead of their payment date as part of the company’s news. The stock dividend is a discrete monetary amount that is paid by the company to stockholders on a given date and shows up as additional cash in their investment accounts. The company typically pays a dividend out of its gross profits; conversely, if a company’s gross profits decrease or disappear, the dividend may also follow suit. In most cases, however, companies will be reluctant to decrease or end their dividend payouts since this often precipitates a huge drop in their stock price as a result of investors leaving for other dividend-paying companies.
In order to obtain the dividend, you must be a stockholder of the given stock by its stated ex-dividend date. The ex-dividend date is a specific date set by the company at which its stock will start trading at its price “except the dividend”. In other words, stockholders who purchase the stock on its ex-dividend date will not receive that stock’s upcoming dividend. Therefore, the stock must actually be purchased the day before its ex-dividend date if you are to obtain the dividend.
Companies also list a record date for their stock dividend payout. The record date is the date at which the company’s accountants will actually record all stockholders of that company’s stock. It is these stockholders that will receive the dividend. In most cases, the record date will occur two days after the ex-dividend date and three days after the last possible day to purchase the stock with its dividend intact. Why is there a three day discrepancy between when a stock is purchased and when it is recorded as purchased? The reason has to do with purchase settlements; all stock purchases and sales require a three day settlement period before they are recognized as valid by the Securities and Exchange Commission (SEC) (and the IRS). Therefore, purchasing a stock on its actual record date will not entitle you to the dividend because you will not be “on the books” until three days after the stock purchase.
One example of a dividend-paying company is Eli Lilly & Company, which pays quarterly dividends to its investors. This company announced on April 18th that it would be paying a dividend on June 10th to investors of record as of May 13th. The ex-dividend date was set at May 11th. What this means for you is that you need to purchase the stock at least one day prior to May 11th (i.e., May 10th or earlier) in order to obtain the dividend payout that will occur on June 10th.
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Because many investors rely on dividend income as a source of primary or supplemental income, they will often try to make some easy money by buying a stock the day before its ex-dividend date and then selling it on its ex-dividend date. This is one way in which money may be made on dividend stocks. However, the risk in taking this approach is that dividend stocks usually depreciate in value on their ex-dividend date because the company is now operating with less cash as a result of paying out a dividend. So, while you may earn a dividend payment of $0.10 per share on a recently purchased stock, you may also lose $0.10 per share on that same stock by the time you sell it on its ex-dividend day. Furthermore, because dividends are taxed, you can actually lose money as a result of this particular strategy.
To Buy, or Not to Buy, for the Dividend
Now that you have an investment account and some investment ideas lined up, should you invest in growth or dividend-paying stocks? Keep in mind that, although growth stocks can increase your net worth considerably, that growth can also stop or even reverse. On the other hand, dividend-paying stocks may not grow as quickly but they are generally more stable. Plus, you get a dividend payout every month or quarter, which means a guaranteed passive income for spending or future investment. Some dividend-paying stocks, such as real estate investment trusts or REITs, pay quite well, making you 10% or more per year in dividend income alone.
An alternative approach to making money on dividend stocks is to actually wait until the ex-dividend date and then purchase them. Because the stocks will have depreciated a certain amount of money, buying them at a discounted price will be easy. You can then wait until those depreciated stocks again appreciate as the next ex-dividend date approaches before selling them.
There are some disadvantages with this approach. First of all, buying and holding onto a stock until its next ex-dividend date takes at least a month, if not longer; meanwhile, the money invested in that stock is unavailable for other stock purchases. Also, stocks that are bought and sold in less than a year’s time are subject to capital gains taxes, which can be significantly higher than the taxes paid on dividends alone.
Given the inherent disadvantages in buying stocks simply for their dividends, is there a dividend stock buying approach that works? Yes. One can still buy and sell stocks simply for their dividend if the company has been carefully researched and found to be undervalued. This way, even if a stock depreciates after its ex-dividend day, the inherent value of the stock shares will result in a price increase over time. Also, it is a good idea to purchase a stock a few days (or even a week) ahead of its ex-dividend day, when its shares are not bound to artificially appreciate as a result of the declared dividend.
As a general rule, investing in stocks that pay a dividend is a good way of ensuring that you have passive income coming in every month or quarter. Because many stocks have tanked in recent months, you cannot rely on simple stock price appreciation to make money anymore. These days, it pays to have dividends as a back-up strategy for (continually) making money on the stock market.
10 Ways to Value a Company and Its Stock
Many different companies pay a stock dividend, from biotechs such as Pfizer to old standards such as Johnson & Johnson. How can you differentiate between all these different companies and decide which dividend-paying stock is best for you? Here are 10 things you should look at before investing in any dividend-paying company:
- The dividend amount: Given that many CD’s pay an annual yield of 3% and are arguably a much safer investment vehicle, it does not make much sense to purchase stock in a company that pays anything less than a 3% dividend yield.
- P/E ratio: While obtaining a dividend yield of 5%, 6%, or even 10% is great, it will mean nothing if your stock price tanks. The P/E ratio, which is the price of the company stock divided by its earnings, is a good indicator of whether or not the stock price is overinflated and therefore prone to dropping. If a company stock price has a P/E ratio of 25 or higher, it may be time to start looking elsewhere.
- Gross revenue: American companies listed on the stock market must file a yearly income statement (also known as a statement of operation). In the income statement are listed items like gross revenue, operating expenses, and net income. If a company does not show its gross revenue to be increasing or at least holding steady compared to the last several years, there may not be much of a future left for this company. Furthermore, while other numbers (e.g., income) are easy to skew, gross revenue is difficult to lie about and arguably remains the truest metric of a company’s financial health.
- Sales growth: If the company’s sales are increasing, that is a good measure of its overall health. More sales typically result in higher profit, which trickle down to continued or even increased dividends.
- Net income: If a company does not report a positive net income, or if it reports a smaller net income compared to the prior year, there may be good reason to not invest in this company. Companies that continually report negative income also have a difficult time appreciating in stock price.
- Operating costs: Contrary to popular belief, operating costs should not decrease year after year but actually increase in proportion to the gross revenue. If they are decreasing, especially drastically, that could mean that the company is laying off workers to bump up its own bottom line. Alternately, the company may be preparing itself for a big change, such as moving overseas or just shutting down.
- Dividend trend: A company that is increasing its dividend payout year after year is usually a company that intends to keep its dividend around for a long time. This is useful because you don’t want to have the nasty surprise of seeing your dividend payout suddenly reduced or eliminated.
- Sector health: While a specific company is not its sector and vice-versa, stocks do trade on strong psychological factors. As a result, a dividend stock that is purchased in a sector that is doing poorly may also do poorly.
- Future outlook: Are the company’s patents expiring soon? Does the company have exciting new products in the pipeline? How many other companies are producing and/or providing the same product as this particular company? These are all questions to ask when analyzing a company for dividend payout, because that payout may not yet be seen for several weeks or months.
- Explaining the business: Does a company’s dividend look great but you have no idea how the money is made to pay that dividend? If you cannot understand the business or the industry, you may be better off looking at other companies whose business models you do understand.
Where to Find Free (or Almost Free) Stock Information
Researching which stocks to buy can be done on the cheap if you know where to look. The Motley Fool has been offering investment advice since 1993, and while some of its services are offered through paid subscription, many other features—including the website and blog—are completely free.
The Motley Fool
Another great way to obtain expert investment advice is by signing up for a free—yes free—subscription from The Wall Street Journal. Sites like Hey It’s Free and Hunt4Freebies provide information on how you can score a free subscription to this information-packed journal. Students can occasionally sign up for the WSJ for free.
Free Stock Screeners
If you need help picking individual stocks to invest in, you can use at least two free stock screeners. What exactly are stock screeners?
In a nutshell, stock screeners are online tools that work with specific criteria, input by you, to create lists of qualifying stocks. For example, if you're looking to compile a list of stocks have a P/E ratio of no greater than 15, then a stock screener can be set to that criterion and provide you with stocks having P/E ratios no higher than 15.
Zachs Stock Screener
Zacks Stock Screener is a stock research company offers both free and paid stock screeners that enables you to analyze stocks based on various parameters.
Google Finance Stock Screener
Google Finance Stock Screener: This screener is fairly simple to use and offers an inyuitive user interface. It's free to download and use.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.