Passive income investing

If you want to invest for passive income, look no further then dividend paying stocks.

We’ll talk about what dividends are, why companies give them out to shareholders and the pros and cons. 

At the end I'll give you four great dividend stocks to put on your watch list.

Dividends are a great way to earn consistent income. Companies pay out dividends to their shareholders on a quarterly basis, but there are also companies that pay out monthly, semi-annually or annually dividends.

When you receive a dividend, it is either deposited in your cash account or it is reinvested to buy more whole or fractional shares. This is also called a dividend reinvestment plan or DRIP.

The ultimate goal of a dividend strategy is to receive dividend payments that meet or exceed your earned income. It is at this moment that you can retire and live off dividend income without ever having to sell the underlying stocks.

It's also important that these dividend payments grow faster than inflation in order to maintain your buying power.

Do you need 1 million dollars to start investing in dividend paying stocks? Of course not. You can start off by just buying one or two shares in dividend-paying companies.

However, it will help if you have more money to invest, because you'll get more in dividend income. The more shares you own the more dividends come your way.

For example, the Coca-Cola Company pays out a 37 cents quarterly dividend, which adds up to one dollar and 48 cents a year.

That's what you would receive if you only owned one Coke share, but if you owned 100 shares you would receive $148 for the year.

In order to see your dividends make an impact, there are three things to take into account.

Number one is, of course, buying dividend stocks on a consistent basis. Number two, the dividends you receive need to be reinvested or used to buy other shares that pay dividends and number three, the companies you invest in need to grow their dividends faster than inflation on a yearly basis.

These three factors will snowball your dividend income. Companies that pay dividends are usually blue-chip companies. These are well established and large companies. They are the top companies in their industry, companies like Walmart, 3M and Proctor & Gamble.

Because these companies are well established they tend to not experience a ton of growth, like a successful startup company.

Many of these blue-chip companies generate a ton of cash, which they end up paying out as a dividend to their shareholders.

Shareholders demand these dividends from companies as a repayment for investing and believing in the company, but leadership in the company also benefits from dividend payments, because they get awarded stock shares and options.

So, let's say you have a successful local company selling ice cream and are planning to expand nationwide. You need more capital in order to achieve this, so you connect with investors who will invest in your company, but they want ownership in the form of stock shares.

Your company goes public and after 15 years you've been able to expand nationally. Your business is at a point where growth is slowing down.

Your investors who’ve held onto these shares want to receive some of their investment money back. So, you decide to pay dividends to your investors, so they can take their dividend income and invest it in a new business opportunity.

Keep in mind that not all companies pay a dividend, because every company goes through the business lifecycle.

A business first starts out as an idea in the mind of the creator. It is in this start-up phase where it can be a small group of people working together, believing in the idea of the creator.

It's also at this point where venture capitalists and angel investors could see the potential of the business.

After working out all the kinks and learning from their mistakes, the company should have a customer base. It now can enter the growth phase. In this phase there are still a lot of growing pains, this is also where a company might decide to go public and issue shares to potential shareholders.

All the revenue a company generates is invested back into the business to further grow the company, think about businesses like Snapchat.

A company eventually hits the maturity stage where it is well established and a leader in its space. It's at this stage cycle where most companies start to pay dividends to their shareholders, companies like Walmart Clorox, ExxonMobil and even Johnson & Johnson.

Being a leader in your market is great, but if companies are not careful they can shift into the decline cycle where their products are becoming obsolete, like the Walkman or Polaroid pictures.

Some of the pros of dividend investing:

They are stable and consistent more so than capital gains. You benefit from the cash payment and also from the increase in the share price of the stock.

Because these companies are seen as more stable they tend to perform better during the stock market crash, because investors will sell their riskier stocks and look at more safe and stable companies and bonds to invest in.

You can also plan out your dividend income, which is something that is harder to do with capital gains.

A couple of cons of dividend investing are: companies that pay out a dividend tend to appreciate slower in the stock market. Companies can also cut or even stop paying a dividend and some companies don't even grow their dividends.

It is therefore important to only invest in great dividend-paying companies, which will not only pay a healthy dividend, but also have the financial capabilities to grow these dividends yearly.

Let's look at four of these companies:

Number one: Walmart - this retail giant has stores worldwide, saving their customers money by providing products at competitive prices. Lately they've been focusing much more on their online presence. They bought jet.com and a delivery company to improve their same-day-delivery.

Number two: Lowe’s - the second biggest home improvement retailer, with of course Home Depot being number one. Lowe's has done such a good job in their field, they've been able to pay a consistently growing dividend for over 50 years!

Number three: McDonald's - the golden arches have been dragged through the mud, especially with the younger generation focusing more on healthier food and snacks. However, McDonald's is still the number one fast food restaurant and this giant pays a quarterly dividend.

And number four: Fastenal - this boring company provides tools and equipment for businesses to create products, build and maintain facilities and they also sell safety products for personnel. 

Fastenal not only has a great business, they also have repeat customers. Nothing is more important for a company than having customers that constantly return to buy your products.