If you own individual stocks, it's generally a smart idea to own at least one dividend-paying equity. The main reason is that dividend stocks with yields below the average of the S 500 index, which stands at 1.62% at present, frequently deliver above-average returns on capital on a multiyear basis. Alternatively, stocks with yields above the S 500 average can serve as powerful hedges against market volatility, and provide healthy levels of income over time. Like any investment, though, you should have a clear idea about how a dividend stock fits into your broader strategy and overall portfolio before buying shares.
So why buy a dividend stock? dividend stocks can serve one of two mutually exclusive roles in a portfolio: capital appreciation or income generation. On the capital appreciation side of the ledger, you want to own stocks with fairly low annualized yields, strong and sustainable earnings power, a premium valuation, and, related to this last point, clear-cut forward momentum in terms of its share price over the prior five-year period. By contrast, stocks suited for the income generation bucket should sport sizable yields, sustainable payouts, healthy free cash flows, a bargain-basement valuation, and relatively low share prices. More on this underappreciated point later.
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Source Fool.com