Tuesday, July 16, 2013

What I Look For In A Dividend Stock

Many of my readers have asked me to write about how I choose which dividend stock to invest in. I’ve been a little hesitant to write this post because well, I don’t want to be held liable for anyone’s decision to invest their money. Also some of my metrics might seem too simple to some investors.


Why spend hours upon hours reading quarterly reports or calculating complicated figures to determine value; I don’t have time for all of that. I like to keep things as simple as possible in my life, so why would the way I invest be any different? So sit back, grab a cold beverage and let’s go over some basic points I look for when investing in dividend stocks.

Dividend Growth History

Before I do anything else, I look at a stock’s dividend history. I like seeing at least 10 years of solid, continuous growth before I even consider looking at a dividend stock any further. It’s a great first screening technique that gets rid of the rift raft right from start. If the dividend is up and down like a horse on a merry-go-round, then it gets crossed off the list.

There may be a few years of stalled growth that I’m willing to allow, especially during a financial crisis, but that’s about it. I am very leery of income trusts because some of the high dividend payouts rarely increase. Even some REITs I’ve looked at have very stagnant dividend payouts. Dividend growth is THE vital component to any dividend investing strategy. Without that extra boost from dividend increases, the compounding effect on your money will be significantly less and it will take more investment capital and more time to make up the difference.

Cash Is King

I generally want the companies I invest in to have some major cash in reserve. If it’s smart to have an emergency fund for everyday people, then it’s brilliant for a company to have some cash on hand to help deal with a blip in its earnings. I don’t pay much attention to a company’s quarterly earnings; as long as they maintain the dividend and increase it once a year, I’ll be a happy investor.

Some companies, mostly utilities, have their cash tied up in assets and will not see a return on their investments until a few years down the road. That new pipeline, power-line or fiber network will need to get built and tested before it will generate revenue from customers. I’m a patient man and I will be a patient investor, as long as the dividends keep coming in.

If you didn’t think I was a quack before, this might just change your mind. Just hear me out.

Healthy Charts

I don’t put much effort into looking at charts but I do think looking at its long term shape does hold some merit. Just take a look at the chart below: (images courtesy of The Globe and Mail)
this
It looks pretty good for a chart if I do say so myself. The line is increasing with a few ups and downs in between, but it’s always going up. Now let’s take a look at another chart:

that
The line starts off looking good but looks like it hits a peak and never fully recovers. It almost seems like investors just don’t know what to think of this company.

I know I’m not an expert, and you may laugh at my point, but which company would you rather have your money invested with? A lot of the companies I invest in do not have a perfect 15 year chart, but they always seem to be going up. That’s how I know other investors feel the same way I do about a certain company and that I’m on the right path to a good investment.

Dividend Payout Ratio

The dividend payout ratio is the ratio between a company’s earnings per share (EPS) and the actual yearly dividend per share that gets paid out. To calculate the dividend payout ratio,  simply divide the yearly dividend by the EPS (Dividend/EPS for the slow ones). The lower the percentage the better, which means the earnings per share easily pays for the dividends per share. I generally like to see 50% to 80% in a potential stock; if it’s lower than 50% then they sure are being cheap and if its higher than 80% then there may be trouble to maintain the dividend. It’s not a for sure sign of a dividend cut but it’s something to keep an eye on. (Just Energy, anyone?)

Some utilities have higher ratios but that’s due to reinvesting capital into more assets as discussed before. I don’t put too much emphasis on the dividend payout ratio, but it’s a good indicator for dividend health and it helps me keep sharp on my grade three math!

If In Doubt, Be A Copy Cat

When you first start out investing on your own, you might be overwhelmed choosing any stock to invest in. I remember when I first started out on my own, I went through some old mutual fund packages to see which stocks they invested in. Sure enough some of their choices were on my first watchlist and that if the egg head financial guys liked them, I must be doing something right.

I like investing in big, large cap blue chip dividend paying stocks and since there isn’t a whole lot of them in Canada, it’s easy to find the good ones fairly quickly. Perhaps one day down the road I’ll pick through some of the mid and low cap stocks for some excitement, but for now I’m focusing on a safer bet with blue chip dividend stocks.

That’s all folks!

That’s basically it; no earth shattering revelations to see here! Like I said before, why make it more complicated then it has to be? Once you find a company you want to invest in, set your price point that gives you the yield you desire and buy when your happy with the share price. You may invest in a stinker or three, but that’s the best way to learn to be a smart investor.

I used to have a lot more metrics for choosing stocks in the past, but I’ve pruned and perfected what works for me. If anything, find out what works for you. Try other suggestions from other investors and set up your own personal metrics for picking stocks. Once you find the stocks you like, the hard part is finding the capital to invest with. Good luck with that one!

This article was written by The Loonie Bin. If you enjoyed this article, please consider subscribing to his feed.

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