Dividend income is secure income while investors with comparatively low risk appetite prefer dividend stocks in their portfolio. It is also a good investment from those who don’t want to watch the market every day and still want to secure their investments and make money. If anybody needs to park money for higher regular return, they can park their money into high dividend stocks. The key things that dividend investors can pay heed to –
Quality of business: Investment in high quality businesses gives comfort in terms of stability, growth and profitability. Investment into business that has strong history of solid growth enables companies to distribute profits by giving dividends. One should consider the dividend stocks by long-term earnings-per share growth or dividend growth. The constant dividend also typically indicates for quality of business growth.
Dividend consistency: Investors prefer companies with long dividend history in the rising trend. Invest in businesses that have higher income that help to ensure that dividends won’t be cut during business downturn. This can be easily analyzed by dividend payout ratios. The rise in dividend in a continuous manner is also a good indicator that company is growing and giving sustainable returns to the investors. One should look for such companies with strong fundamentals and growth records.
Frequency of paying dividend: If the stock reduces its dividend, it indicates that the business has lost its competitive advantage and reinvested the proceeds of the sale into more stable business. Additionally, if the frequency of dividend payout is not consistent, it may mean that the business is not stable. In good time the company is paying while in bad times it is unable to bring growth to distribute profit. Thus, the consistency in general is indicative of the stock being on growth radar.
Reinvestment of dividend: Investors can use reinvestment programs, which would allow them to reinvest dividends automatically without paying commission. With the passage of time, more capital is allocated to the business and dividend payout can continue to increase with growing business. The compounding makes big difference to your portfolio as we can see from following chart.
Region-wise Returns from Dividend Yields (Source: Financial Times and Société Générale)
Dividend payout ratio: Dividend payout ratio is also one of the important criteria, as higher the ratio means that the company is keeping minimum profits for reinvestment in the business for future growth. More than 100% indicate a concern as company is paying out of its current reserves.
Stability and cash flow: Some entities tend to generate high levels of cash like bank, consumer staple, utility and insurers. Such entities with volume sales tend to have a reputation for generating positive cash flows as compared with companies with small product portfolio. Further, the companies generating strong operating cash flow tend to distribute better dividends to investors as well as indicate a healthy picture from future growth perspective. Such companies are good investment bet from dividend perspective. Companies with decent portfolio of products and poor sales might not be able to generate cash flow as poor performance may be eating away cash flow of good product sales.
Identifying value: Identifying the value is very important. One can make greater return if one can invest for a longer period of time in stable companies that pay consistent dividends and raise those dividends on steady basis. This approach can yield greater return but identifying value is important.
Performance in recession: The performance of the company in the recession should also be considered. The real world data can help an investor find companies who are much less cyclical than others. Investors need to find such companies which are not much affected by recession and manage to reward investors by paying dividends.
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