If you are investing in dividend stocks for income, you already know that there are 1000’s of companies to consider when investing your money. So how to you choose the best place to put your money? You’ve heard it a hundred times – to protect your portfolio, be “Diversified”. But what if you diversify using the wrong mix of companies? It’s not hard to build a really poorly performing portfolio – so how can you avoid those pitfalls and rise above?
Well, there’s no silver bullet, but here are a few things that I look for when adding a new position to the DDI Portfolio.
Here’s my Top Five Factors for Choosing the Best Dividend Investments…
1. Are the Current Earnings Greater than the Dividend Paid?
This is probably the most basic rule and the one that should come first. Before investing for a dividend payout, look at the amount of current and recent (last 2 years) earnings for the company you’re going to invest in.
Is the amount of earnings greater than the dividend payout? If it’s not, then this is potentially a red flag telling you to look elsewhere. It’s Cashflow 101, if the amount of money coming in (earnings) is less than the amount of money going out (dividends) then at some point there is going to be a problem. Some times this is a short term problem – perhaps the company had a one-time event that skewed their financial position, but a return to positive cash flow seems likely. This is where as an investor, you’ll need to make the decision to dig deeper before deciding to walk away. While I have invested in companies with earnings that fell short of covering the dividend – some times the risk may be worth taking.
The point, is this is a fairly simple rule that you can use for evaluating the safety of the future dividends. You’ll have to make a decision about “Dividend Coverage” as well – meaning, what percentage of the earnings are paid out in dividends. Obviously the smaller the percentage paid out, the more likely the dividend will be paid on an ongoing basis. I’ll discuss “Dividend Coverage” in more detail in a future post.
2. Is the Earnings Growth Rate Positive?
Now that you know that your company’s earnings can cover the dividend, let’s look to see if the earnings have been growing. Again, I’d start by looking at the last 2 years – if the earnings were positive for that period, I’d look back 5 to 10 years to see what the longer term growth rate is.
There’s no right answer here and even a quarter or two with little or no earnings growth isn’t a deal breaker. However, finding those companies with consistent long-term earnings growth indicates an ability (although not a requirement) to pay increasing dividends.
One of the biggest challenges with investing for income, is keeping up with and exceeding inflation – so it’s not enough just to build your dividend income portfolio with companies with consistent dividend payouts, you need to look for and add those companies that will have the ability to increase their dividend payouts over the long term.
Dividend Investing Top 5 Recap
Most concepts in investing aren’t really very difficult as we’ve seen with the first 2 of our 5 factors to consider before investing in a dividend income stock:
1. Can the earnings support and pay for the dividend?
2. Are earnings growing, in order to support future dividend increases?
In Part 2 of this post I’ll cover the remaining 3 factors that investors should consider before investing in dividend income stocks. Check back soon, as I believe you will find these ideas helpful in making you a better investor.
As always, I’d love to hear your feedback. Do you have a set of rules you use for making your investment decisions? Do you have an investment plan? Let me know how you make your investment decisions with a comment below or feel free to drop me a line anytime at dailydividendinvestor @ gmail .com