Investors, we all love dividends. Other than the thrill of seeing a stock you own rise higher and higher in the stock market, receiving passive dividend income from your investments every year is something we all look forward to.
So if you’re more of an income investor and looking to invest for dividends, your stock portfolio will be markedly different from someone who’s investing for high growth and capital gain. The stocks that will give good, consistent dividends may not necessarily be the kind that will grow by 20-50% a year and vice versa.
So if you investing for dividends, you have to invest accordingly and only pick the best stocks that will give the passive dividend income you want. The question is: How?
So if you’re slightly lost and looking for some direction, here you are .
7 Steps to Select Best Dividend Stocks
(Hint: You can’t just look at dividend yield alone!)
#1 Look for Mid-Large Cap Stocks
The best dividend stocks are usually large, mature companies with stable revenue, profits and cash flow. These companies have little growth left in them. Because these companies are no longer expanding aggressively, the majority of their earnings can be returned to shareholders as dividends.
On the other hand, a smaller, high-growth company needs more cash and resources to grow and expand its business, leaving less money to pay shareholders dividends (if any).
#2 Dividend Payout Ratio is 50% or More
If a company is large, stable and isn’t seeking to grow aggressively any more, then the majority of the profits it makes should be returned to shareholders. So look for a company with a dividend payout ratio of at least 50% or more. For example, Nestlé (Malaysia) returns over 90% of its earnings to shareholders as dividends.
If a company has a low payout ratio, ask yourself why the company is holding on to the cash. Unless they have a good reason to do so or have a way to generate exceptional returns for shareholders, the majority of profits should be paid out as dividends.
#3 Track Record of Paying Consistent Dividends
The company should have a long and stable track record of paying consistent/growing dividends to shareholders. No point if a company is large and successful and has profits to distribute as dividends, but chooses to pay them out inconsistently.
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Check to see a company pay a consistently growing dividend over the last 5-10 years. This shows that as the company grows more and more successful, the management is also willing to share the fruits of its labour with its shareholders.
#4 Company’s Fundamentals Must Be Sustainable
Many dividend investors tend to ignore the overall aspects of a company’s fundamentals. They choose to focus primarily on the amount of dividends they can receive. This is wrong. While dividend yield is obviously important for someone seeking dividends, it is also important to consider the overall health of the company.
A company with deteriorating fundamentals (e.g. falling revenue, profits, cash flow, fading economic moat, etc.) cannot sustain its dividend payout in the long term. The less revenue and profit it makes, the less dividends it can pay.
Over time, a company with falling revenues and profits will see its stock price fall when investors realize that the company is no longer performing. This fall in value will eat into any dividend gains you might have had at the start – leaving you back at square one.