A great dividend stock both appreciates in stock price and gives an added bonus of a growing yield through dividend payments. A few key metrics to look for in picking a dividend stock are payout ratio, dividend growth over years, profitability, earnings growth, cash flow, debt, and the sector's health.
Why are these metrics important?
A company's payout ratio is important to look at because it will help you as an investor establish what to expect out of the investment. A company with a large payout ratio would be most likely a value company that doesn't have much growth potential. This can be risky since the dividend can be cut if the company decides to reinvest some money in the business or the company is losing market share to new innovative companies. On the other hand, a company with a low payout ratio would be most likely a growth-oriented company. The focus of this company would be to keep innovating to increase profits, which means increasing dividends wouldn't be likely unless the company begins shifting the money from research and development to shareholders.
It is admirable to look at companies like Coca-Cola, Proctor & Gamble, and Exxon Mobil, who have all been paying steady dividends for over 100 years. This implies as an investor you are guaranteed a reoccurring source of gains through dividends, even though recessions.
A company's profitability can arguably be the most important factor to look at when picking the perfect dividend stock. A company can manage to pay a dividend when it is not profitable, however, that is not a healthy business and cannot be sustainable for the long term. A dividend-based investment should be a long-term investment, to receive maximal exponential growth.
Profitability and earnings growth go hand in hand. When looking at a company's earnings on a long-term basis a rule of thumb would be earnings growth of 5 percent to 20 percent. Anything above most likely will end up turning into an earnings miss in the next quarter, which could encourage media and yourself that the company's fundamental story is not intact anymore. Another aspect to view is cash flows since dividends are paid from the company's cash flow. Strong cash flow is a good indicator of obtaining a dividend raise or stock buyback.
A very important factor to look out for is an abundance of debt. A good judgment of debt for a company would be the company's debt to equity ratio. A high debt-to-equity ratio would suggest a company is leveraging too much and cannot be sustainable. This comes with a lot of risks which is not what to look for in a dividend-based investment. (The ideal ratio would be under 1.)
Overall sector health is the last component I would recommend viewing. It is crucial that the business will still be around for decades to come. Look at other companies in the sector and see if any possible risks can affect your stock.
As a long-term investor, you are going to have to realize that companies are going to miss expectations from time to time. As well as, have its stock price sell-off, however as long as the fundamental story is intact, your investment will be safe.
A good investment strategy would be to average down your holding on any weakness of stock price as well as buying the stock before the company's ex-dividend date. Although, still manage to have a strict stop loss with the dividends yield accounted for.
The Perfect Example
The perfect dividend stock, in my opinion, would be Apple. Apple checks off all the boxes listed.
- Dividend Yield: 1.40%
- Payout Ratio: 25%
- Dividend Growth: 5 years
- Net Profit Margin: 21.09%
- Q3 18' Free Cash flow: $11.22 B
- Debt to equity: 0.86
- Sector Health: In a class of its own
Apple is currently being reassessed in the eyes of investors from a valuation perspective. What was once thought of as a hardware company can now be thought of as a consumer products company in company with the likes of a Clorox. (This would imply the stock price climbing to the likes of mid to high 200s.)
Apple's brand loyalty is arguably the strongest in the world; even when the prices of iPhones are raised because of releasing higher quality products, consumers don't think twice. Apple's products are a part of us. Even most applications are made for IOS first and generally work better than on Android phones, in combination with all Apple products being linked together through the cloud.
Apple received massive benefits from the recent tax cuts, repatriating hundreds of billions back to America. Apple's large cash position can lead to two different things that would benefit stockholders: either acquire a company to present more growth opportunities in the future or taking the initiative in increasing buybacks of stock and/or growing the dividend.
- Payout Ratio: the percentage of net income the company pays out as dividends to shareholders.
- (Low Payout Ratio: opportunity for a growth-oriented company to raise dividend) (High Payout Ratio: value oriented company, with a constant dividend policy)
- *(Total Dividends Paid/Net Income)
- Profitability: determines the scope of the company's profits in relation to company size.
- Cash Flow: total amount of money being transferred in and out of the business
*Disclosure: I own share of Apple Stock