In this article I am going to share with you how to research dividend stocks and how I research them. First and foremost make sure that you are researching companies that you understand, know their business model and how they work and make money. Now let’s go through the metrics:
1. Payout ratio
This is how much of a company’s profits go to paying a dividend. Lets say a company have a dividend of £1 a share with earnings per share (EPS) of £5. That means the company is paying £1 out of every £5 for dividends or 20%. My preference is to invest in companies with 50% or less of payout ratio. That way the company have enough money left to invest for the future, reduce debt or even keep some cash on the balance sheet.
2. Dividend growth
That shows how quickly and for how long the dividend has been growing in the years. Generally a good streak of dividend growth is a sign of a healthy company. If a company has been able to grow their dividend during a recession for example that shows consistency and that the management is competent. Companies with long streaks of dividend increases tend to be less volatile as people have more trust in them, even during a downturn.
3. Balance sheet
So in order to understand how ”healthy” a company is I like to go through the balance sheet. First of course I check how much long term debt is there. Then I check the trend – are the debt levels going up or down. After that – how much cash is there on the balance sheet, how much they are spending on interest payments and how much free cash flow they have after paying their dividend and their debt payment.
A company which is borrowing money in order to pay a dividend to their shareholders is a huge red flag and means that a trouble is on the horizon in 9/10 cases. Another big red flag for me is if a company is taking out debt for share buybacks. This is not always a bad sign, but in most cases it is a sign for bad management, which do not have a long-term vision for the company.
4. Earnings Growth
This is a very important metric, which goes hand in hand with the dividend growth really. If a company doesn’t grow its earnings it will not be able to grow its dividend aswell. A metric I like to use a lot is p/eg or price to earnings growth ratio.This shows how cheap a stock is compared to the projections of the company for future growth.In my opinion a peg of 1 represents fair value.
5. Management
I cannot stress enough how important good management is for a company. The management can make or break a company and we have seen that time and time again.
The good management in my opinion should have long-term outlook, be honest about their intentions and think what is best for the company and not just for their own pockets. A good way to see if the management team is good or not is how they are managing the debt levels and how are they using the income from the company.
6. Dividend Yield Payout Ratio/Dividend Yield
Ok this is my own metric which I use a lot to value companies. I like to check the dividend yield and compare it to the payout ratio. Let’s say a company has a payout ratio of 30% and a dividend yield of 3%. In my metric that is a score of 1. The lower the number is the better.
As you can see I don’t look at the dividend yield alone as it can be misleading. That is my way of evaluating a company’s dividend. Companies with yields of 10%+ might seem like a good deal, but in most cases they are not. I would much rather have a company with 2% yield and a 15% payout ratio than a company with 12% yield and 140% payout ratio.
After they pass those checks I go a bit more in-depth in their investors relations page. There I go through all the numbers they have and their long-term plans and goals. I open a position in the company only after I like everything I see in all that information.
To be fair it takes quite a while before I find a company which matches that criteria, but that way I am much more confident in the stock long-term.
That is all from me today, hope you had an interesting read and you can now evaluate and find a good stock for your portfolio.