Stock market investing is all about making money. Investors use different strategies and approaches to generate cash for living and leisure. Dividend investing is one of the popular strategies among stock market investors. Generally, retirees and defensive investors adopt a dividend investing approach as this strategy involves low risk and predictable returns.
However, you cannot succeed if you don’t have enough understanding of the key factors involved in dividend investing. Buying stocks only looking at their dividend yield, or the size of dividends isn’t a good dividend investment technique. Indeed, this strategy could lead you to lose your hard earned money. For instance, there are only a few companies in the energy sector that have the potential to sustain their dividends even in the down cycles. The majority of energy companies adjust their dividend payout ratio according to commodity prices and market environment.
On the other hand, chasing a high dividend yield could also turn out to be a bad dividend investing technique; some companies offer high dividend yield to attract investors but their future fundamentals are bleak – which could force them to make dividend cuts in the future.
In addition, the dividend yield is linked to share price performance. When share price moves higher, dividend yield goes down and vice versa. Therefore, the huge drop in stocks price could also be the reason for high dividend yield.
CenturyLink is the perfect example of this scenario. Its dividend yield currently stands around 14%. Unfortunately, the huge growth in its dividend yield isn’t due to higher dividends. The increase in dividend yield is only due to the massive drop in its share price.
Therefore, beginners and dummies should always read some books or articles about dividend investing before buying stocks. In this article, we present four key factors that would help new investors in picking right stocks for their dividend portfolio.
Solid Business Model With Long Dividend History
Warren Buffet always suggests investors buy stocks of the companies that have solid business model along with global recognition. Companies with the extensive business model, strong product line and global recognition generally have the potential to generate sustainable growth in revenues, earnings and cash flows. McDonald’s, Yum Brands, 3M, Microsoft, and many others are the example of companies that have established business models.
After inspecting the business model, the company should also have a long dividend history. This is important because only a few companies that have established business models and efficient management can sustain dividend growth for the long-term. Dividend aristocrats are among the example of companies that have strong business models and long dividend histories. Dividend aristocrats are the list of 57 companies that have raised dividends every year over the past 25 consecutive years.
Are shares Fairly Valued
In order to maximize returns and reduce losses, it’s essential to buy the stock at discount with steady upside potential. Buying dividend stocks at discount would lead investors to generate big capital gains in the long-term. Investors use different metrics to analyze the value of the stock. These metrics include earnings quality, valuations, cash flows and future fundamentals. Companies that have the potential to generate sustainable growth in revenue and earnings are likely to generate a steady share price appreciation in the long term.
Dividend payments are directly linked to financial performance. Companies with strong earnings and cash flow growth always have the potential to make big raises in dividends. Dividends are considered as unsafe when cash flows aren’t offering a cover to dividend payments. For instance, the dividend is unsafe if the company has the capacity to generate $2 billion in free cash flows and its dividend payments stand around $2.5 billion. In this situation, the management has to borrow funds from external sources to make dividend payments.
Share buybacks have significant importance for both the company and its shareholders. Only companies’ that have excess cash after making dividend payments and capital investments launches share buyback programs. Share repurchase means buying outstanding shares from stockholders. Share buybacks always have the positive impact on earnings per share, dividend per share and share price performance.
Dividend investing is a safe investment strategy for retirees and defensive investors. However, it’s crucial to select the right stock for your dividend portfolio to maximize returns. Therefore, examining the above four factors could help you in selecting the best dividend stocks for your portfolio.