Regular and reliable dividend payments are very comforting, especially in times of economic uncertainty. But finding stocks that can pay them off isn’t easy. High yields might sound tempting, but they can also be a warning sign of a possible fall in dividends – so it’s important to exercise caution.
To help you overcome this uncertainty, you need a checklist that covers the most important aspects of dividend investing strategies. It also helps to remove emotions from the decision-making process.
With a few key rules, you’ll find it much easier to find better quality dividend-paying stocks methodologically. The Bae Systems dividend is an example of using a checklist to identify promising dividends.
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Rules for finding dividend stocks
1. Dividend security
Attractive, high returns obviously turn heads – but it’s important to know that a dividend is affordable. Dividend coverage (similar to payout ratio) is an essential measure of a company’s net income relative to the dividend paid to shareholders. It is calculated as the earnings per share divided by the dividend per share and helps indicate how sustainable a dividend is.
A dividend coverage of less than 1x suggests the company cannot fund the payment from its current year profits – and could rely on other sources of funds to pay it off.
An important indicator for income investors is a history of dividend growth – and evidence that growth will continue. Steady dividend growth can be a clue for companies that carefully manage their distribution policies – and reward their shareholders over time. Rather than aggressively distributing their profits, dividend growth companies tend to have more modest returns, but are more adept at sustaining their payouts.
Bae Systems increased its dividend distribution 9 times in the last 10 years – and the dividend per share is should grow by 3.58% in the coming year.
3. High dividend yield (but not excessive)
Dividend yield is an important financial measure of dividends because it tells you the percentage of how much a company pays out in dividends each year relative to its share price. This makes it easier to compare dividend payouts across the market.
High returns are obviously attractive, but beware of excessively high returns. Usually, returns above 10% are an indicator to suggest that there are underlying issues with a stock. This is because when the market suspects a company of not being able to maintain its dividend, the stock price drops and increases returns. It is better to be wary of excessive returns.
What does this mean for potential investors?
Yield, growth and safety are the three main pillars that support some of the most popular dividend investing strategies. But it’s important to know that dividend payouts can be reduced or canceled very quickly when the outlook changes.
To better understand the dividend outlook for any stock, it’s important to do some research yourself. Indeed, we have identified areas of concern with Bae Systems which you can find out here.
Alternatively, if you want to find more dividend stocks that might be worth investigating, you can find some ideas on this Dividend screen.