When investing, past performance are not representative of future performances but knowing a company has paid dividends for 100 years or that they have increased their dividends by 10% for 10 years in a row does matter. As such, understanding a company’s long-term track record is another important part of dividend stock research.
In the first few parts of our series we discussed ways to use screening tools to filter down and find high-quality dividend paying companies. We also covered the key financial metrics that matter along with an efficient way to manage your list of stocks.
In this post we will explore how past performance can help identify good future prospects. Why is track record important? Of course, it goes without saying that past performance is no guarantee of future results. Nobody can see the future. But the past can give you an indication of how a company may continue to behave going forward. A company with a long history of strong sales, earnings, and a strong dividend payout history can be a good prospect for a dividend-seeking investor. A consistent history, provides insight in the management team of the company.
So what are some historic financial ratios that a dividend investor should look at when evaluating a company for potential investment? Analyzing a dividend paying company is obviously not much different from regular financial analysis. All of the traditional metrics apply. However, dividend investors may choose to consider analyzing possible prospects through a more “fixed-income” lens. Of course price appreciation is important and you don’t want the value of your investment to drop. But price appreciation is less important than a steady, stable dividend that will pay out consistently over time.
Cash flow is king for for those seeking a strong dividend paying candidate. A healthy cash flow is imperative for sustaining regular dividend payments. When cash flow starts to suffer, dividends are typically one of the first things cut. An organization that cannot generate cash will not be paying a dividend for long. The stigma of dividend cutting has been somewhat lessened in recent years. But, it is still a red flag. Of course, a company can always issue debt or equity to raise cash. But that is a short-term and unsustainable fix.
Sales & Margins
Look for a company with a long-term track record of sales. A company that has a wide moat with high barriers to entry and low competition can be a good choice. When sales are increasing, the company is growing. It’s making money. The next step is to evaluate the margins. The margins are not easily identifiable in a financial statement but it will usually be disclosed.
AAPL is in the dog house because of it’s decreasing margins. It’s facing stiff competition from Samsung on technology inovations and it’s facing challenges with its margins. Investors need to see growth and when margins are decreasing, growth is challenged.
Look for companies that have consistently had enough cash flow to cover dividend payments. Cash flow is vital to dividend investors. One way to visualize the cash coming in is to look at the company’s EPS or Earnings Per Share. Guidance are usually disclosed as EPS ranges. A growing EPS means the company has more money left for dividends, share buy backs or expansion. A growing EPS can be achieved by reducing cost or increasing revenues. Although sales are good metrics and it highlight the business growth, I find that it is also embedded in the EPS as a bottom line calculation.
One of my primary filter is the Dividend Aristocrat list as you probably know 🙂 For a U.S. corporation, it means 25 years of dividend increases. Increases is what I wrote. Not only does it pay for 25 years, it increases the dividend for 25 years. Compound interest / growth anyone? It’s powerful and it works on its own.
Take a look at the dividend payment history. Has the company ever reduced or eliminated its dividend? Be wary of an organization that has engaged in dividend cuts. You want to see a history of steadily increasing dividend payments.
Consider the fact that bondholders will get be paid out first in the event of a bankruptcy. It makes sense to find a stock that has strong balance sheet with manageable amounts of debt. Debt payments eat into cash flow, and that can hurt dividend payments. Moody’s and S&P ratings are a good way to get a feel for financial health.
Related: Are bonds as safe as they seem?
Management Track Record
Look for managers and owners who have been with a company long-term. Industry veterans tend to know their business inside and out. Are the owners and board friendly to dividend investors? This metric is hard to grab from a financial statement. This point is best managed by understanding the company track record during the tenure of the CEO and by listening to the conference calls. There is an unwritten language that comes up during conference calls and it’s an important research step for investors. Analysts will be on the calls and will ask questions; the words used to answer questions can sometimes be interpreted differently and it could be on purpose. I strongly recommend you listen to conference calls.
The history must be able to tell you something and that means you need to know what you are looking for.
Dividend Stock Research Series
- Looking at Company Metrics
- The Companies That Matter To You
- Managing The List
- Buy & Sell Moments
- Setting Your Price Target
Readers: Any missing historical data that you find important?