As we have discussed in earlier posts, dividend stocks can be an attractive option for investors seeking income. Of course, each investor has their own style and method for evaluating dividend stocks. There are no exact guidelines to follow except your own, and some will find different financial ratios more important than others. But in general, dividend-paying champions from the past tend to have similar traits. There are several key metrics that should be thoroughly reviewed before purchasing shares of dividend-paying publicly traded companies. In this post we will review many of the dividend metrics that matter.
Dividend Stock Research – Company Metrics
The following metrics are the basic metrics any investors will first look at when researching stocks. It’s important you understand them and figure out which one matters for your strategy. Not only is it needed to decide on an investment, it is doubly important to verify them again when you review your portfolio.
The best site I have found for finding all the metrics I want is Globe Investor.
P/E – Price to Earnings
Price to earnings allows an investor to assess the value of the company at a glance. What is important is to compare the P/E amongst the pears. The P/E basically allow you to see how much you are paying for the earnings (and future earnings) of the company.
EPS – Earnings Per Share
EPS measures profit as a percentage of common stock. Investors should focus on companies with strong and growing earnings per share. Rising EPS means that management can afford to raise the dividend on a consistent basis.
Cash is the lifeblood of companies. A company that cannot generate cash will start to make cuts somewhere, and dividends are typically one of the first things to go. Focus on companies with strong cash flow. They will be in a position to consistently raise dividends as well as buy back their own shares.
This measures how much a company pays out in dividends as a percentage of share price. To find the dividend yield, divide annual dividends per share by price per share. (Yield = Annual Dividend Per Share/Share Price). Dividend yield gives you an idea of your cash flow per share. Use the dividend yield to compare dividend-paying stocks with competitors in the same industry. Keep in mind that some individual companies will have higher dividend yields than the corresponding industry ETF.
Dividend Payout Ratio
The best metric to see if a company is giving too much back to investors to the detriment of the company. The ratio is calculated by dividing the annual dividends by the annual EPS (earnings per share). You should always compare the payout ratio within the same sector since it’s more like comparing apples to apples. A consistent payout ratio over time is much better than an erratic one and if the EPS is growing and the ratio is maintained then you have dividend growth which is what you are looking for. When the dividend growth is paid by increasing the ratio, you need to watch out as it may not be sustainable.
Of course, we all know the old saying that past performance is not a predictor of future results. But in general, it is helpful for income investors to focus on companies that have a long history of paying dividends. For example, McDonald’s (NYSE:MCD) has raised its dividend payment every single year since 1976, and Proctor & Gamble (PG) has paid them for over 55 years.
Filtering by US Dividend Aristocrats will eliminate a lot of companies quickly as not many have increased their dividends annually for 25 consecutive years.
Understanding the debt level of a company is a necessary step to making an investment. Liabilities are acceptable as long as they have a purpose and fulfill a need. The most basic liability is ‘salary payable’ which all companies will have. When a company has a ratio below 1, their assets will usually cover the liabilities but when it’s above 1, the company needs to increase its assets to cover the liabilities over time.
ROE – Return On Equity
This shows income as a percentage of owners equity. (ROE = Net Income/Equity). A strong ROE can be an indicator that a company has the ability to raise its prices, it may have a wide moat around its business. A wide moat can help keep potential competition in check and better guarantee a stable dividend.
I like to understand where the stock price is at for the year. It doesn’t mean you don’t buy when it’s high, it’s just an indicator and worth comparing with the index for relative movement. In most cases, when I have a short list of candidates matching the criteria I need, I’ll avoid buying the stock trading at the top of the 52-week ratio.
Cold hard cash is always important. Assessing the use of cash over time can highlight if the company is burning through cash faster than it accumulates it. In some cases, a company might not have any debt but could have trouble managing the business after a transition of any kind and the cash balance could send some signals especially if it’s not tied to share re-purchased.
Companies with strong cash flow are in a position to buy back their own shares on the open market. Many do just that, and this benefits dividend investors because they end up owning a larger percentage of the business. Focus on companies with a decreasing number of shares outstanding when you can.
This metric does not measure the health of a company. However, it is helpful to be aware of the ex-dividend date when it comes time to buy or sell a stock. The “ex-date” refers to the day upon which the holder of the stock receives the dividend payment. Specifically, the owner on the ex-dividend date receives the dividend payment, regardless of who owns the stock before or after.
Again, none of these ratios guarantee that your investment will continue to pay a consistent dividend or provide a good return on investment but historically, winning dividend stocks tend to have similar characteristics. Take a look at all of these metrics when evaluating dividend stocks for your portfolio.
Dividend Stock Research Series
- Looking at Company Metrics
- The Companies That Matter To You
- Managing The List
- Understanding the Track Record
- Setting a Price Target