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Dividends

What to look for in dividend stocks

Here’s all you need to know to choose the right dividend stocks.

Looking for a solid dividend stock to invest in? I’ve got you covered with some metrics you should bear in mind. It’s important you look at companies you like the look of, not just in terms of numbers, but the product/service and stance on topics sensitive to you.

Dividend yield

The dividend yield is incredibly important to dividend investors. It represents the annual dividend relative to the stock price. If a stock price is £10 and the annual dividend is £0.50, the yield would be 5%. The higher the better, though you don’t want it to be too high. A super-high yield in the region of 10% and above could be risky.

It’s always good to go with stocks that have paid out dividends for years with small incremental boosts in payouts. It’s always better to go with a company that will be able to pay out a smaller dividend for years to come (and grow it) compared to one that may cut or cancel the payouts altogether.

Earnings-per-share

The earnings-per-share (or EPS) is how much the company brings in per share. You’ll want this to be higher than the dividend payout, allowing the company to store cash, reinvest the money, and increase the dividend payout over time.

Pay out ratio

This is one metric you want to have as low as possible in most cases. Unique companies like Realty Income, a real estate investment trust (REIT), have high payout ratios as that’s how they’re structured to operate. The majority of other companies are better positioned with lower payout ratios.

The payout ratio represents how much of the company’s net income is put aside for dividends. A company that brings in £1 per share and pays out £0.10 per share in dividends would be 10%.

Realty Income

Cash pay out ratio

This is essentially the same as the payout ratio above, but uses cash flow instead of earnings. Likewise, it’s best to keep this as low as possible.

Price-to-earnings

The price-to-earnings ratio (or P/E for short) divides the share price of a company into the earnings per share. This is a good signal to use in order to tell the value of a dividend stock.


Don’t get caught in the trap

Some companies may boast a dividend yield of 15%, but there’s likely some reasoning behind this. Has the stock price dropped substantially without the dividend being adjusted? British Petroleum is a fine example of such a risky venture right now. Its share price continues to tank whilst management simply refuses to slash the shareholder payout. How sustainable is this?

It’s not a good idea to have such a high payout to shareholders, especially if your ratio from earnings is a little on the unstable side. A lower dividend with a more sustainable balance sheet is a far better choice most of the time. But if you have a good feeling about a company, in particular, your gut is also a good indicator of a potentially good deal.

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