How to Choose Dividend Stocks?
Our process is really based on the idea that getting the questions right and knowing which questions to ask about a specific business when you’re looking at it for the first time and then subsequently as you’re evaluating it, those questions are if anything more valuable than the answers. Anytime one makes an investment, no matter how conservative, no matter how much you’re trying to set aside speculation, you are making projections about the future because that’s where your profits lie, your dividend payments, your capital gains, everything.
Evaluating the financial strength of the company is very important. If we’re fairly comfortable with the company’s ability to pay bond holders that also will generally give you a good start toward finding a safe dividend. A second factor to look at is just whether or not the business is growing or shrinking. You’re kind of either being born or you’re dying in the business world. But if the business is shrinking, it may not be able to sustain that dividend long enough to make it a profitable investment. So you really want to find businesses that in a secular sense kind of strip all the effects of economic cycles, are at least stable and preferably have some potential to grow and then the third point is just looking at the payout ratio, how burdensome is the current dividend on the company’s finances.
How much room is there for say earnings to drop in a recession or if there is some short term bad thing that comes along to hammer profits while still leaving you with your dividend intact and that you have to view in terms of volatility of the business. Very common for utilities to have say 60, 70 percent payout ratios, 60 or 70 percent of their annual earnings going out to shareholders as dividends. That’s generally a pretty safe mark because even in a recession, their earnings don’t drop that much. If you’re looking at a steel mill, there may be no payout ratio that’s low enough to really say that, Is it going to be safe or an oil refinery because at the bottom of their cycles, they lose money and they may not be able to part with any cash to shareholders at all.
Does the company have opportunities to reinvest in its business? For utility it might be building new power plants that are more efficient to replace old ones. They have more money at work, so regulators allow them to collect more from customers. Today, investors are more responsible for their retirement than ever before. That’s makes it important to become part of the investing process and understand how you’re going to replace your paycheck.
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