Question:
How long will the dividend craze last? And what should I be looking for?
Answer:
With interest rates at historic lows, many investors are searching for a strategy focused on income from dividends. We recommend an approach that blends high yield stocks, as well as stocks with a high and sustainable dividend growth rate.
Dividend Growth
The purpose behind investing in dividend growth stocks is that you can count on the company to increase the amount that is paid to you for holding the shares. Now these may not have an extremely high dividend yield currently, but over time, they should increase the amount that they pay out to investors. Eventually, it could surpass what you are receiving from your high yield stocks.
What to Look For
When hunting for dividend growth stocks, we look for those companies that have a history of growing their dividend and haven’t cut the dividend in the past. We seek companies with payout ratios less than 60%, which means they return less than 60% of their earnings to investors in the form of dividends. We see this as the sweet spot of dividend growth stocks. The reason for this number is that for a company to be able to raise their dividend, there has to be earnings left to pay.
Think of a company that has a payout ratio of 100%. This means they pay all their earnings out in the form of dividends. In order for this dividend to grow, the company must grow their earnings quarter after quarter or buy back a meaningful number of shares. Without this, they will be forced to borrow to pay the dividend. For income purposes, we do not recommend investing in the companies who borrow to pay their dividend, as it is likely not sustainable.
Now back to growing earnings, we look for companies that grow their earnings at an equal or higher rate than they grow their dividend to ensure that the dividend is sustainable.
Be Mindful
If one of your dividend growth stocks appreciates by a considerable amount, you may want to consider selling it, as it no longer provides you a competitive yield. For example, if you bought 100 shares of XYZ at a price of $50 for a total value of $5,000 and yielding 3% ($150 in annual income). Shortly after your purchase, the shares appreciate to $75. Now your total value is $7,500, however you still receive that same $150 in annual income, so now, your shares only yield you 2%. There may be better opportunities elsewhere in the market.
High Yield
The purpose behind investing in high yield stocks is to provide income from your investments, especially in periods of low interest rates like we have in the current market. As long as you choose high quality high yield stocks, you can usually count on receiving your income quarter after quarter. While these stocks don’t offer much in terms of growth, generally this is not an investor’s objective when picking high yield stocks.
What to Look For
When selecting high yield stocks, quality is crucial for us. Just like when we choose any stock, we look to ensure that each company is in solid financial condition, and then move to the history of the dividend. Like dividend growth stocks, we look to see if the company has ever cut its dividend, and also look to see the history of the dividend. If the dividend is not reliable, it has no place in a high yield portfolio. We then look at the company’s dividend coverage ratio. If the company is not generating earnings that are sufficient to cover the dividend, STAY AWAY.
Payout ratio comes into play here as well; however, our target payout ratio is substantially higher than with dividend growth stocks. We look for companies with dividend payout ratios of less than 100%. As long as they are not paying in excess of 100% of their earnings, we are generally OK with it. Now as is the case with any investment, valuation should not be overlooked. You don’t want to over pay for any investment, regardless of the strategy. We look at a company’s PEGY, which is the company’s P/E dividend by the long-term growth plus yield. This is an appropriate valuation metric for a dividend paying stock so that yield is taken into account.
At Henssler Financial we believe you should Live Ready, which includes understanding there is more to consider than a stock’s dividend yield. If you have questions regarding your investment holdings, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
