How am I going to select dividend stocks to buy? This is a question my friends often ask me, and many people ask it. The short answer is that you should compare stocks to each other. Most decisions in life are based on comparison, whether it is buying food, when you compare tomatoes, meat, and other food items or choosing a profession. How do you know if your salary is good enough? You compare your wage to average salaries in your industry and to average wages in the country. It is easier to compare two or more objects than to define how good an object is on its own. Your goal is to select the best dividend stocks out there. If you are new to dividend investment, we are going through a process of evaluating shares that pay dividends right now.
1. Dividend Stocks List
First, identify at least one stock you would like to evaluate. There are several sources of dividend lists available. For example, you can Google “S&P 500 dividend aristocrats list” to find them. This list will include companies that have increased their dividend payouts for twenty-five consecutive years or more. The Canadian Dividend All-Star List is a list of Canadian companies that have increased their dividends for five or more calendar years in a row. You can also see our dividend portfolio, or other sources of dividend information. While pumping gas at Chevron gas station or shopping at Walmart, you can ask yourself whether the company pays dividends. Once you have selected one or more companies to look at, start the evaluation process.
2. Dividend Yield
First, check dividend yield. The dividend yield indicates how much a company pays out in dividends each year relative to its share price. Most companies pay dividends quarterly, but some pay monthly or semiannually. Dividend yield can be found on many financial portals like Google Finance or Yahoo Finance. Here is a snapshot from Google Finance:
Canadian Utilities pays a dividend of 0.36 CAD per share quarterly. It is 3.41% annually. Is it a good yield? The answer is that it depends. If you compare it to rates of fixed income today, it is a good yield. Are there other companies that pay a higher yield? Yes, but you need to see whether the dividend is safe. Usually, a very high dividend yield, i.e. above 10%, is considered risky. If you are a long-term investor, the future dividend yield is even more important. How can you estimate future dividend yield?
3. Dividend Payments Over Time
You can see that the dividend payment for Bank of Nova Scotia (BNS) increased every year from 2007 to 2016 except for 2010. Even during the subprime mortgage crisis of 2007–2009, BNS did not cut its dividend; the company just did not increase its dividend in 2010. Dividend growth over last 10 years was 5.19% annually. Today the BNS yield is 3.74%, and if you assume that dividend hikes will continue at a rate of 5.19% annually and be using DRIP after 10 years, you will receive a dividend yield of 7.74%.
4. Payout Ratio
Payout ratio shows what portion of a company’s earnings are paid as dividends, and it is measured in percent. The estimated payout ratio for BNS in 2017 is 46.9%, which means that BNS pays 46.9% of its profits back to its shareholders. Even without increasing earnings per share, BNS will be able to increase its dividends by 53.1%. Indeed, BNS will likely continue increasing its earnings per share, making its dividend even safer.
5. EPS Growth
You should also look for whether the company increases its EPS over time. The more a company earns, the more it will be able to share with its shareholders, i.e. with you. Ideally, the EPS will grow faster than dividend hikes to allow bigger dividend increases in the future. You can see the EPS data on the Morningstar snapshot above.
6. Related Companies
Type a company symbol on the Google Finance page and you will get a list of related companies under the company chart.
Repeat previous evaluation steps with companies from the list, trying to find better dividend, EPS growth, and payout ratios.
7. Market Capitalization
Small businesses have a higher potential for fast growth, but they need to invest generated earnings back into the business to fuel growth. You should look for well-established companies, which usually will be in the mid cap to mega cap range, i.e. from 2 billion to 200 billion capitalization and greater.
8. Final Criteria
To calculate a future dividend yield, multiply the current yield by the estimated dividend growth. Dividend growth should be fueled by EPS growth. Make sure the company with the best future dividend yield (10 years from now) gets into your portfolio. It may be a company that has a high dividend yield now, with a moderate projected increase in the future, or a company that has a low dividend yield now with aggressive dividend increases over time.
It is rewarding to select dividend stocks for yourself; you get familiar with your investment while you are selecting it. Even though not all selected dividend stocks will be excellent performers, you will be able to keep those that do well and exchange those that underperform, unlike when you hold a mutual fund or an ETF. After getting familiar with this evaluation process, it will not take more than an hour to evaluate a company. This will save you on management fees you would otherwise pay either a mutual fund or ETF manager.
PS: In 2016 our dividend portfolio outperformed S&P 500 benchmark.