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Criteria To Look For When Investing In Dividend Stocks

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  • Criteria To Look For When Investing In Dividend Stocks

    Investing in dividend stocks is a great way to build your wealth. The way how dividend stocks work is that they pay out part of the earnings as cash to shareholders. The payment can be made quarterly or yearly. Shareholders can use that cash dividends to either cover their daily expenses or reinvest part of that cash into buying more stocks. Normally the latter is the way to go in order to take advantage of the power of compounding interest.

    When shareholders use part of or all of the dividend to buy more stocks, the shareholders are said to be reinvesting the dividends. Dividend reinvestment is a powerful way to multiply your wealth. With dividend paying stocks, you are getting not only cash from the shares but also capital appreciation from the increase of the share price.

    For example, if a dividend stock has a yield of 3% per year and the capital appreciation is around 10% per year, the total return on investment over that 1 year duration is 13%. This yield is way better than any other investments around such as bonds and fixed deposit.

    Before you dive right into investing in dividend stocks, there are a couple of criteria that you need to look for in cash paying companies. Here is a list of them that you need to pay attention to.

    Revenue and Earnings Growth

    Revenue represents the sales of the company. It's the lifeline of the company. Without sales, the company would go bankrupt let alone paying cash dividend to stock owners. Earnings are what is left after taking out the operating expenses, taxes, debt interest and so on from revenue. Both revenue and earnings are important metrics to screen in a dividend paying company.

    Ideally, you would want to see a growing rate above 10% for both of these numbers. But in reality, only a handful of well-managed companies can grow healthily in terms of revenue and earnings.

    Debt

    Debt represents what the company has borrowed from bank or investors to grow the business. A heavily leveraged company, a company which has loads of debt, will have to service the high debt interest payment. The company will face difficulty in paying back the installment especially during economic downturn. In time like this, a dividend paying company will normally cut part of or even most of the cash dividends to shareholders.

    Ideally, you want to look for a stock that has low debt or best without debt. The metric to screen here would be the debt to equity ratio or debt to capital ratio. These numbers tell you the percentage of debt with respect to stock equity and capital respectively.

    Dividend Payout Ratio

    The dividend payout ratio can be categorized into two categories, dividend to earnings payout ratio and dividend to free cash flow payout ratio. These ratios represent what percentage of earnings or free cash flow is being paid out as dividends. The higher the number of these ratios, the riskier the stocks are.

    A high ratio represents that most of the earnings and free cash flow has been paid out as cash dividends. You certainly want to have a low ratio since that means that the company will have plenty of rooms left to pay dividends out of earnings and free cash flow.

    You should screen these ratios from quarterly financial reports and compare them sequentially and year over year. The best-managed companies will keep these ratios relatively unchanged or best of all slowly going lower. Watch out for a spike in these ratios and find out the reasons behind the drastic change.

    The above are just some of the criteria to look for when it comes to investing in dividend stocks. There are actually other criteria such as the dividend paying history and business outlook that you may want to look into. But these are the basic criteria that I have talked about to get you started. All in all, investing in dividend stocks has been one of the greatest if not the safest ways to build your wealth over the long run.


    Article Source: http://EzineArticles.com/8136212
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