Investors are seeking dividends.
Dividend stock investing has great appeal in the current investing environment. At present, 10-year Treasury bonds yield a little over 2.3 percent, and conventional savings vehicles like a one-year certificate of deposit at your local bank offer a roughly 1.5 percent rate of return on average. Meanwhile, many dividend stocks yield 3 percent, 4 percent or more annually from their payouts. But dividend stocks can significantly change their payouts to you at a whim, dramatically changing the value of your investment. If you’re investing in dividend stocks, you need to be very selective. And if you’re new to dividend stocks, here are seven crucial things to look for before you make a purchase.
Dividend per share
The most basic measure of a dividend stock is how much it pays out to investors for each share of ownership. These figures are readily available in news releases, financial filings with the Securities and Exchange Commission and on most financial websites that display stock information. It’s important to remember, however, that a big dividend per share is only part of the story. As you’ll see, there are plenty of circumstances when a company paying a smaller per-share figure actually ends up delivering much more in total dividends over the long term.
Annualized dividend
Of course, it’s not just the dividend that matters. One of the biggest appeals of dividend investing is the idea of a steady income stream via regular distributions from your investments. That means it’s crucial to find out just how regular those payments are. Some stocks pay a dividend once a year, some pay once per quarter and some pay once per month. A stock that pays 20 cents once a year actually pays less annually than a stock that pays 2 cents each of the 12 months in the year, for 24 cents total. If you don’t normalize for annual payouts, you may overlook a stock with dividend potential that pays a smaller amount but does so more frequently.
Ex-dividend dates
Dividends are always declared with an “ex-dividend date.” In layman’s terms, this is the deadline that determines who gets the payout and who doesn’t. Don’t confuse this with the date dividends actually get paid. For instance, AT&T (NYSE: T) declared its next quarterly dividend will be paid on Nov. 1 to shareholders of record on Oct. 10. That means you have to be a shareholder roughly three weeks in advance of that payment in order to get your dividend check. This is an important factor to consider, especially for companies that pay dividends only once a year. If you aren’t in time to get that distribution, then you miss out.
Special and uneven dividends
Of course, be careful before you simply tally up every dividend paid across the last 12 months. Some corporations choose to make big one-time payouts known as “special dividends” in order to reward shareholders. That’s what retailer Costco Wholesale Corp. (COST) did last spring, paying a $7 per share special dividend on top of its regular 50-cent quarterly dividend. That was great for shareholders at the time, but it’s not a repeatable event and you shouldn’t expect it to be. Much worse, obviously, is a company that was paying a juicy dividend and has recently cut its per-share payout. That’s a troubling sign, and it’s important not to give credit for dividends that won’t exist going forward.
Dividend yield
After you have a good handle on the annual payout that is normalized for any increases and decreases over the last 12 months, it’s time to calculate a stock’s dividend yield. This figure shows what percent of the current share price is paid out annually in dividends. In other words, if a $50 stock pays 50 cents in annual dividends, it has a yield of 1 percent. But a $5 stock that pays 5 cents in annual dividends also has a 1 percent yield. This is an important way to normalize your return from dividends, because the share price of stocks can vary widely. Think of dividend yield as a way to benchmark the annual return on your initial investment via dividend payments.
Dividend payout ratio
Now that you know how much a company pays back in dividends as a share of your initial investment, it’s worth considering how that payout will change over time. Consider that in 2012, Apple (AAPL) paid $2.65 in dividends and enjoyed corporate earnings per share of $44.15. That was just 6 percent of total profits, and left plenty of headroom for aggressive increases in payouts. Since then, Apple has nearly doubled its payout in about five years. The typical payout ratio for large stocks is around 50 percent of earnings. If the payout ratio is approaching 100 percent of earnings then it’s unlikely you’ll see increases — and worse, if things sour, you could see a dividend cut.
Underlying health of the stock
Even if you find a company that is paying out big dividends regularly and that has the earnings to sustain them, that’s only part of the puzzle. There are countless examples of dividend stocks that pay 2 percent or more in dividends crashing, and ultimately losing 20 percent or more in value across just a few months. Sometimes it’s a company-specific challenge, as we’ve seen with toymaker Mattel (MAT), and sometimes it’s a market-wide crisis, as we saw with bank stocks in 2008. It’s important to remember dividend stocks are still stocks — not bonds. And as such, they are subject to much more risk and volatility.
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7 Things to Look for in Dividend Stocks originally appeared on usnews.com
