dividend payments. The income investor looks for companies well equipped to not only continue paying dividends but to also increase the cash amount of those payments.
Working with a seasoned pro
This book should give you the tools to manage your portfolio by yourself. However, if you do decide to hire an investment advisor, I urge you to consult a qualified professional with a track record of successfully investing in the stock market for several years.
Experienced investment advisors can offer you a wealth of advice and information on most areas of financial planning, including taxes, insurance, and strategies that have been successful for them. They can also function as a sounding board when you need feedback on a stock you’re thinking of buying or selling and help steer you clear of potential pitfalls.
A good dividend stock isn’t just one that pays a high dividend. The strength and consistency of the dividend are very important, along with share price and the company’s prospects for a rosy future. Before you can evaluate and select dividend stocks, however, you need to identify a few promising candidates.
Distinguishing dividend stocks from the rest of the pack
Wherever you find stocks, you can find dividend stocks:
✓ Google Finance at www.google.com/finance
✓ Yahoo! Finance at http://finance.yahoo.com
✓ Various personal finance magazines and websites
✓ The Wall Street Journal
✓ Financial Times
✓ This book!
Many stock listings include both a dividend column and a dividend yield column. If the company hasn’t paid a dividend, you see something like 0.00 or a hyphen (-). Some listings show only the previous and current share price and the single-day and year-to-date gain or loss. In that case, you need to dig deeper to find out whether the company pays dividends and the amount of the most recent payment. With most online stock listings, you simply click the ticker symbol for more information about the company.
Exploring sectors where dividend stocks hang out
Companies in certain industries, such as utilities and telecoms, are more likely to pay dividends than companies in other industries, including technology and biotech. The biggest reason for this tendency is that some industries have larger, more established companies, compared with industries that have a higher concentration of smaller, growth-oriented companies.
As you begin investing in dividend stocks, you may want to focus your efforts on the following sectors:
✓ Utilities: Electricity, water, and natural gas (suppliers, not producers)
✓ Energy: Oil, natural gas (producers, not suppliers), and Master Limited Partnerships (MLPs)
✓ Telecoms: Carriers (U.S. and international) and wireless
✓ Consumer staples: Food/beverages, prescription drugs, household products, tobacco, and alcohol
Crunching the numbers
Eeny, meeny, miny, moe is no way to pick dividend stocks. Savvy investors carefully inspect the company reports – balance sheet, income statement, and cash flow statement – and crunch the numbers to evaluate the company’s performance, at least on paper. As you prepare to evaluate a company, research the following figures or calculate them yourself by using numbers from the company’s quarterly report. (Chapter 9 shows you how.)
✓ Current dividend per share (DPS): The quarterly cash payment each investor receives for each share of company stock he or she owns.
✓ Indicated dividend: The projected annual dividend for the next year, assuming the company pays the same dividend per share for each quarter of the next year.
✓ Dividend yield: A ratio that compares the amount the company pays out in dividends per share to its share price. You use yields to gauge a dividend’s rate of return. Yields move inversely to share price – that is, yields go up when share prices go down (and vice versa).
✓ Earnings per share (EPS): The portion of a company’s profit allocated to each share of stock. If XYZ Company sold 2 million shares of stock and earned a profit of $1 million, it earned 50 cents per share, or $1 million/2 million shares = $0.50. A company that earns $1 per share is twice as profitable as the one that earned 50 cents a share.
✓ Price-to-earnings ratio (P/E): The ratio of the share price to the annual earnings per share, which tells you how many dollars you need to invest to receive a dollar of the company’s profits.
✓ Payout ratio: The percentage of a company’s net profit it pays to shareholders in the form of dividends. The payout ratio indicates whether the company is sharing more of its profits with investors or reinvesting it in the company.
✓ Net margin: The ratio of net profits to net revenues, indicating the percentage of each dollar of sales that translates into a profit. High net margins typically indicate that a company has little competition and large demand for its products. This situation allows the company to charge a high price for its products or services.
✓ Return on equity (ROE): The ratio of a company’s annual net profit to shareholder equity, ROE provides some indication of how effective a company is turning investor dollars into profits.
✓ Quick ratio: An indication of a company’s liquidity or ability to meet its short-term financial obligations. The higher the ratio, the more likely it can afford to pay dividends moving forward.
✓ Debt covering ratio: An indication of whether a company has sufficient operating income to cover its current liabilities, including payments on debt.
✓ Cash flow: The difference in how much actual cash comes into the company during the quarter versus how much it pays out. A company can make a lot of sales in a quarter, but if clients don’t pay their
