Jun 12, 2012|
Are these the best dividend stocks out there?
In the world of investing, there are a lot of numbers that could potentially lie. When it comes to dividends though, lying becomes extremely difficult. In fact, it is a near impossibility if dividends over a period stretching few years are being discussed.
Source: Ace Equity (Based on standalone numbers)
The reason dividends are so hard to manipulate is because they are paid directly to the shareholders of the company and have to be paid pretty fast after their announcement. In other words, the company cannot sweep it under the mattress like it can do for a lot of other financial matters. Thus, if the firm announces a certain dividend payout, it better be real.
Given this advantage and a few more, dividend paying stocks have become amongst the most sought after entities in the share markets. However, it should be noted that not all dividend stocks are created equal. There are certain factors that need to be kept in mind while identifying the right dividend stock to invest in.
Here, we make an attempt to identify what we think are three of the most important.
Firstly, the dividends should form a good percentage of the company's total earnings. It is common knowledge that dividends are paid out from the profits that the company earns. Thus, at least 25% of these profits should be paid out as dividends we believe. This indicates the seriousness that the management of the company attaches to dividends. Companies that pay out less than 25% of profits are either not serious or are susceptible to reducing the dividend payout to a significant extent should times take a turn for the worse.
One could of course argue that certain companies that have low dividend payout ratios can also be high growth companies. Hence, it would be wrong to exclude them. While this is certainly true, this article is about high dividend stocks and hence, they can be comfortably excluded from such a list. May be they can be considered in the future when their growth slows down and they start paying a greater percentage of their profits as dividends.
The second most important quality that a good dividend stock should have is that of a strong financial condition. We really do not want companies to take up debt in order to pay their dividends. This strategy, as we all know, is not sustainable in the long run and hence, is quite vulnerable to failure. Besides, a firm with a strong financial position over a period of 8-10 years is also a firm with strong competitive advantages. Thus, there is a greater possibility of this firm maintaining its dividend payouts in the future than the one with a weak position. For this reason, it is advisable to invest in those dividend paying companies that have an average debt to equity ratio of less than one over the past many years.
Lastly, a good dividend stock should also be available at an attractive dividend yield. Now, this does not mean that higher the yield, the better the stock. On the contrary, a higher yield can be a result of an extremely beaten down stock price. Such investments can prove to be dangerous as the stock price may never recover. On the other side, a very low dividend yield is also not very good we believe. As a low dividend yield would mean a very high price and thus, unattractive valuations. Such stocks may take years for the yield to become attractive at the price at which you bought the stock. We believe that the ideal yield should be in the range of 2%-4%. All the stocks within this band should be given top priority.
Using the above three criteria, we got the following list of top 15 most active stocks from amongst the BSE-500 universe. Please bear in mind that these stocks should not be considered straightaway for investment. Nor are the three criteria the only ones to look out for. But the list does act as a good starting point to create a portfolio of good dividend stocks from a long term perspective.
Market price as on June 11, 2012
||Rahul Shah (Research Analyst), Managing Editor, Microcap Millionaires has led the team from the front in developing some of our most stringent and rewarding research processes. As per his own admission, the turning point in Rahul's life as a financial analyst came a few years back when he got introduced to the works of Warren Buffett and Charlie Munger. From Buffett, he understood the value of investing in good quality business with powerful moats and strong management teams. Charlie Munger on the other hand inspired him to be a lifelong learner and use mental models in order to arrive at the crux of matters across most disciplines. Rahul firmly believes that in order to be successful at investing, you have to do the big things right and possess a great temperament and a contrarian streak.
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