The compounding effects of reinvesting dividends over the long-term can be spectacular - but finding stocks to help you do it is a challenge...
The present economic uncertainty is likely to put sustained pressure on dividend payouts over many months. So it's more important than ever that your income stocks are as reliable as possible.
To help you find them, it's worth considering a few important rules that cover some of the most important features of dividend investing. Armed with these measures, you'll help to protect yourself from dividend traps and find those companies with the best chance of offering a solid, sustainable income stream over the long term.
Let's take a look at Phoenix Group (LON:PHNX) as an example of how this works.
Rules for finding dividend shares
1. High (but not excessive) dividend yield
Yield is an important dividend metric because it tells you the percentage of how much a company pays out in dividends each year relative to its share price. That makes it easy to compare dividend payouts right across the market.
High yields are obviously appealing but be careful of excessively high yields (usually above 10%) because they can be a sign of problems. When the market suspects a company may be unable to sustain its dividend, the share price will fall and actually push the yield higher - and this can be a trap. So it pays to be wary of excessive yields.
- Phoenix Group is a player in the Insurance industry. It has a dividend yield of 7.00%.
2. Dividend growth
Another important marker for income investors is a track record of dividend growth - and evidence that the growth will continue. Consistent dividend growth can be a pointer to companies that are carefully managing their payout policies - and rewarding their shareholders over time. Rather than aggressively dishing out earnings, dividend growth companies tend to have more modest yields, but are better at sustaining their payouts.
- Phoenix Group has increased its dividend payout 6 times over the past 10 years - and the dividend per share is forecast to grow by 1.47% in the coming year.
3. Dividend safety
Attractively high yields obviously turn heads - but it’s important to know that a dividend is affordable. Dividend Cover (similar to the payout ratio) is a go-to measure of a company's net income over the dividend paid to shareholders. It’s calculated as earnings per share divided by the dividend per share and helps to indicate how sustainable a dividend is.
Dividend cover of less than 1x suggests that the company can’t fund the payout from its current year earnings - and might be relying on other sources of funds to pay it.
- Phoenix Group has dividend cover of 1.33.
Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser. The author has no position in the stocks mentioned, unless otherwise stated.