Four Key Characteristics To Look For In Dividend Stocks

Written by Hank Coleman

Stock Screening DataThere is a lot of talk about great dividend stocks to purchase for the long-term. But, how do you weed out the great dividend paying stocks from the hundreds of good or mediocre ones? There are a few key metrics that dividend investors need to consider before purchasing their first share. Here are a few of the biggest metrics to consider.

Dividend Yield

Dividend yield is simply the annual amount of dividends per year per share dividend by the price per share of the company’s stock. For example, Apple recently announced that it was issuing a quarterly dividend of $2.65 per share or $10.60 per share annually. With Apple’s share price currently hovering around $600 per share, its dividend yield is 1.76%. A company’s dividend yield provides investors with a way to visually see how much of their investment is being returned to them each year in the form of dividends issued by the company.

Dividend Growth Rate

Another key dividend metric that investors should consider before purchasing shares is the company’s dividend growth rate. Just as you would imagine, a stock’s dividend growth rate shows investors in percentage terms exactly how much the company is increasing their dividends over a period of time, typically annually. For example, McDonalds Corporation (Stock Symbol: MCD) has a 2.8% dividend yield and a history of increasing its dividend by an average of about 19% each year for the past five years. Whether a dividend growth rate is sustainable at these levels for the long-term is debatable, but showing a steady dividend growth rate over the course of several years is one factor that investors should consider. It is also a large factor in valuation models such as the dividend discount model (DDM) which allows investors a fairly simple way to value stock based on dividend growth at a stable rate.

Dividend Payout Ratio

The Dividend Payout Ratio is the percentage of earnings that are distributed annually as dividends. A company who has a Dividend Payout Ratio of 40% distributes 40% of its earnings back to shareholders in the form of a dividend. The other 60% can be used for things such as increasing the company’s retained earnings, buying back shares of its stock, and other financial transactions. Most investors consider 30% to 60% as the ideal Dividend Payout Ratio for a company to have. Comparing dividends against earnings instead of other financial numbers like revenue or free cash flow often give investors a smoother and more stable look at how financially secure a company is and whether or not they will be able to continue issuing a dividend at their current rate.

Free Cash Flow Payout Ratio

The Free Cash Flow Payout Ratio shows a company’s annual dividend payout as a percentage of its free cash flow. This is another ratio that can show you trends with respect to a company’s earnings and dividends. For example, while McDonald’s Corporation has increased its dividend growth rate by almost 19% annually over the past five years, McDonald’s dividends have also grown as a portion of their free cash flow as well. In 2008, dividend payouts accounted for 48% of McDonald’s free cash flow. This past year the ratio was just over 59%. This increase in the Free Cash Flow Payout Ratio may indicate that a company like McDonald’s could face increased trouble in the future continuing to grow its dividend at such a fast rate.

Conclusion

Another great way to find stocks with good dividend metrics is to use a stock screener. Google Stock Screener allows you to screen out stocks to meet certain criteria and show only certain companies. You can search for companies with a dividend yield in a certain range, and you can even screen stocks using a range for the Free Cash Flow Payout Ratio in the Google Stock Screener as well.

While these metrics are simple calculations in most cases to show investors potential undervalued dividend paying stocks, these are just a few methods for stock valuation. They will not replace investors’ need to further conduct their own research when deciding which stocks to invest in, but these metrics provide a good starting point for any dividend investor in search of good values in share prices.

Readers, are there other key dividend metrics that I missed that you use to help value dividend paying stocks? What is your favorite source for stock screening data?

22 Responses to “Four Key Characteristics To Look For In Dividend Stocks”

  1. Peter

    Apr 02. 2012

    Great post Ninja! Good summary of everything you have talked about in the past.

    Regarding the Cash Flow payout ratio, I see that GlobeandMail MyWatchList offers this ratio, but for MCD it shows 29% for TTM. It says the formula is dividend per share divided by cash flow per share. Is that a different formula being used?

    Thanks.

    Reply to this comment
  2. farcodev

    Apr 02. 2012

    Another instructive post. :)

    Good work !!

    Reply to this comment
  3. MyMoneyDesign

    Apr 02. 2012

    Thanks for the metrics Hank! You know I love to apply math to my selection process! I’ll be noting these on my list of things to watch out for in my next round of dividend stock selections.

    Reply to this comment
  4. Peter

    Apr 02. 2012

    Oops, sorry, I just realized this was written by a guest writer. My apologies. But yes, very informative indeed.

    Reply to this comment
  5. My Own Advisor

    Apr 02. 2012

    Great post Hank!

    I also look at consecutive years for dividend payments. I prefer to own mature companies that have a history of paying dividends for 10, 20, 30 or more years.

    Consecutive dividend increases is also a great metric, but that certainly narrows the shopping list, and maybe that’s a good thing :) That list is very short for companies in Canada, some are great companies but haven’t continually increased them for 25 years or more like many U.S. aristocrats. I recall there is only one that has done that: Fortis.

    Also, instead of just looking at cash flow ratios, I look at rising cash flow overall. If a company has increasing cash flow, then I’m not too worried with the ratios since capital expenditures do and need to occur.

    Again, great stuff Hank. Will promote via twitter :)

    Reply to this comment
  6. Thanks for posting about stock selection. I have been looking about it for a few days now. This will serve as a good manual to get my feet wet into stocks

    Reply to this comment
    • The Dividend Ninja

      Apr 03. 2012

      Karunesh I suggest you start off with low cost and low fee Index Funds and Index ETFs. ;) Move into stocks after getting your feet wet.

      Cheers

      Reply to this comment
  7. After College Money

    Apr 03. 2012

    Thanks for the post! I also like Google Stock Screener to find interesting companies that I may not know about. If I find something I like, then I go to MSN Money or the Balance sheet for more detailed information.

    Reply to this comment
  8. Kolton @FMT

    Apr 03. 2012

    I am not much a dividend guru and I’d like to learn much more about them because they seem to be very profitable and provide diversification for investors. I am curious to know if the payout ratios require some sort of mathematics equation on your part or are they given to you like the dividend yield is?

    Reply to this comment
  9. sleepydad

    Apr 04. 2012

    Going back to the basics! That’s great, its always a good reminder of the basics!

    Reply to this comment
  10. Toby

    May 17. 2012

    Excellent article. The next question is “Is the price right?” That is, has the stock become too pricy or is the current price acceptable. Dividend investing has become quite popular of late, and some of the traditonal dividend stocks seem to have gotten too high for comfort. Thanks.

    Reply to this comment
  11. Trevor

    Apr 14. 2013

    Hi DN,

    Newbie here. I am just trying to get my head around the Dividend Growth Rate you mentioned above. How do you calculate it.

    I would assume you take the last 5 yrs of dividends calculate the dividend growth as a percentage year on year and then divide by 5. E.g. THI.TO (Tim Hortons) $0.36, $0.40, $0.52, $0.68, $0.84. I then ((0.40-0.36)/0.36)*100 to get 11.11%, I then repeat for following years and get 30%, 30.77%, 23.53%, sum these and divide by 5 to get an average of 19.08%. (NOTE: I have 4 percentage numbers and dividing by 5, is that right?)

    The reason I ask is because I see different figures on different sites, e.g. ca.dividendinvestor.com has the 3 yr Dividend Growth Rate 3yr Avg of 65.22%, in which they seem to just sum the percentages.

    Cheers for any insight on how to calculate this.

    Reply to this comment
  12. Trevor

    Apr 14. 2013

    Hi again,

    Was also wondering if there is a great place to get the Free Cash Flow Payout Ratio for Canadian stocks? It doesn’t seem to be a readily available figure. Also from what I have been able to gather Cash Flow is different to Free Cash Flow, is that right?

    Cheers,
    Trevor

    Reply to this comment

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