Written by Hank Coleman
There 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 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.
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?