I was reading an interesting article about investing in the stock market by Gary Kaminsky on CNBC.com.
Kaminsky stated that
for the next 10 years, I’m expecting 6-7 percent returns: lower than the historical average set in the 20th century, but not as dire as the recent past. Furthermore, I believe the majority (two-thirds) of those gains will come in the form of reinvested dividends and distributions.
I happen to agree with Kaminsky’s thesis and believe that we are looking at an environment that will produce single digit returns for the next few years. The second part of the statement rings especially true. Dividends are going to be more important than ever to the investment returns of investors.
In the past I have talked about how critical dividend stocks are in building wealth through a passive income stream. Dividend stocks will play an even larger role going forward. So, how can you assess a quality dividend stock?
Look for the following traits.
1. Find companies that have a track record of increasing their dividend payouts.
Don’t be fooled by fly by night companies that my have a generous yield one quarter and it’s gone the next. Invest in companies that have historically paid out a quality dividend and will continue to do so. Verizon (NYSE:VZ), AT&T (NYSE:T), Kraft (KFT) are examples of these types of companies.
2. Look at the company’s cash position.
Dividends are paid out directly from the company’s cash. If a company has massive debt burdens or declining cash flow then its dividend may be in trouble. Certain market sectors are known for their ability to produce significant operating free cash flow. Companies with large inflows of cash on a consistent basis are the best candidates for dividend investments.
3. Watch the dividend payout.
The dividend payout ratio will help you determine exactly how sustainable a company’s dividend is. If you want to find a company’s dividend payout rate, just take the earnings per share of the company and divide it by the company’s annual dividend. If the payout ratio is 70% or more of earnings, be careful. This is a company that may be in line for dividend cut. I always compare the historical dividend payout ratio to the current payout ratio.
4. Keep your eye on the yield.
Every company that pays a dividend is not necessarily a good dividend stock. A good dividend stock should have a yield of 3% or more to qualify as a solid dividend investment. A 3% return on your money in dividends makes it easier to try and generate a positive return on investment even during bear markets. Compare the current dividend yield to the historical average dividend yield. An unusually high yield can be a sign that a stock is undervalued or that the stock’s dividend is due for a dip.
As you can see, dividends have and will continue to be an investor’s best friend. They can generate a solid income stream and provide you with positive real returns even during the bad times like the bear market of 2008.