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Dividend Trends For Selecting Stocks

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A net return on invested capital between 4% and 6% would be quite attractive, especially in today's historically low money market yields. There are few ways that you can safely rely on a return above 4% in today's interest environment. However, a solution is found in dividend yield. A search of dividend yields as of June 3, 2010 lists 350 stocks yielding 4-6% dividend.

However, the yield itself is not the sole determining factor in selecting a long-term high-yield stock. Rather, picking a stock that has increased its dividend yield every quarter for at least 10 years - so-called "dividend achievers" - produces a list of very impressive stocks, at least based on dividend yield.

The decade-long record of growth in dividend yield implies that the trend is going to continue into the future. The combination of 10 years growth in dividends and exceptionally high yield itself produce another interesting attribute. Market value of the stock has tended to grow over the 10 years with less price volatility and more fundamental reliability than average. This means revenue and earnings tend to grow consistently from year to year, and other fundamental indicators do not vary over time, but come in predictably every quarter and year. Using long-term growth in yield is a reliable way to pick companies as value investments. The ability to continue increasing dividends requires effective working capital control as well as consistent profitability.

You will also discover that companies meeting these criteria tend to have relatively low debt ratios. This test (the percentage of long-term debt of total capitalization) is crucial for selecting a company for the long term. When the debt ratio increases over the years (remember General Motors, for example, whose debt grew to 120% of total capital, meaning equity was in the red), it is a strong signal that the company's management is not able to maintain its working capital, and gradually replaces dividend payments with interest payments. You hope to see the debt ratio decline over time or, at the very least, to remain at the same level. As debt increases, future cash flow has to suffer and so does dividend yield.

From the stockholder's point of view, two conclusions tell the whole story:

First, growth in dividend yield is a strong symptom of effective working capital control and long-term profitability, especially when dividend increases have been accomplished over 10 years or more.

Second, dividend success often occurs along with consistent profits, low volatility, and a steady or falling debt ratio. Added together, these are exceptionally strong signs of fundamental strength in the past, and reliable predictions in the future.

You can easily spot companies that are either ascending or descending in their competitive position. Test not only the obvious changes in revenue and earnings, but also the dividend yield and debt ratio. Weakening fundamentals are danger signals, found among companies that are losing their market and competitive positions. Strength and improvement in the same indicators reliably point to those companies that have historically out-performed their competitors, and are most likely to repeat that performance in the future.

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