From dividend investing expert Dave Van Knapp:
Picking Dividend Stocks: Dividend Safety
It is axiomatic in dividend investing that the best dividend stocks score highly on dividend yield, consistency, and growth. When you are focusing on dividends (rather than exclusively on price), you obviously want to own companies that:
have a decent initial yield (more than a bank deposit),
pay their dividends without fail, and
increase their dividends regularly.
As with every form of stock investing, all you have to go on in selecting individual stocks is history and conjecture.
As to history, you want to find stocks that have a demonstrated record of paying dividends consistently (never missing a payment) and raising them often. In my e-book, The Top 40 Dividend Stocks for 2008, I present a scoring system for rating stocks along these two scales (plus several others) in a scoring system I call the Easy-Rate system.
A company's history of dividend payments tells you a few things that you can reasonably project into the future. For example, if a company has paid a dividend every quarter for ten straight years, and raised the dividend in seven of those years, that suggests that the company is run in such a way that dividend-paying is the norm. Management expects to continue to pay the dividend every quarter, and they manage the company's money accordingly. They know they have a constituency of shareholders who expect that dividend and periodic increases, and they "play to" that constituency. Skipping a payment or cutting the dividend would probably cause many shareholders to abandon the stock, bringing a disastrous fall in the stock's price.
But any projection into the future is conjecture, isn't it? There is risk in any prediction, from weather forecasting, to picking your fantasy football team, to selecting the best stocks. Even if the "odds are with you," or "all signs point in that direction," there is risk that any prediction will be wrong.
And so it is with dividend stocks. Even if we take the utmost precautions to pick only stocks with a good yield, great dividend history, and the strongest signs of continuing that history, we can be wrong.
The financial sector in the past 12 months provides some vivid examples of such risk. Many retail banks, commercial banks, investment banks, and mortgage lenders have been pummeled by the sub-prime mortgage crisis, which became a full-blown credit crisis. The iconic Bear Stearns (NYSE:BSC) failed (it was bailed out by the government). The iconic Citigroup (NYSE:C) slashed its dividend along with more than 10,000 jobs. Countrywide Financial (CFC), the country's largest mortgage issuer, nearly went out of business, "saved" only by being purchased at a fire-sale price by Bank of America (NYSE:BAC).
In my e-book, I selected Bank of America as one of the Top 40 dividend stocks. It had a 6.6% yield, good valuation, and had raised its dividend for more than 25 straight years -- a select club with only 59 members. But BAC has been hit hard by the credit crisis, and it is hard to tell whether the acquisition of Countrywide, even for a song, is good or bad in the short term. (It is probably very good in the long term.)
BAC, like a lot of banks right now, needs money. One way to get money, of course, is to cut its dividend. So BAC's dividend is "at risk." So far, BAC has resisted that temptation. It paid its first-quarter dividend, even though the payout exceeded its profits. It paid its second-quarter dividend on June 4. Its next dividend (not yet declared) is scheduled for September 28 -- and this is normally the quarterly payment in which BAC increases its dividend each year. Its CEO, Ken Lewis, "views the dividend as safe," as reported by MarketWatch on June 11 (notice that is after the second-quarter payout).
Because of a significant price drop, BAC is now yielding a sky-high 11.4%.
Is BAC still on my Top 40 list? Yes.
Other than the peril of the dividend being cut, BAC satisfies all my requirements for a top dividend stock. One could argue that this is a once-in-a-lifetime opportunity to get a world-class company -- which will now become the nation's largest mortgage lender -- at a yield of more than 11%. Chances like that do not come along often. Notice that if the dividend is not cut, that 11% yield to a new purchaser will never go down in relation to the original investment. In fact, it will go up if and when BAC increases its dividend.
Should BAC still be on my Top 40 list? Maybe. Do you believe Lewis when he says the dividend is "safe"? What would you expect him to say? Do you think BAC will raise its dividend this year? I don't, but that alone does not disqualify the company. Do you believe that at some point in the future, the financial segment will recover, and stocks like BAC will return to former prices? I do, although it will probably take a few years. Remember the savings and loan crisis of the 1980's and 1990's? Banks recovered from that, albeit with a lot of government help and a number of bank failures.
As an investor, you can make up your own mind about Bank of America. For my money (and I own it), it looks like a good long-term investment. Short term, it is likely to lose more value. But the chance of it failing is near zero. Its dividend is in the stratosphere. And I think it's going to weather this storm, turn the corner, and begin re-appreciating in price. I'm focused on the dividend, so I am not as concerned with how long that takes as I would be with a "growth" stock. In the meantime, I will happily collect my checks each quarter.
That's my conjecture.
However, over at The Oxford Club, investment director Alexander Green thinks Bank of America is not nearly as enticing as Spain's Banco Santander (STD):
Many investors have been searching for higher dividends in the beaten down financial sector. This makes sense at first blush since bank stocks have fallen so far that many sport double-digit yields.
But beware. Many of these dividends will be cut sharply. Some will be eliminated altogether.
That doesn't mean that banks aren't a decent contrarian buy right now. But tread carefully.
Reeling from the rise in foreclosures and the ensuing credit crunch, earnings at many banks are quickly evaporating and, in many cases, disappearing. For example, Citigroup has already lopped its dividend by 41%. National City (NCC), a major regional bank, cut its payout in half. And Washington Mutual (NYSE:WM) slashed its quarterly dividend to a mere penny.
Seventeen of 20 financial companies in the S&P 500 have cut their dividends so far this year, more than in the past five years combined.
These banks didn't take this step lightly. Most blue-chip banks have a long history of not cutting dividends. Management wants to keep shareholders happy. But if the money isn't there to cover the dividend, it will not be maintained. It doesn't make sense to borrow money -- or dilute equity holders -- to continue a payout.
Still, you can get a good idea which financial stocks will maintain or increase their dividends -- and which ones will not -- by taking a close look at the underlying business.
Consider Bank of America, for example. Here's one of the nation's top banks, down so far that it is yielding a mouthwatering 11.4%.
Is this dividend secure? Almost certainly not. Quarterly revenue is down 35%. Earnings have slumped 77%. And analysts have slashed future earnings estimates 20% over the last 90 days. It's just a matter of time before this dividend gets whacked.
On the other hand, take a look at Spain's biggest bank, Banco Santander.
The bank has more than 13,000 branches worldwide, the most of any bank. It has virtually no exposure to sub-prime mortgages.
First-quarter profit rose 37% on revenue of $11.63 billion. And while many major banks are reporting record losses, Santander just reported its tenth consecutive quarter of double-digit profit growth. Management is sticking to its forecast of 15% annual earnings growth over the next two years.
This 8.8% dividend yield will almost certainly rise over the next two years. Banco Santander is a far superior choice for the dividend-oriented investor.