Published March 9th, 2015
This is a guest post from Dividend Earner. The Dividend Earner website is focused on building wealth through dividend income. You can view Dividend Earner’s dividend income growth from 2010 to now at this link.
When investing in dividend stocks, there is a pair of metrics that should really be looked at together as the differential trend can lead to a warning sign. While the individual metrics can meet your criteria individually, the trend line between the two metrics can display a different pattern.
For starters, let’s assume that the stocks you are looking at meet your investing rules. See my 7 investing rules if you don’t have formal rules yet. The rules are yours so feel free to adjust mine. For example, one investor may prefer dividend yield above 2% while another may prefer a dividend yield above 3%. The rules are in place to provide a razor to quickly eliminate investments. Once a stock passes your investment rules, and there should be a good number of them, then you start tracking them for purchase opportunities. I separate my list of potential stocks from my buy list at a point in time.
Identifying the purchase opportunities is where it can get interesting. Sometimes a stock is too expensive and you wait for a pullback, sometimes it’s a matter of waiting for other metrics to get within your range. One metric I like to look at is the dividend growth but by itself the dividend growth doesn’t paint the whole picture as you also want to make sure the dividend payout ratio is within the expected range. As a note, corporations usually have guidelines relating to their payout targets. For example, Canadian banks payout 45%-55% of earnings.
The metrics to pay attention together are:
- Dividend Growth
- EPS Growth
I realize that the two metrics together are the payout ratio. The difference between looking at the two metrics in a graph is that you get to see a graph that’s easier to understand due to the immediate relationship. You obviously need the two metrics to generate a historical payout ratio but all you would get is one trend percentage. Here is a straight up historical payout ratio. A little erratic and not consistent. I chose that type of chart on purpose to highlight the benefits of looking at the payout with the 2 metrics as you can see further down.
When put together, you get to see this kind of graphs. BNS outlines the proper growth in EPS versus the dividend paid. While looking at the most recent year gives you a good actual state of their earnings and payout, looking at the history highlights strength in the management team. With a payout ratio graph, you would not have been able to visualize the gap as easily and it would have been a down graph which makes us think it’s negative at first when in fact, it’s a good thing.
A less stellar example comes with Potash of Saskatchewan which recently raised its payout target but has yet to demonstrate a longer trend with such payout. This could signify a challenge in future growth and therefore future dividend growth.
I believe trends play an important part in choosing a stock and highlighting the strength of a company. Showing how you show the trend is really important to get a good idea of the company’s payout abilities. Having the data and access to the data goes a long way in ensuring good investment decisions.