Stock Selection

Aspects that are essential to consider when screening for dividend stocks include:

  1. Future dividend growth potential has greater impact than current dividend yield
  2. Do not overpay
  3. Look at company fundamentals to determine the sustainability of the dividends and that the company is healthy
  4. Look for companies that has a history of keeping and increasing dividends also in stressful investing environments
  5. Avoid the smallest companies

1. Dividend growth

See Power of Dividends section

2. Do not overpay

There are a great number of companies with an excellent dividend policy so there is no real reason to accept to overpay. Spend the time to find shares that are minimally correctly valued, and preferably undervalued.

Looking at the current P/E of the company gives a first understanding of how the company is valued. However, you will get a much more comprehensive picture by looking at how the P/E has developed over time. To avoid overpaying a simple screening includes setting an upper P/E limit above which you will not consider buying the stock at the current price and then monitor the share price with alerts. Typically a good initial target P/E would be less than 15.

Before buying shares in the company also other valuation metrics, such as DCF, P/S and P/B, should be looked at.

3. Company fundamentals

Trying to predict the future Revenue and profitability development of a company is very difficult even when working inside a company. As an investor, with an outside perspective, it is even more difficult or virtually impossible. Looking at historic figures is no guarantee for future success but the data is available and by screening for companies with a good revenue and profitability momentum you may select stocks where there is an underlying business with a proven growth track-record.

Revenue and EBITDA

To maximize the chances of continuing dividend growth you want to screen for companies that show a strong history of continuous revenue and profitability growth. Identifying stocks that have a Revenue and EBITDA 10-year CAGR (Compound Aggregate Growth Rate) of minimum 5% will give some assurance that there is growth momentum in the company. However, naturally the source of growth also needs to be looked at as part of this may come from acquisitions and not organic growth. It is preferable if as much as possible come from organic growth.

Net profit

Dividends are paid from Net profit and the dividend payout ratio tells you how much of the net profit is paid out in dividends. Ideally the payout ratio should be low (<0.3) at the same time as the dividend yield should be high (>3%)  as this would indicate that the company could keep paying and growing the dividends even if profitability is temporarily negatively impacted. Acceptable pay-out ration vary between industries.

4. Dividend track record

By screening for shares in companies that has a history of continuing to pay dividends also when either the company or the market is not developing favorably there is potentially a greater chance that next time there is a downturn the company will continue to pay dividends. There is a double advantage of obtaining dividends when the stock market or the company is struggling as it will likely create an opportunity to invest when the stock prices are relatively low.

5. Company size matters

Since dividend investing is about finding stable companies with a relatively predictable outlook it is often easier to find these among the bigger companies. They also have the track-record needed to give the needed comfort.