I love dividend stocks as they provide a regular stream of passive income.
One would however argue that if a company has solid management which is capable of providing great financial returns to shareholders that capital from earnings be recycled back to the company for more investment, and potentially providing even better returns to the shareholders in the long run. Berkshire Hathaway under value investing guru Warren Buffett does not issue dividends though the company is highly profitable.
Whether a company should give dividends or not is perhaps a separate discussion altogether and there are probably a few different points of view.
Today, I want to explain why I love to own dividend stocks as part of my overall portfolio and a number of things to look out for when investing into counters which give dividends.
I like dividend stocks which provide consistent and even better, growing dividends over a long period of time as it is like a constant cash-flow coming your way to fund your expenses and lifestyle. When you build up a sizable portfolio of such dividend stocks, the dividend income can come very handy and contribute to your ability to retire from an active job.
In the context of Singapore, average dividend return that you can expect is probably about 5 to 7% per annum.
Dividend is funded through earnings and cashflow generated from a company’s business operations, so when choosing and investing in companies which give dividends, this is a check-list you should perhaps go through as part of your evaluation and analysis process:
You want a company which has a great track record in terms of historical earnings. The earnings per share (EPS) should be consistent and ideally growing year by year. I don’t need the growth to be fantastic as otherwise it is probably a growth stock and the valuation of the stock will be quite different.
There is still a need to monitor the the company for future growth potential. At any point, if you think the historical dividend payout is not going to be sustainable, you may have to plan for exit.
Dividend Payout Ratio
Dividend payout ratio is the percentage of earnings that is paid out to shareholders as dividends. This should not be too high. I would hope this to be below 80%. This is about sustainability of the dividend payout as companies may face adverse cyclical business environments from time to time and earnings may be impacted during those times.
Some boring industries (think staple consumer goods) are not subject to new technological disruptions and practically do not require too much R&D. Companies in these industries sometimes are best candidates to consider as dividend stocks. Again, you want to ensure the company while not exhibiting high growth rates (the likes of Alibaba and Facebook), is an engine generating consistent free cash flow and earnings to reward shareholders.
You will have expectations for the kind of dividend return but do not simply chase after high dividend payout. The fundamentals are still the most important to protect your capital. Also, while 5% to 7% return from dividend stocks is awesome, I like my portfolio to have some growth stocks so the overall average return is higher.
To understand more about dividend stocks, value investing and growth stocks, consider learning from Sean Seah (Asian Buffetologist) through the Value Investing Bootcamp. A video by Sean below, working towards financial freedom by building up your stock portfolio.
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