- Investment strategies
- Why invest in the stock market?
- Buy and hold or technical analysis? Why you need an investment plan
- Value investing and short selling in volatile markets
- Using technical analysis to support value investing
- Investing in the unexpected
- Franking credits, explained
- What is dividend stripping and is it a sensible strategy?
- Investing in quality IPOs
- How to invest in stocks that benefit from a moving Australian dollar
- Reasons to avoid bonds when interest rates are low
- How value investors use Skaffold
- Quality, growth and value = a winning strategy
- Know your investor type and boost your performance
- Technical + fundamental analysis = better buy and sell decisions
- Fundamental investing
- Value investing and the price earnings ratio
- Intrinsic valuation models and methodology
- Value investments or value traps?
- How to find value stocks in a bull market
- Find value investments in expanding markets
- Why capital raisings struggle to add investment value
- How to value an insurance company
- Top stocks
- 5 qualities of top stocks
- How to find stocks with a competitive advantage
- Why return on equity is the best measure of business performance
- Using cash flow to find value investments
- Finding high quality dividend stocks
- Debt is not always a dirty word
- Why Skaffold share investment software makes sense
- Using economic factors to uncover the best investment options
- How do experts find top stocks to invest in?
- Investing in global stocks
- How to invest in international shares on global stock markets
- Benefits of investing in international shares
Finding high quality dividend stocks
Dividends can provide investment income. Find stocks that can also deliver long-term value.
With interest rates at historical lows and further cuts likely, investors chasing income shouldn’t overlook high quality listed stocks paying consistently high dividends. Australian tax laws – which refund the difference between the (30 per cent) tax a company pays (on fully franked dividends) and your own personal tax rate – contribute to the attractiveness of owning stocks paying a high dividend yield.
But focusing on dividend yield – the dividend per share as a percentage of the share price – in isolation can be a trap, especially if a company’s current earnings are unsustainable and start deteriorating. Remember that if you do rely on income from your share portfolio, high dividends don’t always equate to good investments.
Good dividends are not the same as high dividends
Dividends are the main way companies distribute earnings to shareholders, and ‘good dividends’ are those that are affordable and sustainable, without compromising a company’s growth. One of the key determinants of affordable and sustainable dividends is the quality of the underlying business and its ability to consistently grow earnings.
The primary measure of a company’s ability to pay a dividend is profitability, which can be measured through its return on equity (ROE). At face value, the 10.6 per cent dividend yield offered by Australian Pharmaceutical Industries (API) in 2011 appeared attractive. However, a quick look at its ROE at around negative 4 per cent – well below Skaffold’s preferred minimum 15 per cent – raises serious concerns over the sustainability of this yield going forward.
Another obvious measure of dividend sustainability is the quality of a company’s underlying earnings, and how much it’s had to borrow to generate them, so keep an eye on debt levels. For example, while Automotive Holdings Ltd’s (AHE) 2013 dividend yield of 5.4 per cent may look attractive, its net-debt to equity of 140.6 per cent and $12 million cash flow funding gap raises doubts over its sustainability.
Skaffold’s Capital History Evaluate screen presents AHE’s history of equity, debt and return on equity.
Skaffold’s Cash Flow Evaluate screen presents AHE’s cash flow.
Steer clear of companies offering dividends that cannot be supported through cash generated by the business. Similarly, avoid companies that only have a high dividend yield based on a falling share price due to declining fundamentals like high debt, falling profits or negative cash flow.
Sustainable dividends are key
Likewise, alarm bells should ring if any companies you own start paying out dividends that their earnings can no longer sustain. As a value investor looking for income, you should view any signals that current dividend levels are no longer affordable as a potential trigger-point to exit the stock.
Admittedly, some companies attempt to attract investors with a yield they clearly can’t afford, but this strategy is ultimately wealth destroying. That’s because once cash balances are depleted, dividends have to be funded by raising debt or issuing additional equity.
In the case of building products company CSR Limited (CSR), between 2009 and 2011 dividends exceeded Reported Net Profit After Taxes, and between 2003 and the last full year report (31 March 2013), overspending resulted in a Funding Gap of $66 million. If this wasn’t enough to raise a big flag to investors, then a three-fold deterioration in dividends per share (DPS) from $0.34 to $0.05 over the same period would.
Skaffold’s Cash Flow Evaluate Screen compares CSR’s Reported Net Profit After Taxes and Cash Dividends Paid.
CSR’s dividends per share have been declining since 2010.
Unsurprisingly, the company’s profitability, as measured by return on equity (ROE), has averaged an underwhelming 5 per cent since 2011. And since 2006 the share price has tumbled six-fold from $12.50 to around $3.00.
Another blue chip that also can’t afford its dividend is Ten Network Holdings (TEN), which has used debt and additional equity to maintain its average yield at around 6 per cent. In 2011 TEN increased its debt by $37.5 million. The following year the company raised an additional $200 million of equity and paid out almost $115 million in dividends. In anybody’s language, getting one group of shareholders to stump-up cash so it can be given back to other shareholders is bad business.
Screening for top dividend stocks
Skaffold online investment software has made it easy for you to unearth the top dividend stocks by applying numerous screening filters. By only focussing on profitable companies Skaffold has immediately culled the 2000-plus ASX-listed stocks by 80 per cent.
One final Skaffold filter, which isolates stocks forecast to positively grow their intrinsic value, with ROE greater than 15 per cent and a dividend yield of 4 per cent makes finding the best stocks to invest in as easy as child’s play.