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What Makes a Dividend Yield Safe?

March 06, 2013
It’s a very common question for any dividend investor. As much as we look to play offense (try to get a rising yield), it’s critical to also have a good defense, avoiding any stock that might reduce its dividend payout. It’s not always easy to do but it’s the key to being able to rely on a dividend portfolio as an income source. In fact, even having no growth is simply not good enough. Your dividend income should increase by the inflation rate at a minimum in order for you to be able to keep the same lifestyle.

Can All Dividend Drops Be Anticipated?

I’d personally say no. Some things are almost impossible to predict. Just think of events such as the Enron scandal or the recent credit crisis when banks all around the world went from great dividend payers to not paying out anything almost overnight. That is why there is no substitute for having a diversified dividend portfolio, one that can’t be too affected by any one event or regulation change.

There Is Such A Thing As Yield Safety

That being said, the best way to ensure that you have see growing dividend yields year over year is holding names that are paying out what they can afford. Here is what I personally look for in dividend stocks in order to determine if their dividend yield is safe:

-Low Payout Ratio: This can be seen as just one number but in reality, I’m looking for companies that pay out at most 70% of their earnings every year. Anything more means the company might run into issues

-Dividend History: Companies that have a 20 or 30 year old history of paying and raising dividends are generally proven and reliable enough to depend on

-Healthy Underlying Business: I always look at 5 year growth numbers in terms of both revenues and earnings per share. You could look at a different number but I always feel like looking at 1 year growth rates tells a very incomplete story.

-Debt Level: Debt levels are a bit more tricky because it depends a lot on the industry. What I do is compare companies with industry competitors and look for below average levels of debt.

-Underlying Risks: This is a bit more difficult to look at. But think of it this way. What are the odds that competitors will be able to take over major brands that Proctor & Gamble own? How would you compare that to the risk of seeing Apple’s one big product, the iPhone, lose its edge? Those are the type of things I look at.

How many of your dividend holdings are at risk? I’ll do a better analysis of the USDP’s yield safety in the near future.


Rating: 3.3/5 (3 votes)

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