Dividend investors should investigate 10 areas in their analyses of potential buys. That’s according to Mark Lowe in his 2019 book, “Dividend Investing: Simplified - The Step-by-Step Guide to Make Money and Create Passive Income in the Stock Market with Dividend Stocks.”
Five of those areas were discussed in a previous article, and five more are discussed in this one. The first five were consistent cash flow, avoiding heavily indebted companies, checking the health of the industry or sector, the strength of the management team and a strong value proposition.
The second five are avoiding companies with high dividend yields, choosing established companies, investing in blue-chip companies, watching out for speculative companies and investing in sectors you know.
High dividend yields
While we all want higher yields, we should avoid those that look too high. Lowe gave the example of a company that offers a dividend of more than 10% when the market average is about 4.5%.
In this case, the high yield probably means the price has fallen because the market has lowered its expectations about the stock. In other words, the company has not increased its earnings and dividends because it outperformed — quite the opposite, in fact.
Such high dividends can also pop up when a company gets into trouble in the year following a regular dividend payment. The dividend yield will show the same level for a full year even if earnings drop off in any of the next four quarters.
Invest in well-established companies
Many dividend companies become established companies because they deal in basic, unavoidable items such as food, water, gas, housing and hygiene products. Lowe provided this list of dividend-producing sectors with essential products and services:
- Telecommunications
- Energy
- Utilities
- Food
- Clothing
- Toiletries
- Finance
- Real estate.
He added that people buy products from these sectors, regardless of market conditions. On the other hand, they may not buy or will buy fewer products from sectors such as computers, cellphones, restaurants and travel when the economic outlook is dark.
Be prepared for exceptions; as the financial crisis of 2008 reminded us, some seemingly-safe industries such as real estate are not necessarily immune to the laws of financial gravity.
Remember, too, that the very act of paying a dividend makes a company a candidate for established status.
Blue-chip companies
Among the most established of the established companies are those designated as “Blue Chip.” Look for them on the S&P 500 list; as the name suggests, the index includes the 500 or so biggest (by capitalization) companies in the U.S. Regarding the name, apparently it is based on blue poker chips, the most expensive chips in the game.
Lowe said, “This index is composed of the top 500 companies that are performing well and have been evaluated based on specific criteria."
“The S&P committee selects well-established companies that can be considered by investors who are after regular returns with minimal risks," he added.
Watch for speculative companies
Speculative companies are those new to the stock market and not yet a part of any index. They offer higher returns but also can wipe out your investment capital. Leave them for experienced dividend investors or for those who have enough other resources to fall back on if these companies fail.
Not that you should see many of them when hunting for dividend stocks; few companies at this stage have the cash flow or earnings to pay dividends.
Invest in familiar sectors
Lowe recommended investing in sectors you know to all investors, but especially for beginners. He split the American economy and stock markets this way:
- Upper tier (sector).
- Lower tier (industry).
Put another way, a group of industries makes up a sector. For example, he noted that discounter Dollar Tree (DLTR, Financial) and luxury jeweler Tiffany & Co. (TIF, Financial) are both in the consumer discretionary sector, although they are from different industries.
By thinking of industries and sectors, you will be able to compare one company with another. In fact, it is essential that each potential purchase is weighed against its competitors.
There are also relationships that savvy investors can exploit. For example, if energy prices are going down, then it might be wise to move out of energy stocks and into transport stocks (which will benefit from lower fuel prices).
These 11 sectors are worth exploring by dividend investors, in Lowe’s view:
- Financial, comprising the banking, investment funds, insurance and real estate industries.
- Materials, comprising the mining, refinery, chemicals and forestry industries.
- Energy, comprising the oil, gas exploration, energy production, integrated power, alternative energy and renewable energy industries.
- Utilities, comprising the water, gas, electricity and integrated provider industries.
- Telecommunications, comprising the satellite, internet service, cable and wireless industries.
- Consumer discretionary, comprising the consumer durables, apparel, consumer services, media and retail industries.
- Industrial, comprising the manufacturing, fabrication, construction, machinery, defense and aerospace industries
- Consumer staples, comprising the food and beverage, non-durable household products and personal products industries.
- Technology, comprising the information technology, software development and electronics industries.
- Healthcare, comprising the medical devices, hospital management, pharmaceuticals and biotechnology industries.
- Real estate, comprising the retail property, industrial property and residential real estate industries.
If you analyze a company from one of these sectors you know well, you are well positioned to consider three factors suggested by Lowe:
- How the company has performed in the market.
- The company’s competitive advantages or moats.
- Opportunities for growth in the next two to three decades.
Conclusion
In the course of chapter six, digested here over two articles, Lowe has laid out a set of criteria against which to assess potential dividend stocks.
There were 10 criteria in total: consistent cash flow, debt level, sector health, business management, value proposition, dividend yield, stable profits, blue-chip stocks, speculative companies and sector knowledge.
By investigating each of these areas, your chances of avoiding dud dividend stocks are much better.
Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.
Read more here:Â
Dividend Investing: Choosing Dividend Stocks, Part 1
Dividend Investing: The High Dividend Yield Strategy
Dividend Investing: The High Dividend Growth Rate Strategy
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