Any investor in the stock market is required to observe with caution. And selecting dividend stocks to boost your passive income requires you to be doubly cautious. Because, if chosen skilfully, this income stream can have the potential to become main stream too.
Dividend stocks are popular because at times of low or falling interest rates, these could be a source of higher yield when compared to traditional fixed income yields. There is also an upside potential when equity markets experience upward trends.
Although there is no single fixed benchmark to find a good dividend yield stock, one can certainly avoid the trap with stocks offering huge cash dividends, by considering other parameters simultaneously.
Here we list some of the important factors to watch out for, before finalising a good dividend stock.
- Dividend Yield: It is the company’s current annual dividend payment divided by the current share price.
- Dividend History: In this a good track of dividend growth is expected. Even if the current dividend yield is comparatively less, a faster growth rate is certainly needed. Any lack of consistency in such stocks just cannot be ignored. Also, to look for are the Company’s growth strategy and stated dividend policy, if any.
- Dividend Payout Ratio: Expressed as a percentage, Earnings per share divided by dividends per share gives the dividend payout ratio based on earnings. This is sometimes seen by annual dividend payments divided by free cash flow. A lower payout ratio can indicate that the company can maintain or even increase the dividends in future without as much difficulty.
To evaluate dividend safety aspect, investors should also see debt position or debt/equity ratio and the Company’s credit ratings. One must keep in mind that stocks fulfilling these criteria are mostly available at higher valuations.
While all this can take good care in deciding a good dividend stock, there could be times when these may also fall short. The Company, may decide to hold off on dividends and instead reinvest in the business, pay down debt, or acquire another firm or for any other problem in underlying business.
A dividend stock wisely chosen can not only provide a steady income stream but can also generate wealth through capital appreciation.
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