Investors looking to use their investments to fund their living expenses often try to find a stock which pays a good dividend. Below are some of the factors to look for in a company to identify a good dividend paying stock.
1. Dividend Yield
Investors can use the dividend yield ratio to determine the size of dividend which will be paid to the shareholder.
The formula is Dividend Yield= Dividend Per Share/Price Per Share
This compares what annual payout is for the dividend compared to the price of the stock. A dividend payout of 6% is considered a good dividend yield. A higher dividend yield means a higher dividend payout.
2. Large Capitalization Stocks.
These companies are usually the ones that pay a good dividend. Smaller capitalization stocks often reinvest their earnings back into the business so it can grow further. These smaller companies don’t usually pay dividends. Big established companies are more likely to pay dividends to their investors and as they are more likely to generate a profit and pay shareholders the leftover profits.
3. Bond Proxies
There are certain sectors/ stocks which are seen as bond proxies. This means that they provide a steady form of dividend income – similar to bonds. Infrastructure stocks which include toll road operations and airports are one sector known for paying consistent dividends. Telecommunications and REIT stocks also have a reputation of paying strong dividends.
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4. Dividend Payout Ratio
A good dividend payout ratio can give an investor an indication of how much of the firm’s earning is allocated to the paying out dividends to shareholders. Trends of this dividend payout ratio can be compared over time so if the payout increases then it means the firm is maturating and increasing the income it pays out in dividend. Smaller cap stocks are likely to reinvest their earnings into the company and this will be reflected in a low or zero dividend payout ratio. A dividend payout ratio of under 50% is ideal. If this ratio is too high then the company may not be able to continue that dividend payout long term.
The formula to calculate this.
Dividend Payout Ratio: Dividends Paid/ Net Income
Lauren Hua is a private client adviser at Fairmont Equities.
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