Everyone loves a big dividend yield from their stock holdings.
And while they are by no means unique to Australia's stock exchange, local investors have the added benefit of franking credits on their dividends.
But when does a dividend yield become unsustainable?
When does a dividend stock lose its appeal?
My advice for picking great dividend stocks would be to refrain from spending too much time focusing on the dividends.
Of course, you can run a simple stock filter (which sorts stocks by characteristics such as dividend yield), read a dividend policy and observe historical payouts, to get an idea of the chances you'll receive a capital return from a company.
However, far too many times I've seen investors focus undue attention on a company's trailing dividend yield, which is often quoted on stockbroking accounts or popular financial publications (Google Finance, Yahoo Finance etc.), only to find out six months later that the company will cut its dividend because it encountered financial hardship.
Indeed, some of the best dividend stocks currently on the ASX were once non-dividend-paying companies. Think of the likes of TPG Telecom Ltd (ASX: TPM) or ResMed Inc. (CHESS) (ASX: RMD) – both businesses have proven to be great investments.
Had you bought in years ago, you'd now be receiving huge bi-annual dividend payments. Buy either company today, however, and you'll receive a dividend of less than 1% in the next six months.
Three dividend stocks in the sell zone
While it's all well and good for someone to say buy future dividend stocks and hold them forever. It's also prudent to actively monitor your current share portfolio and cut holdings, either in part or in full when it's appropriate.
National Australia Bank Ltd (ASX: NAB) is one dividend stock I'd put in the sell zone. NAB's recent decision to divest the UK division may de-risk its earnings profile, in time. However, the sustainability of its current $1.98 per share annual dividend payout may be threatened when the banking regulator effectively increases NAB's capital requirements or when NAB's bad debts inevitably rise. Coupled with NAB's rich share price, I think it's a certain sell.
G8 Education Ltd (ASX: GEM) is another company offering a big dividend that I've recently stuck in the sell zone. The company is pursuing a roll-up strategy. That's finance jargon for a business that seeks to consolidate a fragmented industry by buying heaps of smaller rivals. Until recently I was quite bullish on G8 Education. However, its affinity for its smaller rival, Affinity Education Group Ltd (ASX: AFJ), concerns me.
Finally, last week I wrote that Rio Tinto Limited (ASX: RIO) could be a better dividend stock than BHP Billiton Limited (ASX: BHP), based on analysts' profit forecasts. However, I should say I'd never buy either stock for income. The very nature of both companies' business models makes them inherently bad investments for income when you're at the wrong end of the market cycle. Sure, they dig up minerals at a big profit margin when prices are high. However, if market prices continue to crumble as they have recently, their leverage to the market cycle (think: asset write-downs, falling margins and huge capital commitments) make them undeniably poor dividend stocks.
