What makes a good dividend investment?
Almost everyone knows share dividends are not guaranteed. At best, they can be reliable and grow over time. Unfortunately, few companies can offer growing dividends each and every year.
That’s why companies which have done just that — such as Commonwealth Bank of Australia (ASX: CBA) — become some of the most valuable on the entire market.
But being a good dividend-paying company is more than just paying a reliable dividend to shareholders. Many companies on the ASX that pay consistent dividends may not have a business model that lends itself to dividend payments over time.
For example, is it a good idea if the company pays a dividend each year but is also loading up on debt? Is a good idea if the company issues shares to pay dividends? Of course, it isn’t.
Ideally, long-term investors — and by that I mean those who are investing for five years or more — should be finding companies which have growing profits, improving margins and recurring revenue. These features should help the company generate good cash flows and not need to raise capital from investors or lenders.
What’s wrong with resources?
If I was going to buy any resources shares Rio Tinto, BHP and Fortescue would be at the top of my watchlist. However, if I were relying on dividends each and every year, I would not buy them in big proportions because I do not believe their businesses lend themselves to providing a stable income for shareholders.
Sure, over the past decade, BHP and Rio Tinto have produced decent dividend returns. However, one fundamental problem they have is that they cannot set the prices of their products (think iron ore, aluminium, coal, etc.)
So although they have strong businesses and are unlikely to go bust, their cash flows can be volatile because commodity prices can rapidly rise and fall depending on supply and demand.
Investing in shares is high risk compared to term deposits and savings accounts. In my opinion, resources shares do not make ideal investments for long-term income-seeking buy-to-hold investors. While some investors may target resources shares for growth, I think it would be a dangerous idea to rely on them for a consistent income stream.