I believe that dividends are a very important part of returns. Historically, according to some estimates, dividends have been around half of all returns.
Some people rely on dividends for their income. I’m sure a lot of shareholders don’t want the stress of needing to decide when to sell shares to access the cash to pay for their expenses.
There are many, many different ways to consider and compare dividend shares. Here are some of the ways I consider dividend shares:
A lot of businesses pay dividends, but I wouldn’t count them as a “dividend” share if the yield is very low.
It’s up to each person to decide what the minimum and maximum yields they would look at. For me, I’d want the yield to be at least as high as the best rate you can get from a bank account. So, at the moment, I’d look at shares with yields of 3% or higher.
At the high end I generally wouldn’t want to consider shares with yields above 7% before franking credits. Anything above 7% normally means there’s something risky about that business, although there is the occasional exception worth looking it. Companies with franking credits could have a grossed-up yield of up to 10% and be okay in my eyes.
Sustainability of the dividend and the payout ratio
With any share, you need to consider how safe the dividend actually is.
The payout ratio simply shows how much of a company’s profit is paid out as a dividend. If it has a payout ratio of 50% it’s keeping half of the profit to re-invest back into the business. A business with a payout ratio of 40% could technically see its earnings halve and still maintain the same dividend (or even increase it) if earnings were expected to jump back up in the following year.
Think of Telstra Corporation Ltd (ASX: TLS), it had a seemingly wonderful dividend for many years. However, it was essentially paying out all of its profit out every year. This leaves nothing for re-investing back into the business. It also meant that if earnings dropped the dividend simply couldn’t be maintained – which is what happened.
You need to find businesses that are delivering earnings growth, even it’s only a few percent. If earnings aren’t growing then the dividend can’t be sustainably grown.
Is the business one which has a long growth runway like a business exposed to ageing demographics or perhaps a listed investment company (LIC) with a long-term track record? Or is it a business which is under pressure from competition and high debt levels like G8 Education Ltd (ASX: GEM)?
Some real estate investment trusts (REITs) can make good income choices because they have rental increases built into their contracts. However, you also have to consider: “What will drive the value of the property higher over time?” Is that REIT at risk from online retail or an oversupply of office space for example? That’s why Rural Funds Group (ASX: RFF) ticks a lot of boxes for me, there are fewer obvious dangers.
Can it handle a recession?
If I depended on dividends to maintain my lifestyle, I wouldn’t want to be invested in shares that could be smashed in a recession.
Australia was somewhat sheltered during the GFC and may not be so lucky next time. That’s why I don’t think holding shares like Commonwealth Bank of Australia (ASX: CBA), Super Retail Group Ltd (ASX: SUL) or Automotive Holdings Group Ltd (ASX: AHG) is a good idea for the next downturn.
So what dividend shares are good options?
I think a portfolio of shares like WAM Research Limited (ASX: WAX), Rural Funds Group, Washington H. Soul Pattinson and Co. Ltd (ASX: SOL) and InvoCare Limited (ASX: IVC) would be some of the shares least likely to decrease the dividend even if the share price were hit. However, the today may not be the best time to buy one or two of those shares. Being patient will likely maximise returns.
Another quality dividend idea for your portfolio could be this top income share that just grew its dividend by 25% and would likely grow profit during a recession.
It's been a nail-biter of a reporting season here in the first half of 2018.
But the real action, in my opinion, is what companies are doing with dividends.
What does this mean for you? Well there is one stock I've found that could very well turn out to be THE best buy of 2018. And while there's no such thing as a 'sure thing' when it comes to investing - this ripper might come as close as I've ever seen.
Motley Fool contributor Tristan Harrison owns shares of InvoCare Limited, RURALFUNDS STAPLED, WAM Research Limited, and Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia owns shares of and has recommended RURALFUNDS STAPLED, Telstra Limited, and Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia owns shares of Super Retail Group Limited. The Motley Fool Australia has recommended Automotive Holdings Group Limited and InvoCare Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.