With interest rates at record lows and fixed income products offering lower yields, income investors are hard-pressed to find alternative investments. The changing market conditions are prompting investors to change their investment strategies in search of sustainable income growth. Of the ASX200, 180 companies pay out a dividend each year. Here's how you can sift through the murky terrain and find champion dividend stocks.
How have dividends performed in 2019?
Following reporting season, aggregate dividends were up 4.9% from the previous year. This was fuelled by the mining and energy sector with BHP Group Ltd (ASX: BHP) and Rio Tinto Limited (ASX: RIO) both paying record dividends on the back of a soaring iron ore price.
In addition, 88.4% of companies paid out a dividend in August following the full-year reporting period. According to analysts, 21% of large-cap companies reported a higher dividend payout. As an income investor, basing your investment decision on growing dividend payouts can be deceptive as many of the companies also reported declining profits. Ideally, dividend growth should also come with profit and share price growth.
How are income stocks classified?
Traditionally, income stocks are divided into defensive yield and cyclical yield categories. Defensive yield stocks are those that offer a buffer against economic downturns when the economy is slowing and bond yields are falling. This category includes sectors such as REITs, consumer staples and utilities, which are all essentials. Companies that fit the defensive yield category include the likes of Stockland Corporation Ltd (ASX:SGP) and Vicinity Centres (ASX:VCX).
Cyclical yield stocks are more weighted to a single sector and are prone to boom and bust cycles. An excellent example of this is the mining and resources sectors and companies such as BHP Group and Rio Tinto.
Finding a champion dividend stock
A champion dividend stock is one that can perform well in all market conditions and is not confined to defensive or cyclical yield categories. In addition, great dividend stocks provide compound income through a growing share price and growing dividend yield.
CSL Limited (ASX: CSL) is a classic example of a champion dividend stock. CSL boasts a unique business model that has performed over the long term and is a core holding for many institutional investors. Trading near all-time highs, and boasting a price-to-earnings ratio around 33, some may argue that the company's valuation is expensive. However, CSL has an impressive track record of compounding income, with its dividend payout rate more than doubling since 2013. In addition, since 2013 the CSL share price has increased nearly 400%, making it the gold standard for a champion dividend stocks.
Foolish takeaway
Although I have given an example of what to look for in a champion dividend stock, investors should do their own research before making an investment decision. In my opinion, a prudent strategy would be to select sectors that are forecast to grow in the long term and establish a watchlist of companies that fit the criteria of a champion dividend stock.
