Picking excellent ASX dividend shares for your portfolio is not a matter of just buying stocks with high yields.
In fact, sky-high dividend yields could be a warning sign that the stock price is plunging or the business is just pumping out unsustainable payouts.
What long-term investors want is consistent income and capital growth.
So how do you find such unicorns?
According to IML portfolio manager Michael O'Neill, the answer comes down to finding three attributes:
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1. Recurring earnings
This is one of the hallmarks of a "quality" company, as far as the IML team is concerned.
"It's part of our investment philosophy and has been since IML started more than 25 years ago," O'Neill said on the IML blog.
"Companies with a high level of recurring earnings are more predictable, and are unlikely to suffer from the same booms and busts as cyclical companies."
He cited conglomerate Wesfarmers Ltd (ASX: WES) as a prime example of a business that enjoys recurring earnings, especially through its hardware chain Bunnings.
"Bunnings is a very high-quality franchise which continues to go from strength to strength, generating strong, and increasing, cash flow," said O'Neill.
"It is dominant in its industry and has become a part of popular culture and embedded in its communities with its DIY mentality, motivated staff and beloved sausage sizzles."
The earnings and dividend growth is maintained by opening new branches, widening its product offerings and improving margins.
"The overall Wesfarmers dividend has benefited greatly from the Bunnings growth engine."
2. Management competence
Believe it or not, there are many businesses that are led by people who don't know what they're doing.
It's no different to how not every restaurant has an acclaimed chef. Some people are simply better at their jobs than others.
O'Neill named Brambles Limited (ASX: BXB) as a company with a management team that's "done a stellar job".
"The current CEO, Graham Chipchase, has been in the role since early 2017, and his team has significantly improved the profitability of the business over that time as well as reduced earnings volatility," he said.
"The CEO is well supported by the Brambles board, led by John Mullen as chair. Mullen has a strong history of leadership in logistics as well as a distinguished board career, and has helped to drive a strong culture of continuous improvement."
Two ways that the business has improved at the helm of Chipchase and Mullen are the turnaround of the Americas division and rejuvenated customer contract terms.
"Brambles' success since Chipchase started in 2017 can be seen in the consistent growth of its pallet pool over the last six years as well as its underlying EBITDA margin expanding by approximately 4% over this period."
3. Reinvestment of profits towards growth
It could be counterintuitive that ploughing profits back into the business is a desirable quality for dividend shares.
But O'Neill reckons it is critical.
"Companies that overpay dividends relative to profits or stretch their balance sheet too thin don't have this luxury," he said.
"Underinvestment will ultimately result in weak earnings growth and/or unsustainable dividends."
Two ASX companies that demonstrate this attribute are Amcor CDI (ASX: AMC) and Sonic Healthcare Ltd (ASX: SHL).
O'Neill pointed out that Sonic consistently holds onto about 30% of its earnings to "fund growth, either through capital expenditure or M&A".
"It has also backed itself and made some big growth leaps by raising equity every few years for larger, company transforming M&A," he said.
"The success of this strategy can be shown by the way it has continued to increase its dividends to shareholders for the last 30 years – it really is an impressive track record."
Amcor has also increased its dividend for all but two years since 2007.
"One of the key drivers of this dividend history has been the way it has bolted on other businesses to its core business over the years, in niche or adjacent packaging businesses, to continue to fuel its growth," said O'Neill.
"On average, it has retained around 30% of its earnings over the years to be able to continue to afford these bolt-ons."
