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For income investors concerned about uncertain economic conditions, the comfort of a regular, reliable dividend is hard to overstate. But finding these kinds of shares isn't easy...
Excessive yields, weak financials and variable payouts can all lead to disappointment for income hunters. So what's needed is a go-to checklist that covers the most important aspects of dividend investment strategies.
With a few key rules, you'll find it much easier to find better quality dividend stocks. Let's take a look at Northwestern (NSQ:NWE) as an example of how this works.
Rules for finding dividend shares
1. High (but not excessive) dividend yield
Yield is an important dividend metric because it tells you the percentage of how much a company pays out in dividends each year relative to its share price. That makes it easy to compare dividend payouts right across the market.
High yields are obviously appealing but be careful of excessively high yields (usually above 10%) because they can be a sign of problems. When the market suspects a company may be unable to sustain its dividend, the share price will fall and actually push the yield higher - and this can be a trap. So it pays to be wary of excessive yields.
Northwestern has a dividend yield of 4.23%.
2. Dividend growth
Another important marker for income investors is a track record of dividend growth - as well as evidence that the growth will continue. Consistent dividend growth can be a pointer to companies that are carefully managing their payout policies - and rewarding their shareholders over time. Rather than aggressively dishing out earnings, dividend growth companies tend to have more modest yields, but are better at sustaining their payouts.
Northwestern has increased its dividend payout 9 times over the past 10 years - and the dividend per share is forecast to grow by 2.02% in the coming year.
3. Dividend safety
Attractively high yields obviously turn heads - but it’s important to know that a dividend is affordable. Dividend Cover (similar to the payout ratio) is a go-to measure of a company's net income over the dividend paid to shareholders. It’s calculated as earnings per share divided by the dividend per share and helps to indicate how sustainable a dividend is.
Dividend cover of less than 1x suggests that the company can’t fund the payout from its current year earnings - and might be relying on other sources of funds to pay it.
Northwestern has dividend cover of 1.40.
What does this mean for potential investors?
Yield, Growth and Safety are the three main pillars that support some of the most popular dividend investing strategies. But it's important to know that dividend payouts can be cut or cancelled very quickly when the outlook changes.
To get a fuller understanding of the dividend prospects for any stock, it's important to do some investigation yourself. Indeed, we've identified areas of concern with Northwestern that you can find out about here.