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There is great comfort to be found in regular, reliable dividend payouts, especially in times of economic uncertainty. But finding shares that can pay them isn't easy. High yields may seem tempting, but they can also be the early warning signs of possible dividend cuts - so it's important to tread carefully.
To help navigate this uncertainty, what's needed is a go-to checklist that covers the most important aspects of dividend investment strategies. This also helps to take emotion out of the decision-making process.
With a few key rules, you'll find it much easier to find better quality dividend stocks in a methodological way. The dividend paid by DS Smith (LON:SMDS) is an example of how to use this checklist approach...
Rules for finding dividend shares
1. 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.
DS Smith has a dividend cover of 2.04.
3. Dividend growth
An important marker for income investors is a track record of dividend growth - and 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.
DS Smith has increased its dividend payout 7 times over the past 10 years - and the dividend per share is forecast to grow by 20.9% in the coming year.
3. High (but not excessive) dividend yield
Dividend Yield is an important dividend financial measure 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 yields above 10% are a flag to suggest there are underlying problems with a share. This is because when the market suspects a company may be unable to sustain its dividend, the share price will fall and actually push the yield higher. It pays to be wary of excessive yields.
DS Smith has a dividend yield of 4.74%.
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 DS Smith that you can find out about here.