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The compounding effects of reinvesting dividends over the long-term can be very beneficial - but finding stocks to help you do it is a challenge...
The present economic uncertainty is likely to put sustained pressure on dividend payouts over many months. So it's more important than ever that your income stocks are as reliable as possible.
To help you find them, it's worth considering a few important rules that cover some of the most important features of dividend investing. Armed with these measures, you'll help to protect yourself from dividend traps and find those companies with the best chance of offering a solid, sustainable income stream over the long term.
Let's take a look at DS Smith (LON:SMDS) 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.
DS Smith is a player in the Containers & Packaging industry. It has a dividend yield of 5.46%.
2. Dividend growth
Another 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 9.93% 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.
DS Smith has dividend cover of 1.66.
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.