I took a family member to the doctor’s office last week after a long day of researching dividend-paying stocks. The doctor began the visit by checking blood pressure along with other vitals. I, on the other hand, was still running numbers of stocks in my head while partially keeping my attention on the doctor. As odd as it may sound, it was at that moment I noticed a correlation between tracking the financials of a company and a doctor checking the vitals of his patient.
Anyone familiar with equity investing has been tempted at one time or another to purchase a high-yielding dividend stock. In many ways these stocks can make or break your portfolio. You can do more than purchase the stock and cross your fingers until the ex-dividend date passes. It is your job to do your due diligence on the company’s financials to make an educated decision whether the dividend is safe or not.
Before I managed money professionally, I did all my financial research through Yahoo Finance. I still use the Web site as a feather in my cap for number crunching and news tracking. In my opinion, the best page on the Web site is the “key statistics,” found as a hyperlink on the left hand side, which gives a brief overview of the financial vitals of a company based on the latest earnings record.
One ratio that can be checked just as quickly as your blood pressure is a company’s dividend payout ratio. This ratio is the percentage of net income or company earnings paid to shareholders in the form of a dividend. The percentage of earnings not paid to shareholders is considered stockholder equity and hopefully invested back into the company to generate future earnings growth and dividend growth.
Typically a reasonable dividend payout ratio is between 40 percent to 60 percent but may vary by sector. A company competing in a high growth sector will usually have a lower or zero dividend payout ratio since they are driving much of the earnings back into the company for the sake of growth. Mature companies in sectors with a high barrier of entry might return a much larger percentage of earnings back to the shareholders in the form of a dividend.
A company’s dividend payment is never guaranteed and the company may increase, decrease or eliminate dividend payments all together. A dividend payout ratio in excess of 100 percent is difficult for a company to sustain and can mean a rising debt load or shrinking cash position. I like to benchmark a company’s dividend relative to its competitors. If the dividend payout ratio looks irregularly high, it could indicate a future dividend cut which is sometimes followed by a substantial price drop in the stock.
Investing in a company that pays a hefty dividend can be a great way to produce returns within your portfolio. I have come across portfolios where the investor has amassed great wealth by holding a stock for many years while constantly reinvesting the dividend. Albert Einstein once said, “The most powerful force in the universe is compound interest.” Unfortunately, not all dividends were created equal and a stock’s price will constantly fluctuate in value such that, upon sale, the shares may be worth more or less than the original price. It may prove wise to frequently review the health of your portfolio by checking the vitals of your stock holdings.
Griffin Dalrymple, a wealth manager at Coastal Wealth Investment Group LLC in Palmetto, can be reached at (941) 847-0035.