How to Invest in Dividend Stocks using Value Investing Principals

Today we’ll look at how to select dividend stocks. If you’re interested in receiving dividend income, then finding quality dividend stocks is a good place to start. You can find information on companies that pay dividends online. Several good sites for aiding your search are Barron’s, Morningstar, Seeking Alpha, The Wall Street Journal, and Value Line.

Barron’s, Seeking Alpha, and The Wall Street Journal have detailed articles on companies. Morningstar has financial information that you can use to research companies and Value Line is a subscription based service (you may be able to get their basic service free if your library subscribes to it) that gives a lot of detailed financial data about the company as well as future projections.

Once you’ve found companies that interest you take the time to review each companies annual report and 10-K. The 10-K has most of the financial information you’ll need to make an assessment of the company. You can also take a look at the companies 10-Q. The 10-Q is a quarterly financial report that can give you more up to date information past the date that the 10-K was distributed. Most companies should have an investor relation web page that contains all of these documents. You can also find a companies 10-K on the securities and exchange commission website.

Now that you know where to look, lets talk about what makes a quality dividend paying company. In the process of evaluating companies we will be using the value investing approach. If your unfamiliar with value investing The Intelligent Investor makes for a great read. You can find it at a bookstore near you or online. Once you have a list of dividend paying companies the first thing you’ll want to do to evaluate the company is find out how much of the profits are being given to shareholders in the form of a dividend. are we talking about 2%, 7%, 80% or more? This evaluation should be done on each company.

In general the lower the dividend payout, the more likely it is that the dividend is sustainable. A company that pays all of it’s earnings in the form of dividends might seem enticing (REITs sometimes fall in this category) however equally important is the dividend payment your going to receive next quarter, next year and the year after that. It’s best to make sure that the company can maintain the dividend. Thus a 4% dividend is much more likely to be sustainable than a larger dividend percentage.

Another important thing to note: If your investing near the bottom of a recession and stock prices are very low, the dividend dollar amount stays the same (If it’s not cut by the company) but the dividend percentage will increase. A 3% dividend in non recession times can become 5%, 7%, 10% or more depending on how low the stock price goes. This is a great time to invest in dividend paying stocks as long as the company is in good shape and the dividend is sustainable.

Once you have selected a group of companies that have a sustainable dividend, generally under 5% the next step is to research each company and find out how much debt they have. You’ll want to make sure that the companies debt can be paid off within several years. Divide the total outstanding company debt by the net profit from the companies income statement. If you come up with five or fewer years, generally the company should be able to payoff it’s debt within a reasonable time frame. You can also look at the companies balance sheet for the companies total cash and compare it to the total debt. It’s possible that the company has more than enough cash to pay it’s debt either in part or in full if it wanted to.

At this point you should have narrowed your list of dividend stocks to those with sustainable payments and manageable debt loads. Now it’s time to look at your list and select companies with dividend growth potential. When evaluating a stock for dividend growth we are looking for the dividend to increase year after year. Within ten years the dividend should have grown more than fifty percent. Next let’s remove any companies from the list where the dividend was cut or removed within the last ten years. This should leave you with a list of companies that exhibit good dividend growth potential in the future.

If your investing for the long term, reinvesting your dividends is a good way to compound your money over time. After you’ve invested in a companies stock with your brokerage account, you can choose weather you would like the dividend paid in cash or reinvested. If you choose to reinvest the dividend your brokerage account will purchase more shares (or fractional shares depending on the amount to be reinvested) automatically each time the dividend gets paid out. This form of dividend reinvestment is called DRIP (dividend reinvestment plan).

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