My 6 Checklists for Picking Great Dividend Income Stocks
Best Dividend Paying Stocks To Buy In Nigeria Stock Market – Learn How To Buy Shares In Companies That Pay High Dividend Yield Every Year.
A lot of investors overlook the power of dividend. In fact, since 1990, dividend has generated half of the stock market investing profits in the stock market. Further, dividend stocks offer investors consistent income and are often a hedge against share price fall.
Not every company that pays dividend actually qualifies as a good dividend income stock, so it’s better for an investor to know when he is better off investing in “Treasury Bills, FGN Bonds,” or keeping their cash in “Fixed Deposit”
As of this writing, CBN Treasury bills pay between 11-12% per annum while 5-10 year FGB bonds hover around 15%.
With such juicy and risk-free return on your investment payable semi-annually, why then should one consider a dividend stock?
The reason isn’t unconnected to the fact that returns from Treasury bills and FGB bonds are subject to interest rate risk, and as inflation inches upward, your return doesn’t increase; it is fixed throughout the tenor and might even reduce in value as real return turns negative. Negative real return arises when the inflation rate increases faster than your return on investment.
This is the reason, smarter investors don’t buy a stock because it pays dividend consistently but that the return as measured by dividend yield is close to the average yield on Treasury or FGB Bonds and likely double in 5 years or less. A dividend yield is calculated by dividing the dividend per share by share price. It is a measure of the percentage of cash paid to shareholders based on the amount invested.
Let’s take UBA as a perfect example of how dividend income stock can generate an above-average return on your investment if you had bought the stock for N4 in 2014 when it paid 10k per share.
The yield as of then was 2.5% while 10-year FGN bond in the period was 11.89% to 12.09%. (Source: Proshare)
FGN bond as that period paid more and seems attractive compared to UBA stock.
But now, equity investors in UBA now enjoy a better return of 21.25% today and sells for N8 per share (85k per share dividend divided by N4 paid on purchase in 2014), an impressive long-term return that beats the same FGB bond of 12%.
The big question, how can one scoop up dividend stocks that also have an upside potential? Yes! I mentioned share appreciation because, a company that rewards its shareholders year on year will, no doubt, attract more investors who place a premium on the value and as such, see its share price increases on accumulation.
Here are my 6 checklists to spot great dividend stock in the NSE market.
The dividend yield lets you measure the return expected when you buy at the current market price. It’s best benchmarked with CBN Treasury and FGB Bonds and should not be far less or more.
As of this writing, the FGN bond is 12%, so a modest dividend yield of 8-10% makes more sense. A dividend yield above 15% calls for further scrutiny as such tempting level could be a result of a massive sell-off since lower prices translate to higher yield, an investor should stick to a moderate yield of 8-10%.
Consistency of Dividend Payment.
Your preferred stock should be a dividend aristocrat; a stock that had been paying dividend consistently for 7-10 years. Dividend aristocrat is known for their consistency in dividend payment and such tends to be a safe haven for investors looking for retirement stocks.
Annual Dividend Per Share Growth of 10%.
This is a key metric to watch as it is the reason UBA stock yield, as shared earlier, jumped from 2.5% to 21.25% in 4-5 years. Based on the dividend history of the bank, it has an average annual growth of 15%. Using rule 72, a stock should have an average dividend growth rate of 14% to double its payout to shareholders in 5 years. For 20% growth rate, it will take 3-4 years.
When you have several dividend income stocks with high and low yields to choose from, use their average annual dividend per share growth to screen for the best. High yield doesn’t mean it is a great pick; you might end up having your cash payout reduced if it’s been stable or stagnant but a lower yield with above-average growth will reward you more in the future.
The average payout shouldn’t be in excess to deter the company from re-investment. Smart investors know that growth comes from re-invested profit and as such should feel uncomfortable buying equities in a company that pays a higher portion of its profit back to shareholders except it’s a special dividend from income realized from one-off asset sale. The rule of thumb is to buy stock with dividend payout less than 40% of its earnings per share.
Return on Equity vs Debt to Equity.
A great dividend stock utilizes shareholders fund to generate more profit above industry average while reducing its interest expenses or lower exposure to high-interest debt. A higher cost of debt could affect profit after tax hence, reduce distributable and re-investible profits. The average return on equity of a good dividend stock in the last 7-10 years should be above 10% while debt to equity should be reducing or less than 1.
But, for businesses that generate deposit liabilities like Banks, focus on the cost of risks, capital adequacy ratio and Non-performing loan ratio.
On insurance stocks, focus on average claim ratio, expense ratio and combined ratio as a way to measure profitability.
Average Free Cash Flow Growth.
Dividend is paid from cash generated from operations, not from net profit. As a smart investor, you should focus on the free cash flow reported on the cash flow statement. To know what the free cash flow is, deduct capital expenditure from cash flow generated from operating activities.
Companies can manipulate their net earnings at the end of the year but cannot doctor their cash flow. Great dividend income stocks don’t just grow their net earnings but also generate enough cash to pay shareholders at the end of the year.
Based on these checklists, I will be sharing recommended dividend income stocks you can buy on this blog,