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Follow the ‘dividend identifier' strategy to boost your overall portfolio returns in 2016

by , 11 January 2016

There's a lot of uncertainty in the equity markets at the moment. The markets are choppy, up one day and down the next. This is evident when analysing the JSE.

With the level of uncertainty in the markets, dividend paying shares are great investments.

Richard Russell, writer of the Dow Theory Letters says, “A stock dividend is a true return on the investment. Everything else is hope and speculation.” 

You see, the regular payments provide good passive income streams to boost the performance of your investments.

Over time, this is a great strategy to offset an overall bad performing market. If you time your investments right, you might just get a few good dividend payers at a discount…

But the challenge is actually finding these great dividend payers when there’s so much noise in the market.

In these uncertain times, there are three ways you can identify great dividend companies…

Dividend Identifier #1: Good companies with a history of sustainable dividends

As a starting point, you need to look at tried and tested companies with consistent dividend records and prospects to maintain their earnings in the future.

An example of a JSE company that has a strong history of operating in the market is Bowler Metcalf.

You see, there aren’t many small cap counters that have been able to weather tough trading conditions and continued to operate for over 40 years without going bankrupt. But Bowler Metcalf has done exactly this.

Bowler was founded in 1972 and listed on the JSE 28 years ago, in 1987. Somehow the company has been able to generate the consistent cash flows needed to pump out dividends annually for almost two and half decades. That’s right, Bowler hasn’t missed a dividend payment since 1992.

Bowler’s dividend pay-outs have grown consistently from 2.87c in 1996 to 41.4c in 2015. That’s an over 1,300% growth in dividends alone!

Dividend Identifier #2: A good balance between cash, investments and debt

The second dividend identifier you must look for is a well-developed company that has a lot of cash available.

You see, young companies need to spend more of their earnings on infrastructure investment to expand. This leaves less money available for dividends. But old, large companies with great infrastructure in place don’t need to spend much money to expand further. This leaves more cash available for dividends.

In other words, you must look for companies with extra cash available to fund dividends. But you also must make sure that the company wants to grow its dividends and that it doesn’t have too much debt.

To establish if a company would be able to service its debts, you can look at the debt equity ratio. A good debt to equity ratio is lower than 0.7. This shows their debt levels are lower than 70% than their total equity. And the company isn’t using too much debt to finance its assets placing it in a strong financial situation.

An example of a company with a favourable debt to equity ratio is technology group, Adapt IT. Adapt IT’s debt to equity ratio is around 0.67 (67%).

If you want to analyse a company’s debt to equity ratio further, you can compare a company’s debt to equity ratio with its competitors. The technology sector has a debt to equity ratio around 104.5%.

Dividend Identifier #3: A strong historical dividend yield

You can find the dividend yield of a company in mainstream financial newspapers and on financial websites.

You can also calculate it by dividing the dividends paid by the share price. As this method uses historic dividends, you need to use it along with the previous two methods to get an accurate indication of future possibilities.

A consistent dividend growth rate is what you must look for. However, one thing you must remember is companies that cut dividends are the last thing you want. Many JSE stocks specialising in resources or commodities have cut their dividends due to low commodity prices. The cash is simply not there for resource stocks to pay shareholders dividends. 

Now, more than ever, is the right time to invest in dividend paying companies

Most seasoned investors have income paying shares as part of their portfolios.

If you don’t have income payers, it’s good to consider adding these shares to you own portfolio to secure market bearing returns in the long run.

Remember in general, if you want to buy the best dividend paying stocks you should look for large companies that generate truckloads of cash, spend enough on growth, and don’t need to spend much of their income on debts.

More importantly, look for constant, growing dividends year after year.

Knowledge brings you wealth,
 

Joshua Benton
MoneyMorning Editor

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