Here's how to avoid the worst dividend paying shares on the market

by , 01 July 2016
Here's how to avoid the worst dividend paying shares on the market
Companies that pay huge dividends give your portfolio a certain level of protection and a steady flow of passive income.

This extra income stream is perfect for investors nearing retirement because it relieves some of the financial pressure and grows your retirement savings with very little effort. With a powerful dividend packed portfolio, you don't have to tap into your capital or savings to grow your position in the markets.

But that doesn't mean you should rush out and buy any old dividend paying stock on the JSE. As I'm about to show you, some dividend paying companies can actually lose you money.

Not all dividend payers are good investments. I'll reveal four ways to find the best dividend payers and avoid getting caught in the dividend dilemma.
 
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Why some dividend paying shares can leave you broke...

  
Companies that pay dividends must be able to afford the dividend payout.
  
You see, when they pay dividends, they have less money to use for the expansion and development of the business.
 
Unfortunately, there are some companies on the JSE that pay out all their profits in dividends, just to attract unsuspecting investors. Doing this is unsustainable for the business and could result the company’s share price falling and eventually closing its doors.
 
When the dividend payout rate is higher than the company’s growth rate, alarm bells should be going off.
  

Palabora Mining’s unsustainable dividends destroyed the company

 
In 2013, Rio Tinto owned 57% of Palabora Mining. Rio Tinto encouraged the company to pay high dividends to its investors even though it was putting Palabora Mining into a tight spot.
  
The shareholders were happy with their high dividends until the inevitable happened. The company couldn’t keep up with paying these high dividends and the stock price fell 50% in four months. Now, it’s been suspended.
  
The shareholders lost big time. The only company that benefitted was Rio Tinto. It started selling off its ownership of Palabora Mining in bits and pieces, making a massive profit in the process. 

Lewis paid great dividends but lost half its share price value

 
Another great example of a poor performing dividend paying share is Lewis (JSE: LEW). Towards the second quarter of 2015, this company had a dividend yield just above 7%. Today, its dividend yield is 10.30%. You might think that’s a great share for your portfolio but when you take a second look; you’ll be disappointed in its performance.
 
 
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The company went through a tough time in its credit life insurance business. It knocked revenue, profits and even dividend distributions.
 
In July 2015 the share hit a peak share price of 10,000cps. Since then it tumbled all the way down to around 5,000cps. If you bought this share in the hope that its wonderful dividend would grow your portfolio, you’d have lost more than half your investment capital in less than a year.

How do you avoid these bad dividend payers?
 

Four ways to avoid the worst dividend paying shares on the market

 
When investing in dividend paying shares, you need to keep a close eye on the companies in your portfolio. Even though some dividend paying companies offer a solid performance, adding the wrong one can rip your investment portfolio apart.
 
Follow these four tips to avoid the bad dividend payers.

1. Make sure the dividend payout ratio is no more than 7%


The dividend payout ratio is the portion of net income the company pays in dividends. By keeping it below or on 7%, the company hangs on to the vital earnings it needs to grow the company. This money can be used for expanding its footprint, streamlining operations or updating machinery which improves the bottom line. 

2. Check that the company isn’t using debt to pay dividends


A well-managed company will reduce dividends to improve cash flow. Companies that have low profits or cash flow problems but still pay dividends are heading for trouble. If they’re using debt to pay dividends, this is a red flag. They’re handing out money they simply don’t have. It means the company is in financial trouble.
 
 
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3. Look at past dividends - History can teach us a lot of things


It’s a good idea to look back at the company’s history to see that the dividend payout ratio is consistent. Avoid companies that increase dividends too quickly. Instead, look for companies that increase the dividends slowly and steadily in line with the business profits.
 

4. Make sure that company has a good management team


Look for companies where management own a large portion of shares. This means that it gives them an incentive to grow the business. Also, check that the management team has a good track record in managing successful businesses.
 
So, before you decide to invest in a company simply because they pay attractive dividends, apply these four tips in your research. Soon, you’ll have a portfolio packed with some of the best dividend paying shares in the market today.
 
Let’s build your wealth together,
 

Aiden Sookdin,
Editorial Director
The South African Investor
 
P.S. The South African Investor Pillar One Advisors are some of the best dividend stock pickers in the country today.
 
One of the shares in its portfolio pays a dividend of around 6.38% and gives you exposure to the offshore property market. It owns properties like the Grand Arcade in Wigan, UK – a 425,000 square foot shopping mall with more than 40 shops and an annual footfall of 6.3 million shoppers. It also owns a number of hotels it rents to Holiday Inn in the UK. It also has property in the rest of Europe.

That can’t be said for its competitors. The closest competitor is Sirius Real Estate with its dividend yield of 3.13%. Capital and Counties property has a dividend yield of a mere 0.37%. In short this investment has the very best pay-out in the sector!

If it grows its dividend by 5% a year in pound terms, and the rand weakens as expected, you’ll end up with a whole lot more cash in your pocket. In fact, if the trend holds true you could end up with 540c worth of dividends alone in the next five years. That means a 54% return on your money from dividends alone. Add in some more capital appreciation and it’s not a tough ask to see the share price hit R16.65 in the same time frame – bringing the total return on the share to 121.6% over the next five years.
 
If you’d like to find out what this share is, and tap into the full South African Investor portfolio of shares, then take advantage of this exclusive invitation right now.

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