If you’re investing in shares for their dividend payments, it’s crucial to remember some vital points. It will help you invest in the right companies.
You have to invest for the long-term and ensure you diversify your portfolio
The following two tips will help your dividend portfolio work for you, explain the team of experts at Daily Wealth
Tip #1: Don’t chase dividend yield blindly
Company A is not better than Company B if A pays a 10% dividend yield and B just 5%. It might very well be that Company A’s dividend is unsustainable. This might mean Company A cuts it down (entirely) next year.
Sustainability is the key word when looking for dividend yield
Will the company be able to keep paying this yield in the coming years? Even more important: will the company be able to increase this yield? Looking at the pay-out ratio
will give you an idea of dividend sustainability. But cash flows
are the true indicators.
Once you’ve bought a dividend stock, you will need to check regularly (every quarter for example) if the fundamentals haven’t changed. New competitors or new products may impact a company’s profit margin. This could force it to cut back its dividend.
Check company reports to find out more about the company’s markets and products. This will also help you see whether things are changing in the industry.
Tip #2: Build different layers in your dividend portfolio
Some investors stick entirely to dividend growth stocks.
These are stocks that are generally yielding 2% to 3% in today’s market, but have been increasing their dividends regularly. Dividend growth investors build their holdings by reinvesting an ever increasing dividend stream.
There is an advantage with the compounding effect of growing dividends. But try to limit dividend growth stocks to 60% of your total portfolio.
Invest the other 40% of your portfolio in stocks that do not offer (much) dividend growth, but that are already yielding 5% to 6%.
Look for a large buffer between operating cash inflows and dividend cash outflows before investing in these stocks. This protects your dividend income from an inevitable downturn in the economy. A downturn will affect profits and force companies to stop growing their dividends temporarily.
When profit margins are at an all-time high, mean reversion (a return to a lower long-term average profit margin) is a real risk. A lot of companies may not be able to keep growing their dividends at the same rate.
So there you have it, two tips to help your dividend portfolio work for you.