The best dividend stocks have hidden assets, provide both income and capital gains potential, and have these three financial factors in common
We generally feel that most Successful Investors should hold a total of 10 to 20 mainly well-established, dividend-paying stocks, chosen mainly from our average or higher ratings. They should also spread their holdings out across most if not all of the five main economic sectors.
The best dividend stocks offer investors a measure of security. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.
For a rising portfolio
Learn everything you need to know in 'How to Find the Best Growth Stocks' for FREE from The Successful Investor.
Canadian Growth Stocks: CGI Group, CAE Inc., Fortis Inc. Stock and more.
The best dividend stocks have hidden assets
Successful investors recognize that hidden assets are a great way to cut risk, for conservative and aggressive investors alike. One great example is research and development.
When a company spends money on research and development, it can create a hidden asset with the potential to expand the company’s long-term profit.
Companies have to treat research and development spending as a day-to-day expense, much like maintenance or tax payments. As a result, this spending comes right out of the current year’s earnings. This tends to lower the company’s current earnings, since the spending takes time to have an impact (and, in fact, it may not pay off). This pay-now, profit later (if at all) process tends to inflate a company’s price-to-earnings ratio, or P/E. That’s because the spending cuts the company’s earnings—the “E,” or denominator, of the P/E ratio. As the E shrinks, the P/E ratio rises.
While high research spending can make a business look less profitable than it really is, if it’s invested wisely, it is more like a long-term investment than an expense. When research pays off, it can yield dramatic long-term returns, including sustainable dividends.
The best dividend stocks offer sustainable dividends
Investors generally look to aggressive stocks for capital gains and to more conservative stocks for income. However, there are some dividend stocks offering yields that are as high—or even higher—than yields on more established companies.
However, it’s important to watch out for unusually high dividend yields. Investors should avoid judging a company based solely on its dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because a high yield can sometimes be a danger sign rather than a bargain.
For example, a dividend stock’s yield could be high simply due to the fact that share price has dropped sharply (because you use a company’s share price to calculate yield) in anticipation of a dividend cut. That’s why we recommend that Successful Investors look beyond dividend yield when making investment decisions, and look for companies that also have established a sound business and have a history of building revenue and cash flow. Those are good indications that their dividends will be sustainable.
The best dividend stocks will include these financial factors
Dividend history is very important to dividend stocks. Ideally, you should look for dividend stocks that have been paying dividends for 5 or more years.
Also, as a general rule, companies that make money regularly are safer than chronic or even occasional money losers. As mentioned earlier, companies can fake earnings, but dividends are cash outlays. If you only buy dividend-paying stocks, you’ll avoid most frauds.
What is the dividend stock’s debt load like? Would it have a hard time recovering from an economic downturn? The more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first—especially ones that also keep trying to allocate part of their cash flow to paying dividends
Bonus Tip: What to watch out for in aggressive dividend stocks
In general, there are three big mistakes that investors can make when investing in aggressive dividend stocks:
Investing too much of your portfolio in aggressive stocks
Picking a stock based on a high dividend yield without confirming its dividend sustainability
Not looking for stocks with hidden assets
What would you do if you invested in a high-dividend-paying stock only to find out that the dividend was a danger sign rather than a bargain?
What mistakes have you made with investments in aggressive growth stocks?
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