Sunday, September 19, 2010

Dividends Safety

As a DIY value investor, I view dividends from the stocks that I owned very seriously. They are the portion of my passive income that I expect to come in automatically into my account regardless of the daily fluctuation in stock prices. Moreover, I would definitely prefer that those dividends be maintained even though the general economy may be going through a difficult period of stress and are sustainable over a long period.

To ensure that the dividends are "safe" and will not be cut at the slightest sign of volatility, I look for the following:-

1) Dividend payout ratio. For a growth oriented company, I would expect the dividend payout ratio not to exceed 60%. However, for the Reits and infrastructure trust that I invest, it can be higher provided I am convince that the businesses are stable and back by long term contracts or are in providing some essential critical services with high barrier of entry.

2) Earnings in a economic downturn. Ask if the company cut dividends in an economic downturn will give you a clue into the sustainability of those dividends.

3) Debt to Equity Ratio. If the company has a high proportion of debt, than a lot of the earnings will be utilised to make interest payments, making it more uncertain that dividends can be sustained when economic environment changes.

4) Extremely high dividends yields. As usual, worry when things look to good to be true. Usually, these are cases where the company stock price has fallen dramatically due to worsening outlook.

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