With UK inflation picking up on the back of the weaker pound, dividend investors will need to be selective when picking dividend stocks this year. Inflation essentially reduces purchasing power, so in order to avoid going backwards, investors should be looking for companies that can increase their dividend payouts at growth rates at least equal to, but ideally higher than, inflation.
How can investors do that? Heres four things to look for.
It may sound simplistic, but arguably the first thing that investors should look for when analysing dividend growth stocks is revenue growth. Revenue is at the top of the income statement for a reason, and a companys profitability starts with its ability to grow revenue.
If revenue is declining, its much harder for a company to grow earnings and dividends. So its wise to examine the companys revenue growth history, and also look at revenue forecasts for the years ahead.
Earnings and cash flow
After revenue, its also essential to examine earnings and cash flow trends.Investors should look for earnings per share that are rising and that are comfortably in excess of the dividends paid per share. One handy metric in this regard is the dividend coverage ratio, which indicates the capacity of a company to pay its dividend out of the profit attributable to shareholders. The ratio is calculated by dividing net income by the total dividends paid and investors should look for a ratio of at least 1.5 to ensure the dividend isnt at risk.
Its also worth looking at a companys operating cash flow, as when alls said and done, a company requires cash to actually pay a dividend. Investors should look at whether the companys cash flow is increasing and whether its sufficient to pay the dividend.
Dividend growth history
Another aspect to examine is the companys dividend growth history. Find the companys recent dividend history and calculate the rate of growth year to year. Look for companies that have boostedtheir dividend payouts consistently at a rate above inflation, 5%-10% per year is ideal. Its also worth examining analyst forecasts for future dividend payouts and this information can be found relatively easily through the internet.
Lastly, its worth actually looking into the companys dividend policy the set of guidelines it uses to decide how much of its earnings it will pay out to shareholders. This can usually be found on the companys website or in the annual report. Does the company mention how it increases its dividend? Is dividend growth related to profitability or is it tied to inflation? Its also worth getting a feel for managements commitment to the dividend, and how much emphasis the company places on rewarding shareholders through that dividend.
By paying attention to these issues, investors should be able to make an informed decision about the companys dividend prospects and as a result, invest in companies that have strong payoutgrowth prospects going forward.
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