In the current artificially depressed interest rate environment that we live in, it’s crucial to search for assets that can produce satisfactory returns. Dividend payouts represent a relatively reliable source of income to investors. But not all dividends were created equal. Some have a big question mark hanging above them while some are as reliable as death and taxes. It’s extremely important you know how to distinguish between the two groups.
What to look for in dividends
The following are the 3 most important criteria when it comes to dividend selection:
Criteria #1: Payout ratio
The payout ratio tells you what portion of the net income of the company is being distributed back to shareholders in the form of dividends. If the ratio is too high, it’s a warning sign that if things turn for the worse, your dividends are in danger of being eliminated. On the other hand, too low a ratio means that the company isn’t too thrilled to compensate you, the shareholder, for your trust and patience. My rule of thumb is that a payout ratio between 30% and 70% represents a good and healthy payout.
Criteria #2: Dividend yield
A dividend yield is the dollar amount distributed per share divided by the current price of share. If the yield is too low, it’s not that attractive because you are earning less on each dollar you invest. On the other hand, too high a yield may pose some risk. Extremely high dividend yields often precede a collapse in the business. I usually like to see yields between 3% – 7%, depending on the industry.
Criteria #3: Dividend growth
It’s always nice to know that your annual dividend payout has increased year-over-year. This indicates a healthy business and assures that you will never lose your money to inflation. I like to see my dividends increase at a minimum rate of 5% per annum.
My favorite dividend picks
In today’s market, the following 3 companies stand out as exceptional candidates in the dividend segment:
- Leggett & Platt, Inc. (NYSE:LEG) manufactures metal wires, bed springs and other steel mechanisms. The company sports a healthy 3.8% dividend with a payout ratio of 67%. Leggett has quite a remarkable track record of dividend payouts. In fact, 2012 marked the 41st consecutive annual dividend increase for Leggett & Platt, with a compound annual growth rate of 13% over that period. You simply can’t go too wrong here.