Use These Tools to Determine Safe Dividend Payers

By Andrey Dashkov, analyst, Casey Research

Let’s talk about dividends again…

With so much uncertainty in the market, plenty of people are looking at dividends to provide stable, passive income. That’s not a bad idea.

But since 2020, companies have been canceling or suspending dividends on a grand scale. For example, since 2002, there were 467 cancellations or suspensions.

More than one half of them happened since 2020.

For context, there were over 50 dividend cancellations back in 2009, in the middle of the last financial crisis.

This time, they aren’t just obscure mom-and-pop companies. For example, American Campus Communities (ACC) suspended its dividend in April. And it’s a $9-billion public company.

(To be clear, if the company isn’t paying its next dividend, I count it as canceled.)

Given the recession fears, I believe there’ll be more to come.

And when a dividend gets canceled, investors can suffer massive losses.

This is why it’s important to hold only the safest dividend payers out there.

And there’s a tool you can use to figure out which companies fit that bill…

Watch Out for “Junk Dividends”

“Junk dividends” are high dividends that companies can’t afford to pay.

High-dividend stocks attract investors who value the steady income. But high-dividend stocks need to keep paying those dividends, or investors will go elsewhere… and the share price will get decimated.

That’s why it’s important to not chase “junk dividends” that promise high yields. Instead, you should look for companies that can afford to pay reasonable dividends.

So I advise you to look for companies whose dividend yield is under 7%. This is a good rule of thumb to start. But if you want to dig deeper, there’s another metric that you should know…

Another Way to Find Safe Dividends

A key point with dividends is that the company making those payments should not strain its cash flow while doing so.

One way to measure this strain is the payout ratio.

Which is the ratio of dividends paid to a profitability metric, like net income.

So if a company paid $100 million in dividends in 2021 and made $200 million in net income, its payout ratio is one-half, or 50%.

The higher a payout ratio is, the more difficult it is for a company to maintain or increase its dividends.

You can use other profitability metrics, like free cash flow (FCF), to calculate the payout ratio.

However, metrics like that are harder to find or calculate. Using net income is more convenient, and the information it provides you with is a good start.

What’s a good payout ratio? Normally, if a company can keep its average payout ratio below 80% for at least five years, that’s a good sign. It’s not a guarantee of anything, but it should give you confidence that you’re on the right track to finding a reliable dividend.

To get you started, I dug up some of the highest-dividend stocks with a payout ratio under 80%.

For good measure, I only selected companies with a market capitalization of at least $10 billion. Those are less risky than some of the high-yielding small-caps.

Source: Capital IQ

Also note that I avoided companies with dividend yields that are higher than 7%. Companies with that high of a yield may be too risky. And you may not only lose your dividend – your whole position can get decimated if you pay attention to the dividend at the expense of everything else.

At this time of ultra-low interest rates and endless money printing, making sure your dividend payers can afford to keep making those distributions is key.

Just remember that this tool is a starting point. You should always do your own research, and make sure a company fits all your criteria before you invest in it. And as always, don’t bet the farm on a single trade.

Good investing,

Andrey Dashkov
Analyst, Casey Research