There are many common misconceptions about dividend investing. For example, all dividend paying stocks are stable companies. Or, a dividend from a stock will more than offset any losses you receive in share price over the long term. However, there is one that I find most persistent in both new and experienced dividend investors. It is often viewed as a reason to buy a stock, yet it should never be the only reason. I know I have been guilty of basing a buy decision on this misconception in the past.[ad#tdg-embedded]
That misconception is that a dividend stock that increases its dividend is a good buy.
Please do not get me wrong, as a dividend growth investor one of my most important criteria when completing stock analysis is a long track record of increasing dividends. However it is not the be all and end all that it can seem like when you read a blog like mine. There are numerous other factors that must go into your decision to buy a stock.
Here is just a sampling of some of the other items you need to analyze when making the decision to buy:
– Earnings per share
– Revenue growth
– Cash flow per share
– Debt to total capital
– Free cash flow
– Return on capital
This quick list does not even list the valuation tools you need to utilize like DCF, Graham, or other methodology to come up with a buy range.
My point is that it is not just about the dividend increases. Blindly buying stocks from the Dividend Aristocrats or Dividend Achievers lists will only lead to heartache (overly dramatic pause here!). You need to consider many other factors before buying that company.
As many know, the book A Random Walk Down Wall Street by Burton Malkiel is largely taken up with arguments and evidence of all of the failures of fundamental and technical analysis. However, one of the few exceptions cited by Malkiel is the indication given by a rise in the dividend payout. He concedes that studies have shown that “Dividend increases, in fact, are usually an accurate indicator of increases in future earnings.” So, while you might not want to blindly buy solely on this basis, even a leading skeptic of our ability to beat the market concedes there is value in the announcement.
Good post. Payout ratio is something that I look at, in addition to your other criteria.
But I would also say that if EPS, and free cash flow is not growing, then there will not usually be a dividend hike.
With all other ducks in a row, I consider a stock with a recent dividend increase a safer purchase over another without an increase.
But I do agree looking at just the dividend increase is silly.
Case in point, GE. GE is as blue chip, widow and orphan stock as you can get. Many years of dividend growth, but despite the CEO lieing to everyone, the dividend was cut.
A good reminder of what to look at.
Free cash flow is one thing that I always check when looking at a stock. And as you mention, debt to total capital is important. I like to check the debt levels on Yahoo Finance, on a quarterly basis, to see if the company’s debt is rising or falling.
Dividends do make a difference and in a market that fluctuates mildly or even in a moderate downturn – A high yielding stock offers not only protection but a hedge against the down side. This is providing it is a company with strong fundamentals. Many dividend stocks go down slower and stay closer to their intrinsic value in a downturn – HOWEVER – In a bear market {like we saw last year} one would be better off clearing their port folio and going to cash. the problem is that even most experts can’t accurately predict when a bear market will take place much less agree when is taking place until it is evident to all “hey we’re in a bear market”
I must agree with the authors main point. Just because a stock has a good yield doesn’t mean it is a good investment.
To make matters even more confusing for mom and pa retail investor, institutional investors
manipulate things and know the bear market to take place…Until it’s a bear market