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As dividend investors, we need to be constantly on the lookout for ways to reduce the risk in our portfolios. Even with relatively stable and fundamentally sound dividend stocks, there is work to do to determine how safe a that dividend growth company might be. In other words, we need to watch for certain warning signs that can tip us off to nasty things to come.[ad#tdg-embedded]
There are a couple of things that investors can look for when trying to judge the safety of the dividend stocks they invest in. Here are a couple of them:
1. Dividend Yields Abnormally High Compared to Historical Levels
Many beginner dividend investors believe that a high dividend yield is the shiate. It must be because it means that the share price is low in relation to the dividend being paid right? Nope. In fact, an abnormally high dividend yield often spells disaster. It means that some event has triggered the stock price of that company to dive bomb and you need to find out why so that you are comfortable with the reason. I always review the historical dividend yield over as long a history as I can get to see what is “normal” for that company. If it looks too good to be true then it might just be.2
2. High Dividend Payout Ratio
The dividend payout ratio tells you how much of the firm’s profit is being paid out in the form of dividends. Generally, there should be a balance for a good dividend stock so that it is not too high and is sustainable for the company. Again, history is important here as is industry dynamics. Some industries such as utilities have high payout ratios while others are low.
There are of course a number of other metrics one can look at, including debt-to-equity, the quick ratio, and interest coverage. They all provide different levels of depth into the ability for a company to service its dividend payment over time. If you are a dividend investor then it is in your best interest to ensure that dividend is sustainable. It takes work and a diversified asset allocation to ensure you are protected.
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