Dividends

Guide to Investing in Dividend Stocks

Peter Silfvander

Guide to Investing in Dividend Stocks

Let’s be honest, it can be daunting when trying to filter through a pile of tickers when all we want to uncover is a stock with promising dividend returns. However, with a screener, we can make this process more straightforward and lead you to find your desired investment. Here is Maqro’s simple screener to help you out.

Screener

Screeners allow us to filter through the myriad of stocks and deduce desirable assets that we want to invest into. There are multiple filters to apply to the screener that help you sort and find those that pay a regular and sustainable dividend.

Before this, the investor should be aware of some dividend investing strategies that may guide their selection of stocks when these filters are applied.

  • High Dividends: For yield-seeking investors, high dividend yields represent a way to gain attractive returns for the stock. However, investors need to be careful as to whether these high yield ratios can be sustained into the future.
  • Cyclical Dividends: To take advantage of cyclicality in markets and sectors, cyclical dividends provide exposure to companies in industries such as mining and construction. These companies will provide increased dividends in favourable market cycles and lowered dividends in unfavourable market cycles.
  • Defensive Dividends: If you want to ensure the dividends you are banking on are safe, then you should look for additional factors to help support the notion you will continue to receive dividends in the future. Uses of cash is a critical concern here and setting realistic growth expectations

Before engaging in the screening process, it is advised that investors evaluate their investment objectives and which dividend strategy is the most appropriate to better assess the metrics that have been suggested below. It should be noted that this screening process is not the definitive method and speaking to an advisor is encouraged.

Step 1: Finding a database

In order to begin your investigation, the investor must source a reliable and up-to-date database. Beyond price movements, a reliable database should have metrics pertaining to earnings, financial statements as well as the ability to filter stocks. The Maqro platform, for example, demonstrates these qualities allowing investors to easily filter companies to their desired characteristics. It is critical that companies have positive earnings as this is a critical indicator of cash flow and the company’s overall ability to generate returns for shareholders.

Step 2: Market cap

Navigating a database may appear to be a perplexing task, however, a good place to start would be with market caps. A market cap is a proxy for the size of the company which offers a few divided signals.

Companies with larger market caps tend to be large companies, and their size acts as a reflection of the scope of their operations. Size can affect a company’s ability to pay out dividends as larger companies tend to have higher degrees of liquidity and a greater pool of productive assets to sustain their dividends. Smaller companies on the other hand risk being vulnerable to economic downturns or increased competition, forcing these companies to re-evaluate their dividend policy. These do not always hold, but an investor should aim for companies with a market cap above $500M.

Step 3: Sectors

Dividends and the prospect of dividends can vary greatly between sectors. For sectors that are high growth and highly competitive, it is unlikely that companies will opt to pay dividends; instead choosing to use this cash to support its capital expenditure, expanding the company’s operations, or choosing to fortify its moat. It is why we tend to see fewer technology companies pay dividends as these firms choose to reinvest their cash and innovate.

On the flipside, mature industries not only indicate some degree of earnings stability, but also the flexibility of using cash other than to finance new projects or to repay the debt; leaving more cash to be funneled to shareholders as dividends. It is important to compare similar companies within the same industry to find high-performing dividends stocks.

Step 4: Payout ratio

At first sight, a high payout ratio may seem very enticing; however, we must look beneath the bonnet. For a healthy dividend stock, the company should display some consistent level of payouts and ensure cash management is prudent over time.

In some cases, it may be useful to investigate executive shareholders; they may be inflating their earnings by reaping higher dividends- avoid these companies as it is unlikely management is looking out for the investors and are prioritising their motives.

Photo of a stock screener from the MaqroTrader platform

MaqroTrader stock screener

Looking under the hood to forecast a company’s ability to pay future dividends

Conducting a deep dive into companies and industries

After screening for parameters and narrowing down your universe of stocks, you now want to do a deep dive on your found stocks. Depending on whether you include selected industries in your screening parameters, it may be useful to get a better understanding of which industry your company is in for comparison. This will help identify dividend stocks with superb metrics within their industry before you start with the fundamental analysis.

ASX and company websites as tools

Once this is done, go to the ASX website and find your companies’ historical announcements which contain the companies’ published annual reports and financial statements. Download the most recent three annual reports and financial statements, or if the company has not recently reported its annual statement, compare the half-yearly or quarterly reports. Don’t worry – we’ll walk you through what to look for in these reports.

Browsing the company website to understand what your company does, how it makes money, and what its strengths are, will give you good context for reading its reports – making the process of fundamental analysis easier and more interesting.

Tip: The ASX website for the company provides a quick and easy overview of the company’s revenue, profit, and dividends to get an overview before deep diving 

Fundamental analysis as a second step 

Reading annual reports for insight into dividend behaviour

Start with the annual report and browse through the opening pages which highlight the key financial and operational achievements the company has attained to get an overview of the company’s performance.

Income statements show dividend paying ability

After this, make your way to the “financial reports” section, which contains the three financial statements: the income statement, balance sheet, and cash flow statement. The income statement explains the company’s revenues, expenses, and taxes to arrive at a net profit after tax (NPAT). Look for growing revenues and NPAT, with a consistent or increasing margin between revenues and expenses. Ultimately, the NPAT is the cash available to the company to pay out dividends, so you want a healthy and growing NPAT year on year.

Checking balance sheets for insolvency

After this comes the balance sheet, which highlights companies’ assets, liabilities, and equity. Here, the most important figures to look at are the cash holdings, total assets and total liabilities, and current assets and current liabilities. An increasing cash holding is a sign of good financial health as it provides a company “safety net”. Both total and current assets should be greater than liabilities, so the company is not in danger of becoming insolvent. Moreover, look at the current and historical D/E ratio to understand companies’ leverage compared to its industry peers.

Understanding cash flows and dividends paid

Lastly, the cash flow statement shows the cash flows from operating activities, investment activities, and financing activities. This shows a breakdown to arrive at the cash holdings, so look out for substantial increases in outflows of cash and substantial decreases in inflows of cash. The company might be heavily investing in R&D, PP&E, or have substantial loans (borrowings), which may detriment its dividend-paying ability, depending on the industry. The cash flow statement also shows the total dividends paid to shareholders for the current year.

Tip: Pick mature companies which will leverage, and reinvest in, its existing products or services to produce high, sustainable, and growing dividends

Can the company maintain and grow dividends?

Payout policies provide track record insight

Within the annual report, companies often state their dividend payout policy and the annual payout ratio. This policy highlights a percentage range of earnings that the company has committed to pay out as dividends to shareholders. Dividend payout ratios vary from industry, so again check the average ranges for your companies’ industries. Look through the historical annual reports to see companies’ histories of meeting the payout policy to indicate whether the company has met its past dividend commitments. If the company does not have a payout policy or state its payout ratio, take the ratio of earnings per share (EPS) to dividends per share (DPS) to find this, and check for historical consistency.

Indicating future ability through increasing earnings and dividends

However, meeting dividend payout policy commitments are not the whole story. The payout policy indicates whether companies pay out the appropriate percentage of their earnings, but it does not indicate whether those earnings are growing or not. Looking for healthy growth in dividends paid in the cash flow statement well together with DPS will indicate companies’ future ability to pay dividends. If the company can meet its debt obligations, increase its earnings, reinvest for growth, and increase dividends, it’s a sign of good financial health. This is where fundamental analysis is necessary to ascertain future growth possibilities.

Management and analyst expectations for future dividends

For future earnings and dividend expectations, companies’ management often states their earnings guidance and expected dividends for the year. Checking companies’ history of meeting, and perhaps exceeding, this guidance will highlight management’s track record. It is a definite red flag if management consistently does not meet their earnings guidance. Broker reports and analyst coverage of companies often include detailed expectations of earnings, growth, and dividends with some including models of financial statements. These are very useful for determining industry consensus on companies’ outlooks and ultimately their ability to grow and pay out dividends.

Tip: Look at online resources like Yahoo Finance, or enquire with Maqro for detailed company reports

Photo of the MaqroSearch portal that shows company announcements and macro themes

MaqroSearch portal

How does the company outlook and macroeconomic environment factor in?

Looking beyond company reports

Future earnings and dividend-paying ability, as indicated by management and analyst expectations, depends on a variety of outside factors, including macroeconomic, sector- and industry-specific factors as well as trends.

Macroeconomic factors may affect profitability

Macroeconomic factors may include the prices of commodities for manufacturing or mining companies, interest rates for financial services companies, and labour wages for labour-intensive industries. Understanding the inputs and outputs of your companies, and which are sensitive to certain macroeconomic factors help determine which risks or opportunities they may face in the future.

Sector and industry risks are often correlated

From the above examples, the opportunities of increasing commodities for a manufacturing or mining company or risks of labour wages for labour-intensive industries may affect the company’s sector or industry as a whole. Sector- and industry-specific risks and opportunities are common, so determining how the company seeks to mitigate risks and take advantage of opportunities may reveal comparative advantages in companies’ operations, positioning them better for future growth and dividends.

Is your company future-proof?

While some sectors, industries, and companies are at the forefront of innovation and disruption, others are being disrupted and catching up to modern processes and technology. Industry and sector trends may highlight if your chosen company is taking advantage of these trends or being disrupted by them – affecting their future earnings and dividends.

Tip: Check Maqro’s website to receive up-to-date macroeconomic analysis, industry trends, and news, or sign up to receive tailored recommendations and stock advice

Maqro’s top dividend picks for 2021

Fortescue Metals Group Limited (ASX:FMG) – 11.46% forecasted dividend yield

FMG is an Australian iron ore company listed on the ASX within the materials sector involved in the exploration, development, production, processing, and selling of iron ore. The current share price of FMG is $24 with a market cap of $73.89bn. FMG will be reporting its full-year earnings on the 30th of August, where the dividends will also be released. FMG can be categorised as a cyclical dividend stock, as it targets a payout ratio of 50%-80% of its full-year earnings, which are expected to be significantly higher than the previous year due to high iron ore prices and production. FMG also has a very strong balance sheet with significant assets and cash reserves. FMG has a history of paying a high dividend payout ratio in favourable market cycles, and we believe the strong tailwinds of iron ore prices and FMG’s production will deliver strong dividends for FY21.

Our FY21 forecast for FMG is an EPS of $3.29 and a DPS of $2.75, producing a payout ratio of 83.72% and a dividend yield of 11.46% at the current share price of $24.

Aurizon Holdings Limited (ASX:AZJ) – 7.12% forecasted dividend yield

AZJ is an Australian rail freight operator listed on the ASX within the industrials sector, transporting more than 250 million tonnes of commodities each year. At the current share price of $3.93, it has a market cap of $7.12bn. AZJ will report its annual earnings on the 9th of August, where the dividends will be published. AZJ has a strong balance sheet of assets and low current liabilities. AZJ can be categorised as a high dividend as it targets a payout ratio of 70%-100% of underlying earnings and has a good history of dividend growth and consistency. As Australia’s largest rail freight operator, it leverages Australia’s commodity-exporting status, which has provided stable revenues and earnings, even throughout the pandemic. This has positioned it well to pay sustainable and growing dividends in the past, and we believe it will continue to do so for FY21 and beyond.

Our FY21 forecast for AZJ is an EPS of $0.27 and a DPS of $0.28, producing a payout ratio of 101.07% and a dividend yield of 7.12% at the current share price of $3.93.

Commonwealth Bank of Australia (ASX:CBA) – 3.49% forecasted dividend yield

CBA is an Australian multinational bank listed on the ASX within the financial services sector. It is the largest company on the ASX with a market cap of $179.98bn and a share price of $102. CBA will be reporting its full-year earnings on the 11th of August, where the dividends will also be released. CBA has a strong balance sheet with a capital position and liquidity coverage ratio above regulatory benchmarks and requirements. CBA targets a payout ratio of 70%-80% of its full-year earnings and CBA previously increased its dividend by 50% to $1.5 per share in March, reflecting the bank’s optimism of the economy’s recovery. CBA can be categorised as a defensive dividend as it has a history of paying a high dividend payout ratio and holds a significant position in the Australian banking industry. This, together with its bulky $1.5bn loss loan provisions, established in May 2020 as risk mitigation for defaulting loans, should support a healthy dividend for investors in this FY21 reporting season as well as future reporting seasons.

Our FY21 forecast for CBA is an EPS of $4.74 and a DPS of $3.56, producing a payout ratio of 75.16% and a dividend yield of 3.49% at the current share price of $102.

Ready to invest with Maqro today?

Sign up to Maqro