Business and Financial Education: A Canadian Perspective.
Wednesday, February 2, 2011
How to Select Dividend Paying Stocks for Your Portfolio.
How to select a quality dividend stock is a necessary skill for enterprising investors. There are a number of key characteristics to look for before investing in a dividend-paying company.
Firstly, the intelligent investor should begin by looking at company's that have strong brand names. These brand names keep customers coming back in good times and bad, and they provide a moat that keeps new competitors at bay. A strong brand name also provides the company with the ability to generate higher profit margins than its competitors for the same goods.
The textbook example of a company that can generate healthy and steady profits due to its brand name is Coca-Cola (NYSE:KO). Coke's products are known worldwide and the company's ability to charge higher prices than its generic competitors, such as President's Choice, Cott, and RC Cola, is proof that the public perceives the brand itself as something worth shelling out money for. To be sure, Coke's operating margin (or profit generated on each dollar in revenue before taxes) is consistently about 25%! This means that after all expenses, the company nets 25 cents in profit from every dollar it takes in. That leaves a lot of room for error before the company would start losing money on its over-priced sugar water.
Coke's Operating Margin.
Another key characteristic to look for in a company is one that consistently raises its dividend. Coke, for instance, has raised the amount of money that it pays out to shareholders for 48 years in a row. That means that as a shareholder, you have gotten a raise every year for almost 5 decades! Not bad for essentially selling the same product over and over again.
In order for a company to continually raise its dividend, it has to either be able to raise the price it charges for its products, sell its product to more customers, or reduce expenses. Ideally, price increases and higher sales would be great. When it comes to price increases, tobacco companies have been among the leaders throughout the years. Philip Morris International (NYSE:PM) sells cigarettes in international markets outside of North America. Almost every year, the company is able to raise prices and maintain its customer base. Cigarettes are what economists call an "inelastic" product, which means that customers are NOT very sensitive to increases in price. As the owner of a company, being able to raise prices is a good thing, especially if there is a steady or declining market for your product.
If you are buying a company for its dividend payments it is important to ensure that the company is not giving its shareholders more than it can afford. Johnson & Johnson (NYSE:JNJ), for instance, has raised its dividend for almost 50 years in a row and it still generates far more income than it pays out. In 2010 the company paid out 1.93 per share in earnings, but it generated 4.70 in earnings. That leaves plenty of room for it to grow its dividends in the future.
And most importantly, never over-pay for any business. If you are looking to generate a steady stream of income payments, look for healthy yields above current 10 year bond rates, otherwise owning the company might not be worth the extra risk.