7 Things to Consider Before Buying Dividend Stocks (+2K Views)

The basic principle behind dividend paying stocks is that they pay YOU to own THEM but do they outperform non-dividend paying stocks over time and what should you consider when buying a dividend stock?

The comments above and below are from the original article, written by Sean Brodrick (UncommonWisdom.com), which has been edited ([ ]) and abridged (…) to a limited degree by munKNEE.com to give a faster and easier read.

The answer to this question is that in most markets, dividend paying stocks do at least as well as non-dividend paying stocks, once you add dividends back in, and in bearish or underperforming markets, dividend paying stocks can really outperform. Specifically, over a 35-year period, non-dividend paying stocks posted an average annual return of 2.5% – that’s less than T-bills – but dividend-paying stocks averaged an annual return of between 8.9% and 10.9%. That’s a huge difference. The combination of hefty dividends and share price appreciation is called “Total Return” and in the decade of the 2000’s, dividends contributed 56% of total return, according to research from Dividend Growth Investor.

Before you buy, here are 7 “Do’s” to consider when buying a dividend stock:

1. Dividend Growth
Look for a good history of dividend growth, with the potential for dividend growth over time. After all, dividends are what this service is about.

2. 3% or Higher
When it comes to the actual dividend, we want at least 3% and preferably higher. Higher is better, as long as the dividend is safe.

3. Financial Growth Potential
Find a company with strong financial performance in the past, and the potential for even better financial performance in the future.

4. Good Free Cash Flow
Strong free cash flow helps a company grow its dividend and its business.

5. Below-average Debt
The financial leverage ratio, which is total assets divided by shareholders’ equity (book value), is a good all purpose debt measure. A leverage ratio of 1.0 means that the company has no debt, and the higher the ratio, the more debt, with leverage ratios below 5.0, and lower is better. Some industries carry more debt as part of their business models, so look for stocks with below-average debt compared to their peers.

6. An Outstanding Business Model
An advantage in the company’s business model, something that will protect them in the bad times and help them outperform in the good times.

7. A Good Entry Price
If a stock has already run up, consider entering it in stages because one truth of the market is that stocks go down as well as up, and we may get a better price later on. That said, you want to avoid stocks trading below $5 a share. They’re probably in trouble, and that means their dividend probably is, too.

The above are guidelines, not the clasps on a straightjacket, so there will be exceptions but it’s a good start.

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