When it comes to dividends, quality is more important than quantity. When looking for passive income investments, it’s tempting to focus on stocks with high yields. However, a high yield is not always a reliable indicator of a good dividend-paying company.
Here are five key metrics to consider when evaluating a dividend stock:
1. Free cash flow yield: This metric, calculated by dividing free cash flow per share by the share price, shows how efficiently a company generates cash. Companies like Apple, Alphabet, and Meta Platforms have high free cash flow yields, indicating strong financial health.
2. Payout ratio: The payout ratio, calculated by dividing the dividend per share by earnings per share, helps determine if a company can afford its dividend payments. A lower payout ratio is generally preferred for financial stability.
3. Capital return yield: This metric considers both dividend payments and stock repurchases to provide a comprehensive view of a company’s capital return program. Companies like Apple and Deere have significant capital return yields, reflecting their commitment to rewarding shareholders.
4. Consecutive years of dividend increases: Companies with a history of raising dividends annually demonstrate financial stability and growth potential. Procter & Gamble, for example, has raised its dividend for 68 consecutive years, making it a reliable dividend payer.
5. Total return: When assessing dividend stocks, total return (including dividends) is more important than stock price appreciation alone. Companies like Target have delivered strong total returns over the years, highlighting the value of dividend income.
Ultimately, a dividend is only as strong as the company paying it. By considering metrics like free cash flow yield, payout ratio, capital return yield, dividend growth history, and total return, investors can make informed decisions when choosing dividend stocks.