How To Find A Good Dividend Stock In Uncertain Times
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How do you find a good dividend stock when even good, solid companies get roughed up?
Look at what’s happened recently… three valuable lessons for dividend investors. Each one is a mini-case study that helps you know how to find a good dividend stock.
(And two of these lessons come from Dividend Aristocrats, the best dividend stocks.)
IBM Corp. (IBM), Coca-Cola Co. (KO), and McDonald’s Corp. (MCD), all solid dividend stocks, have basically told investors the same thing.
“Times are changing and we haven’t kept pace. Things are tough right now, so we’re not going to be performing very well for awhile.”
At IBM, there’s been a startling admission from Chief Executive Virginia Rometty after turning in ten quarters in a row of flat or sliding sales.
“We’ve got to reinvent ourselves like we’ve done in prior generations.”
Big Blue has been hammered hard…
At Coca-Cola, quarterly profits are down 14%. CEO Muhtar Kent has told investors the company is working on a fix.
“We are streamlining our operations and further aligning our incentive plans to deliver against our growth objectives.”
McDonald’s… in the same boat as IBM and Coca-Cola. In the latest quarterly results, sales at U.S. locations open at least 13 months are off 3.3%.
CEO Don Thompson is searching for an answer, trying to find out what kind of a menu will pull people back in.
“McDonald’s is in the business of satisfying customers and that will never fall out of favor. The question is what do you do to do that?”
Each one of these companies gives you a valuable window into the process of how to find a good dividend stock, and the questions you should ask.
When the CEO of Coca-Cola, which has been paying steady, growing dividends for the past 51 years admits that things aren’t going well, there’s one question we all ask as dividend investors.
“Will they cut the dividend?”
You’ll find the answer to this question in three difference places.
To Find A Good Dividend Stock, Make These Three Moves
First, take a look at the balance sheet. Check out how strong the cash flow is, how much operating capital is on hand, and how much debt the company is burdened with.
Second, look at the dividend payout ratio. When a company plows too much of its quarterly earnings back into dividends, there’s usually trouble ahead. The company needs plenty of money for other things, which could range from an acquisition to paying down debt. It might also need money for research, or to pay for a new division. Maybe a new product that might take awhile to ramp up and become profitable.
Here’s something else to remember about the dividend payout ratio.
The steadier it is, the better. Beware of fluctuations. And when the dividend payout ratio is steady, you’ll usually see the stock trade at a higher P/E (Price/Earnings) ratio.
This kind of consistency is a sign of quality, which helps the stock sell for a premium. It’s the same idea as the premium price for a stock that pays consistent dividends.
Third, shake down the leadership team. Solid management is talented at anticipating problems. It takes action to soften the blow of these problems. The company’s C-level executives should have the skill to steer their organization through rough stretches, to respond quickly to shifting markets, and to keep their companies profitable.
But another issue comes into play here…
Will management have the courage to cut the dividend when it’s in the best long-term interest of the company and its shareholders? Or will it take the easy way out, keep the dividend payments rolling, keep shareholders happy, and in the process, dig a deeper hole?
These are probably the toughest decisions a company’s leadership makes. The decision for you, as a dividend investor, boils down to how you think management can perform…. whether or not it’s up to the challenge.
Will Today’s Good Dividend Stock Perform Well Tomorrow?
Look at how you believe the company will perform, and the role it will play in the years ahead. Will consumers get tired of what the company makes? Will its products fall out of favor? Will changing tastes and changing technologies pass the company by?
These are all good questions for you to ask.
And after looking at the balance sheet, the dividend payout ratio, and the management team, you’ll have an even better sense of where the company is headed.
You’ll also have a better sense of whether or not the dividends will be cut.
At Coca-Cola, putting an end to more than half a century of consistent, growing dividends would be as shocking as the company revealing Coke’s secret formula.
There’s a different culture at IBM, which cut its dividend in 1975 and 1992.
McDonald’s… it falls between the two. It’s paid dividends without a cut for 37 years.
So when you want to know how to find a good dividend stock, and you look at the history of consistent dividend payments, don’t mistake past performance for future performance.
Companies with a track record of paying dividends can make a better case for rewarding investors in the months and years ahead, but it’s no promise.
And there’s no promise that IBM, Coca Cola, and McDonald’s will continue to dominate their industries.
After all, in 1965, Howard Johnson’s did more business than McDonald’s, Burger King, and Kentucky Fried Chicken combined.
Today, it has vanished, and only one HoJo remains.
IBM Corp. (IBM)
Dividend Yield: 2.72%
Annual Payout: $4.40
Payout Ratio: 25.1%
McDonald’s (MCD)
Dividend Yield: 3.74%
Annual Payout: $3.40
Payout Ratio: 63.4%
Coca-Cola Co. (KO)
Dividend Yield: 3.0%
Annual Payout: $1.22
Payout Ratio: 59.2%
Category: Dividend Stocks To Buy?
