Home Dividend Companies 3 Tips on Picking Your Next Dividend Stock

3 Tips on Picking Your Next Dividend Stock

It’s not always easy to select good dividend-paying stocks.

Several conditions need to be met to ensure the stream of income is both attractive and resilient.

If the dividend yield is too low and is unable to beat inflation, this defeats the purpose of investing.

On the other hand, a high dividend yield may end up being a value trap as an impending dividend cut may loom large.

Companies that seem to pay out a dependable dividend may suddenly cut or eliminate them when faced with stressful economic conditions.

All in, it can be tough to zoom in on a suitable dividend-paying company that offers you stability and peace of mind.

Investors need not fret, however.

The key to locating great dividend stocks lies in choosing stocks within the right industry or sector.

Here are three categories of stocks that offer stable and consistent dividends.

Monopoly-type businesses

One reliable source for consistent dividends are businesses that have a monopoly or near-monopoly.

Such businesses are often regulated so that they are not allowed to earn supernormal profits.

This, however, does not preclude them from earning a respectable return and paying out a portion of profits as dividends.

One example of such a business is NetLink NBN Trust (SGX: CJLU), which was spun off from Singtel (SGX: Z74) back in 2017.

NetLink designs, owns and operates the passive fibre network infrastructure for Singapore’s next-generation nationwide broadband network (NBN).

The group has a monopoly on fibre connections to residential homes and competes with other vendors to supply network connections to business customers.

For the fiscal year ended 31 March 2020, NetLink paid out a total dividend of S$0.0505, translating to a dividend yield of around 5.2%.

Another example is Singapore Exchange Limited (SGX: S68), or SGX.

The bourse operator is the only stock exchange operating in Singapore, although it competes with other regional exchanges such as the Hong Kong Stock Exchange (HKSE: 388) and Bursa Malaysia (KLSE: 1818).

SGX’s trailing 12-month dividend amounted to S$0.30, translating to a dividend yield of around 3.6%

Real estate investment trusts (REITs)

The second category of dependable dividend-paying stocks is REITs.

A REIT is essentially a portfolio of real estate assets bundled together into a security that’s traded on a stock exchange.

REITs do not pay corporate taxes when they payout at least 90% of taxable income in the form of a distribution.

Because of this rule, REITs regularly pay out a consistent dividend to unitholders.

As the properties usually sign long-term rental contracts with tenants, the resulting rental income is deemed to be predictable and stable.

This feature makes REITs very popular with income-seeking investors.

The COVID-19 pandemic has led investors to question if the REIT model still works.

My view is that REITs with well-located properties that enjoy consistent demand from tenants will be able to ride out the storm.

Although many REITs have had to temporarily cut their distributions to support tenants, others managed to grow their distributions even during these tough times.

Dividend-paying growth companies

The final category you should look at are companies that are growing their business as well as their dividends.

Remember that growth companies come in many forms.

One type consists of companies that are growing very rapidly but do not pay out a dividend as they need all the cash for further expansion.

Another category consists of companies that are still growing, but end up generating more cash than they need and can afford to reward shareholders with some dividends.

Note that companies in this category should be reputable, with a long operating history and stellar track record.

These attributes will power their growth for many more years, and their dividends will also rise in tandem.

One example is Nike (NYSE: NKE), the leading sports footwear and apparel company.

Its dividend yield is just 1% currently, but it has raised its full-year 2020 dividend from US$0.86 to US$0.955 despite suffering a 37% year on year decline in net profit due to store closures from COVID-19.

Another example is Starbucks (NASDAQ: SBUX).

The coffee chain has a dividend yield of 2.2% but has also been growing its dividend year on year.

The company’s nine-month 2020 dividend stood at US$1.23, up from US$1.08 during the same period last year.

Dividends rose despite the company reporting an 80% year on year plunge in net profit, also due to extensive store closures related to COVID-19.

These two examples show that buying companies with a strong franchise can yield rising dividends over time.

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Disclaimer: Royston Yang owns shares in NetLink NBN Trust, Singapore Exchange Limited, Nike and Starbucks.