Monday, January 14, 2013

How to pick a dividend stock in 2013

Dividend stocks will again make up a large portion of investment income for 2013, as few other income investment alternatives exist.  All bonds, municipal, corporate, and high yield remain very expensive.  I do not cover preferred stock or real estate investments in this blog.  Dividends may not be and should not be your only source of investment income, but in 2013, they will provide significant retirement cash flow.  How should you pick a dividend stock in 2013?

Dividend stocks come in two flavors.   One group of stocks pay less than 3% but are active enough to provide additional income in the form of covered calls.   Caterpillar, CAT, and Qualcomm, QCOM are stocks that I have written about often in this blog.   I call the other group of dividend stocks  DIVIDEND MACHINES.  These stocks are less volatile but generate more dividend cash flow and are the subject of this post.

For 2013 my criteria for picking a dividend machine has changed just a little from 2012 and 2011.   I still require a company to pay me at least a three percent yield at the price I buy it.  In 2013, I will stick with the requirement that earnings per share (EPS) for the previous four quarters must be greater than the dividend payout.    In 2011, I required only the current quarter’s EPS to be greater than the dividend payout.  In 2012, I raised the bar to make sure the last four quarters of earnings was greater than the last four quarters of dividends.   In 2013, I will maintain that benchmark.

Risk for any investor is important and I use two measures for dividend machines.   First, I expect a dividend machine company to do more than just continue to pay me the same dividend.   My expenses go up every year and I expect my income to go up as well.   If a company has increased the dividend during difficult times, I consider that to be a sign that I have invested in good company and it is a measure of low risk.

I looked back at my list of dividend machines and found that during the 2001 dot com crash, few of these companies reduced the dividend.   That is not surprising because most of the carnage in the 2001 stock market crash were high technology companies with low or no EPS.   Not very many of the companies that imploded paid dividends.   Only recently have companies like Intel (INTC) or Microsoft (MSFT) paid regular and increasing dividends. 

 However, during the 2008 market crash, dividend stocks did take quite a hit. In 2008, quality companies stopped or cut their dividends, i.e.  banks.   Many companies recovered and started to pay again.  However, I want to make sure any future investments I make in dividend machines are at a low risk of cutting my dividend.  Therefore, a company must have a history of steady and regular increases of dividends since 2007, or 6 years, to be considered a dividend machine.   In 2011 and 2012, I required a history of regular dividend increases for at least five years.   In 2013, I am raising that bar to six years.         

            My last dividend machine criterion, the last one, is debt to equity ratio (D/E) ratio.    If a company has a responsible history of managing their debt, they are more likely than not to stay in business and be able to pay a steady and ever increasing dividend.   D/E ratios vary a lot among industries.   Some businesses need more debt than others to conduct their business.   A D/E ratio of one or less or equal to industry standards will continue be the level that is acceptable for a company to be considered a dividend machine.

            I recommend DIVIDEND MACHINES periodically in this blog.  In 2011, I picked one every Monday for 52 weeks; in 2012, I picked 48 stocks randomly though 48 weeks.  In 2013, I am not going to pre define how many stocks I profile, we will just have to see what the market provides for us.   This week, I expect to share one or two stock picks with you so that you too can make steady, increasing retirement cash flow from dividend stocks.

            Study these criteria and add them to your dividend stock screens for 2013; I believe you will be pleased with the results.