Wednesday, February 13, 2013

A Guide to Finding Dividend Machines

Four Criteria

Three percent  Dividend Yield
EPS greater than Dividend
Five Years of Dividend Increases
D/E ratio 1 or less or industry standard.
Finding Dividend Machines

Dividend Machine is the name I give to companies that meet four criteria.   The criteria are: dividend yield, earnings per share, dividend increases and debt to equity ratio. 

Dividend Yield

The most safe investment is suppose to be a U.S. 10 year treasury bond. This bond pays about two percent.  Investing in stocks is riskier and therefore, any stock investment should pay me more money than the U.S. 10 year treasury.  The dividend yield I expect out a company that I call a dividend machine is three percent.

Earnings Per Share

I want to make sure the companies I buy can afford to continue to pay the dividend.  I use earnings per share (EPS) as my measure.  If a company makes more money than it pays out in dividends, then I think it is reasonable to assume that the company will continue to pay me dividends.   The company's most recent four quarters of EPS and their most recent four quarters of dividends determine if a company makes the grade as a dividend machine.  EPS must be equal to or greater than the dividend.

Dividend Increases

In addition to creating more income than I can with a government bond and in addition to finding a company that makes more money that it pays me, I want to buy stocks that will increase my income over time.  Cost of living is guaranteed to double every 20 years.  I am old enough to have experienced this more than once.  Therefore, my income needs to double every 20 years.  

A company that has increased dividend income every year since 2007 should continue to increase my income.  That  period included the very difficult economic times of 2008  and the associated stock market crash.  To be considered a dividend machine a company must demonstrate a dividend increase every year since 2007.

Debt to Equity Ratio

I decided to use debt to equity ratio (D/E)  to determine if a company is financially sound.  When a company has little debt compared to the value of it's business, I feel more comfortable.   For  every dollar of equity in a company it should owe no more than a dollar of debt.  This ratio of debt to equity (D/E) is 1.  However, some industries need a lot of debt to operate.  I sometimes include companies in my dividend machine list that have a D/E ratio of greater than 1 as long as all the companies in that industry have similar levels of debt.  


These four criteria, when employed together, have helped me manage my dividend stock portfolio.  I try to use criteria that are easily obtained through Schwab or Yahoo Finance or MSN Money.   When I  profile stocks I call dividend machines, these are the four criteria I use to screen for those companies. 


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