HOW TO PICK DIVIDEND STOCKS

Another very interesting point is the payout ratio. The payout ratio is basically telling you how much of the net income, what you see up here, how much of that is paid out as a dividend. So, for instance, here in 2008, 59.5% of the net income was paid out as a dividend. Whereas in 2017, it’s only 37.3. And the TCM means trailing 12 months. So, looking back at the past 12 months, we can see that they’ve been paying out 41.1% of net income in dividend. Everything else equal you would like that to be a low number because the lower number is, the more they can also afford to pay out in the future.

Another key ratio I’d like to talk about is the interest coverage. Basically, the interest coverage is asking how many times can we pay our interest expenses with our operating income, and we would like that to be above ten. As you can see here, Intel has very, very little debt, which is also why the interest coverage is so high. So, the company is very stable, and it’s not because of debt that you should fear that they can’t pay out dividends in the future.

Another good point to talk about is what happened during the last financial crisis — what happened from 2008 to 2009 for instance. They hike the dividend slightly. I think this was more signaling more than anything else because you also saw that the net income actually dropped a bit, but it’s still a very steady company having no debt as we see here for 2009 with the interest coverage. So even if we should see a financial crisis, everything else equal, looking at these numbers, looking at the earnings per share — how profitable they are looking at the revenue and the growth of the revenue. Looking at they had no debt. It looks like that you should not fear that they won’t pay out any dividend if we face a new financial crisis.

So, let’s turn our attention to what appears to be a more risky dividend stock. As with everything else in stock investing, you always have to consider: What am I paying and what I’m getting back.

So let’s look at an example of what might appear to be a riskier dividend stock and the stock I would like to talk about is GameStop. The stock ticker is GME. Many of you likely are familiar with GameStop. They’re in malls all over the world, and they sell computer games, hardware, various gadgets for science fiction, fantasy, and much more.

Gamestop is currently trading around $15, and you will quickly go down here to the dividend, and you’ll say: Wow, we were making $1.52. So, you’ll be getting a 10% return on the dividend alone. Why would that not be a great dividend stock?

Let’s remember what we talked about when it came to the payout ratio. Payout ratio is a way to look at how much of the company’s profit is paid out in dividend. As you can see here, there is only a dash. The reason why there is a dash is that over the trailing 12 months, GameStop actually had a deficit. They lost $0.43 per share. So, they’re paying out dividends of an income that they don’t have, and you might be thinking, how can it be that you can pay out a dividend if you’re not making any money? Well, that’s very simple unless you have cash on hand and that will deplete at some point in time.

You have to take on debt or issue equity that would dilute the shares of the current investors. So, in other words, if GameStop is not becoming profitable soon, they can simply not sustain the dividend. To me, this looks like a very risky play to invest in. Keep in mind that I have not assessed the business, per se. The business could be fantastic, and it sure is priced attractively in many ways. But if you are an income investor and you rely on dividend rather than capital gains, then GameStop is likely not for you.

If we are looking specifically at Gamestop, they are struggling with a few things right now. Partly, they’re under immense pressure from Amazon, and they have rising costs because they want to compete in e-commerce. You can see that reflected in the operating margin, as up here, that is taking a hit. They also have impairments on some of their investments that did not turn out profitable. Without going into the specifics of the company, we can see that over the past ten years, the trend is not good, and as you just mentioned, the outlook looks pretty bleak. As a pure dividend investor, I would be very careful investing in GameStop.

So, I would like to provide you with more specific guidance if you’re looking to invest in dividend stocks. First, we need to talk a bit about the terminology. We need to know the difference between the dividend rate and the dividend yield. The dividend rate is what each stock pays out to you ask an investor. So, if a stock is trading at one hundred dollars, and it pays out $7 every year, then the rate is 7. The yield is seven divided by one hundred or 7%. In other words, the yield is very good to compare dividend stocks because you have a percentage. For instance, if you compare our stock here at priced one hundred dollars and at a $7 yearly dividend rate, if you compare that to a dividend rate of three dollars and 26 cents and the price of a stock, that is $46.57. That yield is still 7%.

So, again it’s very good for comparison. Another important metric to look at is the interest coverage ratio. As a good rule of thumb, I would like that to be more than ten. If you are an income investor and plan to collect dividend for a long time, you would like to avoid debt as debt is often why companies have to cut their dividend.

It’s hard to provide a fixed rule for the payout ratio. Everything else equal, you would like for it to be low and less than 50% to ensure that it can be sustained and preferably even hike the dividend in the future. I would also recommend to check up on the earnings. Did it or did not take a big hit during the past financial crisis? And the reason for that is that when we experienced the next financial crisis, the dividend won’t be cut.

I hope you enjoyed this lesson about how to pick dividend stocks. For building a portfolio, it’s important to learn how to analyze dividend stocks as an alternative to fixed-income bonds. After watching this lesson, I hope you are both capable of calculating the dividend yield and which red flags to look out for.