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5 Characteristics of a Successful Dividend Stock

These traits have always been strong predictors of success


number 5 dollar billEverybody likes winners. Looking at the history of the most successful dividend stocks, I have been able to identify several traits that have been strong predictors of performance.

Rising EPS

A business has to be able to have strong competitive advantages and has to deliver value to consumers in the form of goods or services they need. By having a strong brand, a business can afford to raise prices and have a differentiated product that is more desirable than the competition. A business that manages to grow earnings per share, either organically or through acquisitions, can afford to pay a rising dividend.

High Return on Equity

High returns on equity are important to companies. Only a company with a wide moat is able to charge higher prices. Growing such a business might not be as easy as putting additional investments in it. Companies with high returns on equity typically have excessive cash flows generated each year, which cannot be easily deployed 100% of the time. Some portion will be deployed, but these companies need to be mindful of the returns generated from new investments. If you generate 20% on your investment, making a new investment might increase earnings per share, but it might not be desirable because it could generate a lower return on equity. I typically want to see a stable ROE, because a declining one shows me management is taking on any project available — regardless of profitability — without having the best interests of shareholders in mind.

Decreasing number of shares

Some of the most successful companies in the world generate so much cash flow they tend to have stock buybacks, which decrease the number of shares outstanding. This helps EPS, but also makes each share more valuable as it provides shareholders with a larger percentage of the business without doing anything. Few companies consistently repurchase shares however, as most end up buying back stock when times are good and stock prices are high — and stop buying back shares when times are tough but stock prices are low

Sustainable Dividend Payout Ratio

Some of the best dividend stocks have been able to create a balance between the amount of money they reinvest in the business and the amount they distribute to shareholders in the form of dividends or share buybacks. A company that distributes too much to shareholders might be unable to maintain its business without selling more stock or taking on additional debt. A company that pays too little in dividends might focus too much at growth — at any price — which might reduce returns on equity over time.

Dividend Growth History

The companies that are able to generate higher amounts of excess cash flows each year tend to boost distributions annually. This creates a dividend stream for investors, which increases at or above the rate of inflation each year. By strategically allocating these growing dividends through dividend reinvestment, investors are essentially turbocharging their income.

There are less than 300 companies in the US that have a culture of sharing their success with shareholders in the form of higher dividends. It behooves investors to use these five metrics of success to find these profit-sharing companies.

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