How to Invest for Safe Dividends

Read this before you invest in popular dividend stocks such as BCE Inc. (TSX:BCE)(NYSE:BCE), for growing income.

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In the past few years, we saw that companies which rely on high commodity prices to make profits aren’t reliable in maintaining their dividends. As a result, investors in various energy and mining stocks have had unpleasant memories of dividend cuts.

To invest for safe dividends, investors should first look for companies whose products and services are needed no matter how the economy is doing.

People need gas and electricity, cell phones and internet, and banking services. So, these leaders in the utility, telecom, and banking industries are essential: Fortis Inc. (TSX:FTS)(NYSE:FTS), BCE Inc. (TSX:BCE)(NYSE:BCE), and Royal Bank of Canada (TSX:RY)(NYSE:RY).

They are also willing to share profits with shareholders in the form of dividends. Their shareholders have been enjoying growing income every year without having to buy more shares.

Money_Dividends_grow16-9

Track record of profitability

These companies have remained profitable and steadily become more profitable over time.

In the last five years, Fortis has increased its earnings per share (EPS) by 5.3% per year. Similarly, in that period, BCE and Royal Bank have increased their EPS at an annualized rate of 2% and 7.3%, respectively.

Track record of dividend growth

Companies’ dividend-hike announcements are music to long-term investors’ ears. Fortis has the longest dividend-growth streak of the group — 43 consecutive years, to be exact!

BCE has hiked its dividend for eight consecutive years. Royal Bank hiked its dividend for six consecutive years; it froze its dividend during the Financial Crisis.

Having a track record of dividend growth is reassuring, but it doesn’t guarantee the safety of their dividends and that they will grow in the future.

Payout ratio and future growth

Two factors help improve the safety of a company’s dividend: the payout ratio and future earnings growth.

The payout ratio calculates the percentage of earnings that are paid out as dividends. So, the lower the payout ratio, the safer the dividend. However, it’s best to compare a company’s payout ratio with that of its competitors.

Based on their annual payouts, Fortis’s payout ratio is about 65%, BCE’s is about 82%, and Royal Bank’s is roughly 48%.

Since earnings growth lowers the payout ratio, the higher the growth rate, the safer the dividend.

Investor takeaway

You can invest for safe dividends from Fortis, BCE, and Royal Bank. However, their earnings-growth rates will directly affect their dividend growth going forward.

In the next three to five years, Fortis is expected to grow its EPS by 5.7-7%. This range aligns with management’s annualized dividend-growth target of 6% for the next few years.

In the same period, BCE and Royal Bank are expected to grow their EPS by 3.7-4.7% and 4.5-6.1%, respectively.

So, given the choice of the three, Fortis and Royal Bank should experience higher dividend growth. The two offer decent yields of at least 3.5%. But, most importantly, they aren’t excessively overvalued today.

Investing for safe dividends is one way to reduce uncertainty.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of FORTIS INC.

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