3 Things to Look for When Investing in Dividend Stocks

Are you interested in buying shares of dividend stocks? Here are three important concepts to consider!

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Investing in dividend stocks could allow you to retire earlier. By building large positions of solid dividend companies, investors could replace their primary source of income, allowing them to achieve financial independence. However, there are important concepts that investors should be aware of. Investing in dividend stocks isn’t as simple as looking at a company’s forward yield. In this article, I’ll discuss three things to look for when investing in dividend stocks.

Start by looking at Dividend Aristocrats

When looking for dividend stocks to invest in, it would be a good idea to start by browsing a list of Dividend Aristocrats. The requirements to be listed as a Dividend Aristocrat in Canada differ from those in the United States. In Canada, stocks need to raise dividend distributions for at least five consecutive years. Companies that are able to do so demonstrate the ability to allocate capital intelligently.

Fortis is one of the best examples of a company that is able to raise its dividend on an annual basis. In fact, the company has successfully increased its distribution for 47 straight years. That gives it the second-longest active dividend-growth streak in Canada.

Of course, there are other companies, like Bank of Nova Scotia that have been able to pay dividends for nearly two centuries in a row. However, unlike Fortis, Bank of Nova Scotia wasn’t able to continue its increases through the Great Recession. Because of this, I would suggest sticking with the former if investors were required to pick between the two.

Is there room for growth?

Investors should also look for stocks that have a low dividend-payout ratio. This metric is determined by dividing a company’s dividend by its earnings. Theoretically, companies with low payout ratios tend to be safer. This is because if a company undergoes a period of weaker business performance, it has a larger pool of reserve funds to continue paying dividends to investors. Generally, I look for companies with a payout ratio of 50% or lower.

Canadian National Railway is an example of an exceptional dividend stock with a low payout ratio. The company has managed to increase its distribution for 25 years; however, its payout ratio is only at 35.7%. This suggests that the company has a lot of room to comfortably continue increasing its distribution in the future. goeasy is another company that has a very low payout ratio. Despite its impressive dividend increases over the past decade, the company has maintained a payout ratio of 16.3%.

Does the stock’s distribution beat inflation?

Finally, investors should consider whether a stock’s dividend is able to at least keep up with inflation. Theoretically, investors would be looking to hold shares of dividend stocks that could raise distributions faster than the rate of inflation over the long term. Personally, I aim to hold shares of companies that maintain a five-year dividend-growth rate of 10% or higher. If a stock has other qualities that make up for a slightly lower dividend-growth rate, then a growth rate of 5% would be the lowest I deem acceptable.

goeasy has a very notable dividend-growth rate. In 2014, it paid a quarterly dividend of $0.085 per share. In 2021, its quarterly dividend had increased to $0.660 per share. That represents a CAGR of 34%, greatly outpacing inflation.

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 Jed Lloren owns BANK OF NOVA SCOTIA. The Motley Fool recommends BANK OF NOVA SCOTIA, Canadian National Railway, and FORTIS INC.

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