The spate of regulatory interventions by the Chinese government has led to fear in the markets, and an overall correction. This has surfaced many cheap deals, including some dividend-paying stocks. If you are searching for sustainable yields, read on.
As stock prices fall, some names that do not usually pay a high dividend emerge as attractive. For example, education companies, targeted by the regulators, have become some of the best opportunities in the market, offering at least 5% of forward dividend yield and a deep fair value discount.
But if this is your only stock selection criteria, you could end up with undesired results.
The yield ratio is still a good metric. But an over-reliance on it will lead to a pick of companies that appear to have extremely attractive dividends, but do not necessarily have a regular payout history or ability over different market conditions.
Simply put, the (forward) dividend yield has two components. It is calculated based on a year's worth of (future) dividend payments divided by a stock's current share price. That means, there are two situations for the yield ratio to increase -- either the company decides to pay more out from the profit pot, or the share price drops.
There are four features that can guide you to sustainable dividend payers:
1. Financial Resiliency
A sound balance sheet can help a company weather challenges well. Characteristics like low debt levels and a good cash flow typically allow the company to set aside liquidity to reward shareholders in a form of a dividend. While it is impossible to predict the next target the government plans to chastise, investors can foresee a company’s financial preparedness for headwinds. Ideally, from a total return perspective, a dividend-paying stock should avoid hoarding too much cash, as that could slow its growth rate.
2. Industry
The type of business is also indicative of its ability to pay a constant dividend. For example, in the real estate sector, the tendency of yield payout can differ from one sub-sector to another. The major cash flow of a real estate investment and management firm is from leasing their property to earn a stable income. This type of real estate company tends to pay a regular and sustainable dividend, compared to a developer.
3. Stage of Growth
The stability of the company's cash flow and dividend payout can be gauged by its stage of development. When a mature company enters its ‘comfort zone’ after years of growth, it would risk less to slow down growth and distribute more cash to reward shareholders. These companies usually operate for decades, with very high visibility of revenue as well as the future development for the company itself and the industry. Its dividend payout would generally be more predictable.
4. Diversified Business
Finally, does the company have a diversified business? This question became very real in recent times. When the core business comes under tighter regulation, it’d be ideal for a company to have some leeway with other revenue streams. Like in conglomerates, a diversified business strategy would give a company some buffer when one or two businesses do not work out very well in a particular year, while ensuring a sustainable dividend payout for shareowners.
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