Know Your Dividend Red Flags

It can be hard to beat dividend stocks. The best ones not only pay you regularly throughout the year (and increase those payouts over time), but their share prices also grow. Still, just like other stocks, dividend payers are not guaranteed to do right by you. Learn to spot red flags and you may be able to avoid some losses.

Researchers Eugene Fama and Kenneth French, studying data from 1927 to 2014, found that dividend payers outperformed non-payers, averaging 10.4 percent annual growth vs. 8.5 percent. Meanwhile, dividends have accounted for 42 percent of the return of the S&P 500 Index between 1930 and 2017, per Morningstar data.

Still, every year, plenty of companies reduce or even eliminate their payouts — often in times of trouble, when their stock prices are also heading south. Red flags such as extremely high yields, industry headwinds, spotty track records and high payout ratios can warn you to minimize your losses.

A huge dividend yield can be due to the stock having plunged in price, with few investors believing in it. If an industry enters a downswing, as happens in cyclical industries and during economic crises, there may not be any earnings to distribute, leading to dividend cuts or suspensions — which can turn out to be temporary or permanent.

Companies with inconsistent histories of dividend payments can be disappointments — especially in a bear market, when external factors may strain their resources. Fortunately, many companies sport long dividend histories. Procter & Gamble, for example, has paid a dividend every year since 1891!

A company’s payout ratio — calculated by dividing the annual dividend by earnings per share — reflects the sustainability of its dividend. If a company is paying out more than it’s making, that’s not a good sign, so a payout ratio well below 100 percent is best.

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