This past Friday, Dividend.com released a list of “10 Big-Name Stocks Going Ex-Dividend this Week.” Many traders utilize dividend ex-dates in an attempt to hold a stock just long enough to collect its dividend. But many investors confuse this strategy with investing.
Here at Dividends & Income Daily, we know that just because a company is big and pays a dividend, it’s not necessarily a solid income investment.
So, with that in mind, I decided to run them through our seven guiding principles of dividend investing and see how they really measure up.
Hint: Only half survived.
Chiseling it Down
Starting with the first rule – a simple business model – we can go ahead and immediately remove Honeywell (HON) from contention.
While it’s a solid company and meets the majority of our other requirements, there are just way too many moving parts to this conglomerate for me to consider it safe.
Since the remaining companies all meet our requirement for steady demand, let’s skip right ahead to the next prerequisite on our list – positive cash flow.
All of the remaining nine companies do have positive cash flow, but to varying degrees. What we’re after are companies that can comfortably meet their dividend payments due to ample free cash flow (FCF). All of the companies pass this test.
Moving right along to requirement four – high cash balances – the remaining nine companies all pass muster. Ditto for requirement five – minimal need for credit.
The Homestretch
The last two requirements in our strategy are strong earnings buffers and a history of dividend hikes.
One of the best measurements of earnings buffers is the dividend payout ratio (DPR). We prefer a company with a DPR of 80% or lower. Any higher and we increase the risk of holding a stock that gets its dividend cut in the future.
Once again, all eight remaining companies pass the test, with DPRs well below our required level.
When it comes to dividend growth, however, not everyone survives.
Whirlpool (WHR) failed to hike its dividend in 18 of the past 27 years. We like to see a more solid record of raises, so it’s officially out.
After running Dividend.com’s list through our seven requirements for solid dividend investments, we’ve narrowed it down to eight companies.
There’s one last test I always use before making a purchase… and that’s valuation.
When buying any stock, we only want companies that are a bargain compared to their peers.
With that in mind, we can knock two more companies off the list – Nike (NKE) and Novartis (NVS).
They meet all of the other requirements, but have high price-to-earnings (P/E) ratios and trade at premium valuations to their respective industries.
In fact, Novartis trades at a 25% premium to its industry, while Nike trades at a 20% premium.
A Few Final Thoughts
Since we’re looking for the most solid income-generating investments, Goldman Sachs (GS) is out, too. GS may be a great company, but with a yield of just 1.23%, there are other more suitable stocks to add to our income portfolio.
So there you have it…
Ten stocks enter, but only five stocks emerge income-investment worthy – Lockheed Martin (LMT), Time Warner (TWX), McDonald’s (MCD), Omnicom Group (OMC) and L-3 Communications (LLL).
Bottom Line: Ex-dividend dates are important when implementing a dividend capture strategy. But we shouldn’t confuse this trading strategy with income investing. And just because someone puts together a list of stocks and sends it to you, doesn’t mean you shouldn’t do your own research before investing in them.
Until next time…
Safe (and high-yield) investing,
Jason Williams
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