One of the first steps in building a solid dividend income portfolio is defining a stock selection strategy. A carefully planned strategy can help an investor find stocks that not only pay a dividend, but are the most stable and secure investment opportunities available. There are hundreds of companies that pay a dividend to their shareholders, which can make the process of finding the best companies a difficult task.
Just because a company pays a dividend does not mean it is in good financial shape. While it may be tempting to select a stock with a double digit yield, there are usually many red flags associated with a company such as this. Instead of chasing high yields, it is better to find stocks that offer consistent yields that continue to grow overtime.
As I work to build a solid dividend income portfolio, I have defined my selection criteria to find stocks below.
How to Find Stocks that Pay Dividends
The following set of criteria will be used to find stocks that will help build my dividend income portfolio. Each specific criterion has its own specific purpose when it comes to stock selection. Using all of these factors together as a whole will help to identify only the best income producing stocks.
- 10+ Years of Consecutive Dividend Growth – Past dividend growth is important when selecting income stocks. A company that continues to increase its payout every year (without sacrificing future growth) is a good sign of a healthy company. In the past I would only screen companies that had 25 years of consistent increases but realized I was missing out on some great opportunities.
- Current Yield >= 2% – Any company offering a current yield under 2% will be filtered out in the screening process. Even in a low interest rate environment, there are less risky investments (certificate of deposit) that return around 1%. While there is no maximum limit on the yield listed, any stock returning over 6% will be reviewed more closely.
- Dividend Payout Ratio <= 70% – The dividend payout ratio (DPR) will help to screen out companies that are allocating over 70% of earnings towards paying distributions. Anything over this mark will be excluded and deemed too risky of an investment. The historical DPR for a company will also be reviewed to ensure the percentage is not increasing on a consistent basis.
- P/E Ratio <= 20 – Using the price to earnings ratio (P/E) will help find stocks that are undervalued. Any dividend stock with a trailing P/E under 20 will be included in the screening process. However, each company will be further scrutinized and the price to earnings will be compared to that of its peers. Ideally, any stock added to this portfolio will have a trailing P/E that is less than or equal to its industry average. This will help to ensure I buy stocks that are on clearance.
- Operating Margin >= Industry Average – The operating margin is a percentage of how much money a company makes for every dollar of sales. The higher the profit margin the better, which is why I will try and find stocks that have a higher margin than their peers. While not an absolute must, the preferred screening process will look for companies that have a higher operating margin than the industry average.
- Increasing Dividend Growth Rate – The dividend growth rate of a company is a critical part in screening investment opportunities. I plan to look for companies that have 5 consecutive years of double digit growth or those that have a growth rate that has been increasing. Used in combination with the current yield, a company that has a low yield but is growing their dividend will be considered a good sign.
Additional Factors to Find Stocks
There are a few additional factors that I plan to use to find stocks of only the top dividend paying companies. Here are a few other items I will look at when deciding on companies to add to my dividend income portfolio.
- Direct Stock Purchase Plans – An important part of building my portfolio will be to cut down on expenses wherever possible. Many companies offer direct stock purchase plans (DSPP) which can be used to buy stocks. These plans can cut down on fees and commissions that are charged by an online stock broker. After narrowing down the list of stocks, this additional criteria will be used to find stocks.
- Sector and Industry – To prevent overloading my portfolio with stocks from a particular industry, I will use the sector and industry in my selection analysis. While the focus is to build a dividend income portfolio, I want to still have built in diversity from the overall market.
Final Thoughts
The criteria listed above to find stocks are the guidelines I will use to build my dividend income portfolio. Each of these factors is subject to interpretation and may be changed in the future. I will use these guidelines as an initial screen to narrow down the hundreds of dividend paying stocks into only the best.
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