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Matt Frankel, Investment Planning

10 Metrics Dividend Investors Need to Know

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• There are hundreds of possible metrics you can use to evaluate a stock.

• But, some are more important than others. • For dividend stocks, here are 10 of the

most important metrics you can use to make informed investment decisions.

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1. Payout ratio• A stock’s payout ratio is a

measurement of its dividend payment as a percentage of its earnings.

• A relatively low payout ratio indicates that the company has lots of room to increase its dividend in the future.

• It also shows a stock’s ability to continue its dividend payments if times get tough.

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• As a general rule, I like to see payout ratios that are below 60%, but there are some exceptions.

• For example, real estate investment trusts (REITs) are required to pay out at least 90% of their income, so a high payout ratio isn’t a sign of trouble in this case.

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2. Dividend yield• Surprisingly, dividend

yield is possibly the least important metric on this list.

• Just because a stock’s dividend yield is high doesn’t make it a good investment.

• However, if all of a stock’s other metrics look good, a higher dividend yield can be an advantage.

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• It’s also worth noting that, because dividend yield depends on the current share price, yields can rise significantly when the market drops.

• So, in corrections and market crashes, it may be a good time to lock in higher yields on your favorite dividend stocks.

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3. Dividend history and growth• One of the most

important factors when choosing a dividend stock for the long term is consistency.

• Does the stock pay a dividend every year without fail?

• Does the stock have a strong history of increasing its dividend?

• While past performance doesn’t guarantee future results, a strong history is likely to continue.

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• Let’s look at two of my favorite dividend stocks to illustrate the metrics we’ve discussed so far – Wal-Mart (WMT) and Johnson & Johnson (JNJ).

Two examples

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• Wal-Mart has a dividend yield of 3.33%, and a strong 41% payout ratio. The company has increased its dividend for 40 years in a row.

• Johnson & Johnson pays a slightly lower 3.05% yield and has a 57% payout ratio – and has increased its dividend for 52 consecutive years. In other words, the last time Johnson & Johnson shareholders didn’t get a dividend increase was in the early 1960s!

Two examples

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4. Interest coverage• Also known as “debt

coverage,” this metric tells us how easy it is for a company to pay its debts.

• For example, an interest coverage ratio of 4.0:1 means that for every $1 in interest owed, the company earns $4.

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• Interest coverage tells us whether a company will be able to pay its debts and continue its dividend if profits drop.

• For example, Wal-Mart has interest coverage of 11.2:1, meaning that only a small percentage of its profits are used for paying debts, so the company could absorb a large profit decline relatively easily.

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5. Total return• A stock’s dividend is

only one part of an investment’s performance.

• Total return incorporates both dividend yield and share price appreciation.

• For example, if a stock pays a 4% dividend and its share price rises by 10%, its total return is 14%.

• A stock with a high total return can build incredible wealth over long periods of time.

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• Wal-Mart and Johnson & Johnson have produced average annual total returns of 10.1% and 10.7% over the past 20 years.

• To put this in perspective, if you had invested $10,000 in each of these stocks in 1995, you would have nearly $125,000 today!

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6. EPS and revenue growth• A strong history of

earnings and revenue growth is a good indicator of a rising dividend.

• Ideally, a company’s earnings and revenue will grow at approximately the same rate, as you can see is the case with Wal-Mart

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7. P/E ratio• Perhaps the most

widely used valuation metric, a P/E ratio is most useful for comparing companies in similar industries.

• The P/E is a measurement of how much a company’s stock costs in relation to its earnings

Retailer P/E Ratio (TTM)Wal-Mart (WMT) 12.3

Target (TGT) 16.5

Costco (COST) 28.8

Best Buy (BBY) 15.0

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8. Share buybacks• There are two main

ways a company can return capital to shareholders: dividends and share buybacks.

• Many of the most solid dividend stocks also have large share repurchase programs.

Photo: Flickr user Steven Dipolo

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• Many investors actually prefer share buybacks to dividends.– Dividends paid to investors are taxed;

however, buybacks are not, even though they both represent a return of capital.

– Plus, most long-term investors reinvest their dividends anyway.

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9. Beta• When choosing dividend

stocks for the long term, you certainly don’t want ultra-volatile stocks that dive and skyrocket with every market movement.

• A stock’s beta is a measurement of volatility.

• Specifically, it compares a stock’s volatility to that of the S&P 500.

If a stock’s beta is…

The stock is…

Less than 1 Less volatile than the S&P 500

Exactly 1 Exactly as volatile as the S&P 500

Greater than 1 More volatile than the S&P 500

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• Johnson & Johnson has a beta of 0.6, meaning it is 60% as reactive to market movements as the S&P 500.

• So, if the S&P drops by 10%, your shares of Johnson & Johnson can be expected to fall by approximately 6%

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10. Return on equity (ROE)• Return on equity, or ROE,

is the amount of profit a company earns as a percentage of shareholders’ equity.

• A high ROE may indicate that a company has pricing power over its competition, or some other competitive advantage.

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• Wal-Mart has a ROE (TTM) of 19.78%, superior to its industry’s average of 17.65%.

• This indicates that Wal-Mart generates profits more effectively than its competitors because of its competitive advantages. In Wal-Mart’s case, its main advantage is its size.

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