5 Secrets of Successful Dividend Investing

LONDON -- Here are five rules that you can use to find dividend shares.

Rule 1: Bigger is often safer
Large companies are often more geographically diverse and have established brands and a strong market position. This helps them to maintain and increase shareholder dividends.

Filter 1: FTSE 100 companies only.

Rule 2: Bigger yields are better
There's little point investing for income but buying shares with tiny yields.

Filter 2: Shares must yield over 4%.

Rule 3: Earnings growth potential is compulsory
I want dividend payers to be able to increase their payouts. This is more likely if they can increase earnings first.

Filter 3: EPS growth is forecast.

Rule 4: Invest in companies committed to dividend increases
If a company has previously been increasing its dividend, there will be significant pressure on management to continue.

Filter 4: The dividend must have increased every year for at least the past three years.

Rule 5: Dividend must be covered by profits.
If a company's dividend is not covered by its profits, a future cut is more likely.

Filter 5: Dividend cover of at least 10%.

My rules reduce the entire FTSE 100 to just five qualifying shares.

Company

Price (Pence)

2013 P/E (Forecast)

2013 Yield (%, Forecast)

Market Cap (Million Pounds)

Tesco  (LSE: TSCO  )

356

11.1

4.1

28,600

British American Tobacco  (LSE: BATS  )

3,261

14.5

4.5

63,160

GlaxoSmithKline  (LSE: GSK  )

1,420

12.0

5.5

69,760

Centrica  (LSE: CNA  )

347

12.4

5.0

18,020

Wm Morrison Supermarkets  (LSE: MRW  )

257

9.7

4.5

6,200

Tesco
Tesco has the longest history of successive dividend increases of any FTSE 100 company. If the company ups its dividend in its final results, it will be the 28th year in a row that the payout to shareholders has increased.

Tesco has recently been taking steps to reassure its investors. The company has now appointed a new boss of its core U.K. division. Tesco is also placing its U.S. operation "Fresh & Easy" under review. This has been taken as a signal that Tesco is preparing to dispose of the loss-making chain.

Tesco shares now trade at a high for the year.

British American Tobacco
BATS is another of the FTSE 100's top dividend payers. In the past five years, its dividends to shareholders have increased at an average rate of 17.7% per annum.

British American Tobacco is the company behind cigarette brands such as Dunhill, Kent, and Lucky Strike. In this business, customers are famously loyal (as in addicted). This enables BATS to pay such a reliable dividend.

Some of you may have ethical concerns about investing in a cigarette manufacturer. What deters me from investing in BATS is my belief that worldwide tobacco sales may have peaked.

BATS is forecast to report a 6.3% dividend increase for 2012, to be followed by a 9% rise in 2013.

GlaxoSmithKline
Pharmaceutical giant GlaxoSmithKline sells a range of products that its consumers would struggle to live without. This delivers a high visibility of future sales and profits. This flows through to a very reliable shareholder dividend.

Glaxo also owns some top consumer brands worldwide, including Lucozade, Horlicks, and Ribena.

The strength of Glaxo's business is evident in its shareholder dividend. The company has been increasing its dividend to shareholders every years since 1998. In the past five years, it has increased at an average of 7.8% per annum.

A 6.2% dividend increase is forecast for 2013, followed by a 4.2% rise the year after.

Centrica
Centrica is the utility firm behind British Gas. As such, much of its revenues are derived from a highly regulated non-discretionary industry. This is the double-edged sword that all utilities operate with. The fact that consumers are so reluctant to ever reduce energy consumption gives a high degree of visibility to Centrica's earnings. On the other hand, the power of the industry regulator means that the rules of the game can change very quickly.

In the past five years, the Centrica dividend has been increased at an average rate of 9.2% per annum. Another two years of above inflation increases are forecast.

Wm Morrison Supermarkets
Morrisons is currently fighting competition on a number of fronts: traditional peers such as Tesco and Sainsbury's, along with foreign discounters Aldi and Lidl. Recent market surveys have shown Morrisons losing market share. This has spooked the markets, and the shares now trade near a low for the year.

Concerns over Morrisons' profitability are best illustrated by the trend in analyst forecasts. This time last year, the consensus was for 2013 earnings per share of 28.7 pence. This has since declined to 26.5 pence, a forecast increase of just 1.5% on last year's profits.

Morrisons' dividend is expected to increase by 9.7% for 2013, followed by a 7.7% rise for 2014.

These dividend rules might be a good place to start, but I am not a great dividend investor. If you are looking for an income guru, then Neil Woodford is your man. This money manager has been regarded as one of the U.K.'s top fund managers for more than 10 years, so you can learn from this master investor, The Motley Fool has prepared this free report: "8 Shares Held by Britain's Super Investor." This report is completely free and comes with no further commitment. To start reading today, just click here.


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  • Report this Comment On January 29, 2013, at 3:35 AM, Sotograndeman wrote:

    "These dividend rules might be a good place to start, but I am not a great dividend investor."

    I'd like to see TMF writers stay well within their circle-of-competence! They might thereby stand a chance of "enriching" the reader. There's way too much simplistic and naive advice being doled out.

  • Report this Comment On February 01, 2013, at 11:47 AM, rnewfie wrote:

    <i>Rule 1: Bigger is often safer.

    Large companies are often more geographically diverse and have established brands and a strong market position. This helps them to maintain and increase shareholder dividends.

    Filter 1: FTSE 100 companies only.</i>

    Geographical diversity is not particularly relevant and I am not sure if it helps in increasing dividends either.

    You need to set your own filter in terms of company size. If you set your MCAP at a more realistic lower limit of say, £2B, then you increase your company count to around 135.

    The smallest company in the FTSE100 at present is Serco, which has an MCAP of £2.7B. There are 8 companies in the FTSE250 which are bigger and possibly safer that Serco. Why put an arbitrary limit on FTSE100 companies?

    <i>Rule 2: Bigger yields are better.

    There's little point investing for income but buying shares with tiny yields.

    Filter 2: Shares must yield over 4%.</i>

    I am not sure what you are trying to say here, but you seem to be putting a randomly generated number as a lower limit. Why 4%?

    There are 79 companies in the FTSE350 with yields above 4%, but are they safe? The main criteria to safety is at least a minimum dividend cover.

    <i>Rule 3: Earnings growth potential is compulsory

    I want dividend payers to be able to increase their payouts. This is more likely if they can increase earnings first.

    Filter 3: EPS growth is forecast.</i>

    Not necessarily true. Earnings are not always relevant. Some companies have a dividend policy whereby they will increase dividend payouts even if they temporarily cannot afford to do so. You need to look at companies which have actually increased the payout every year, or using the filter I prefer, for at least the past 6 years.

    Some companies choose to not increase the dividend even if they have made huge profits. Earnings and dividends are not closely coupled.

    <i>Rule 4: Invest in companies committed to dividend increases

    If a company has previously been increasing its dividend, there will be significant pressure on management to continue.

    Filter 4: The dividend must have increased every year for at least the past three years.</i>

    As I said above, I prefer 6 years to be more safe. Look at their dividend policy though.

    <i>Rule 5: Dividend must be covered by profits.

    If a company's dividend is not covered by its profits, a future cut is more likely.

    Filter 5: Dividend cover of at least 10%.</i>

    Cover of at least 10% (I am assuming you mean 1.1x), is bordering on dangerous. I would not invest in any company with a dividend cover of less than 1.5x. There are 270 companies in the FTSE350 with a cover of over 1.1x. You cannot be seriously saying that all of these are worthy of our investment! Maybe for possible capital growth, but not for long term income.

    Using the figure of 1.5x, there are still 227 companies to choose from.

    Regards,

    Ron (IPD)

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