As with making any investment decisions, it's essential for investors to do their own homework and to properly assess stocks before buying. In this clip from "Ask Us Anything" on Motley Fool Live, recorded on July 12, Motley Fool contributors Lou Whiteman and Tyler Crowe talk about why, if something looks too good to be true, then maybe it is. Here are some red flags to consider with dividend stocks.
Lou Whiteman: It's true that the higher dividend payout, the rockier the company. In other words, red flag if the dividend is high. I'll let you answer. I think this one is that, there is no one-size-fits-all. At certain companies like REITs, we talked about REITs a lot, are required, basically, to let the cash flow in so you're going to see higher. So it's not a red flag. I do think it's worth looking into, why is it so high though?
Tyler Crowe: Right. Also, it's important to determine which payout ratio we're talking about. A lot of times we talk about payout ratio based on your net income. But your dividend isn't paid out in income. You get dividends paid out in cash. So, sometimes, in a more asset-heavy business that has lots of depreciation, real estate, infrastructure, things like that, you want to look at something else that's closer to a payout ratio based on free cash flow. Most of the time, you'll hear things like discretionary cash flow, infrastructure companies, where it's like operating costs minus maintenance CapEx because maintenance is a capital expenditure. Again, we're getting wonky accounting definitions here. But basically, it's like the leftover cash before, you're investing in growth. Some people will use that. But I tend to like, because of where I have invested for so long, basically being in energy, being in infrastructure, being in real estate, I have tended to look at cash flow. But for a more conventional company, Apple (AAPL +0.40%), somebody like that, earnings payout ratio probably is just good enough.
Whiteman: Yeah. Of course, Apple is the ultimate example because, even if they earned nothing for the next 10 years, they would still have enough cash in the bank, [laughs]. That's the exception to every rule. One other way to think about safe, just a stat that I wanted to get and then we'll get into the questions. The other way that dividends tend to be safe is, is that especially when you look at the Aristocrats, these are companies that have increased their dividends for 25 years. Even if they're not at that level, but companies that have been around paying dividends. You're right, you can fake cash to some extent, but you can't. These tend to be more stable, healthier companies. That's what Bill and John were getting at, at S&P survey in months where the S&P 500 had a negative mark. The S&P 500 went down. Seventy percent of the time the Aristocrats outperformed the market then. In markets like this that are volatile, Dividend Aristocrat isn't just a blue blood because there are a lot of companies that don't fall on that list that are good, stable companies. But it is a good, if nothing else, ballast for a portfolio, even if you are a high-growth investor, to have some of that stability so you aren't so rocked when things are volatile in the high-end.
