The volatile market conditions of the past few years offer an excellent reminder that whether Wall Street is booming or floundering, there are few investments more comfortable to hold than reliable dividend stocks.
These steady sources of passive income can help investors do quite well on a long-term basis while reducing their portfolio-related stress. But as with anything that is good in life, to find companies that pay sustainable dividends, you have to do the work. To assist you in your search, here are a few attributes that all safe dividend stocks have in common.
Healthy and reliable earnings
To pay out dividends, companies need ample capital, and the most obvious way to generate it is through earnings. The key for investors is to find companies that can generate strong earnings over long periods of time, positioning them to not only maintain their dividend payouts but also to raise them -- ideally, every year.
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One way to assess a company's ability to maintain its dividend at its current level is by looking at its dividend payout ratio, or the percentage of earnings distributed to shareholders. For example, if a company generated earnings per share of $1 in a given year, and paid out $0.25 in dividends annually to its common shareholders, then that company would have a dividend payout ratio of 25%.
Obviously, you need to look at the project trajectory of the company's earnings, and how else it spends retained earnings, but a 25% payout ratio is quite healthy and could well indicate that a company has ample room to increase its dividends. If a payout ratio is above 80% or even 90%, however, there's reason to question if the company will be able to grow its dividend, or even sustain it at its current level, especially if earnings unexpectedly decline.
There are exceptions, of course. For instance, real estate investment trusts (REITs) will have very high payout ratios because to legally qualify for the special tax advantages they are required to distribute at least 90% of their taxable income in dividends annually. A REIT's dividends are therefore heavily influenced by its earnings, and the payout is therefore more likely to fluctuate.
Check out their history
Another thing that safe dividend stocks have in common is that they have paid those dividends consistently over long periods of time and during difficult market conditions. It's not hard for a business to increase its dividend or buy back shares when the economy and markets are booming, but can it do so when things aren't so rosy?
One place to start looking for companies with strong payout track records is the list of Dividend Kings -- companies that have raised their dividends for at least 50 consecutive years. At this point, these companies have all demonstrated the ability to keep paying and boosting their dividends during the pandemic, the Great Recession, and other periods of market turmoil such as the bursting of the dot-com bubble.
Check out Coca-Cola (KO 2.25%), owner of what is arguably the most iconic beverage brand in the world. The company has paid and raised its dividend for 60 straight years. At the current stock price, it also offers a pretty healthy yield of 3%, well above the average of 1.7% for companies in the S&P 500 index. That might not seem so great now that interest rates have risen to levels not seen in years, but its track record of dividend growth is one reason legendary investor Warren Buffett has held Coca-Cola stock in the Berkshire Hathaway portfolio for decades.
Look at consistency, look at earnings
Safe dividend stocks are those attached to companies with enough earnings power to comfortably keep covering their dividends. They also typically have long histories of paying and raising their dividends. That's not to say that a newer company can't be a good dividend investment. But a reputation built over decades becomes a key reason that investors and institutional funds buy a stock, and when a company has earned that reputation, its management will be less willing to cut the dividend unless it is absolutely necessary.
