It's been a fairly volatile and unusual first half of the year. You've seen a bull market for technology stocks -- the Nasdaq Composite is up more than 30% year to date -- yet it has been a difficult first half for other industries like banking, energy, insurance, and healthcare.
A still-sputtering economy has put pressures on many companies' balance sheets, and some have been forced to suspend their dividends or even cut them. If you invest in a stock that has cut its dividend or are concerned about a holding that may be heading that way, here are signs your next stock may offer a safer and more stable payout.
Dividend history
While it does not tell the whole story, a stock's dividend history is a good place to start in determining how stable a dividend is and how committed a company is to safely maintaining it. When examining dividend history, look at how many years in a row the company has increased its annual payout. Most of the popular dividend stock sites provide this information upfront.
Stocks that have been able to increase their annual payouts consistently are recognized by inclusion on a few different lists. There are some 300 stocks considered Dividend Achievers, meaning they have increased their dividends for at least 10 years straight. Then, there are Divided Kings, which have done it for 50 straight years. Currently, there are only 48 stocks on the Dividend Kings list.
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Now, it doesn't necessarily mean that those with the longest streaks are the best dividend stocks -- there are other factors to consider. But if a stock has a streak of only several years, combined with a choppy history of increases, that's a red flag. There are some instances like the pandemic when even good dividend stocks are forced to cut or suspend their dividends -- so take that into account. But broadly speaking, multiyear increases are a good sign of stability.
Payout ratio
The payout ratio might be the most important metric to watch if you're concerned with dividend safety. The payout ratio is the percentage of earnings paid out in dividends. While there are some exceptions -- as real estate investment trusts (REITs) and business development companies (BDCs) are required to distribute a percentage of their earnings as dividends -- for the most part, there is a sweet spot for the payout ratio.
Typically, you want a company to keep its payout ratio between 25% and 50%. Over 50% usually warrants further investigation. Under 25% is OK too, but too far below that level raises concerns the company may not be as committed to the dividend as it should be.
In short, a payout ratio that's too high means that the company is probably paying too much to keep up with a dividend it can't afford, especially if market conditions worsen. It might be funding the dividend at the expense of other investments, which could hamper its growth or hurt its balance sheet. Ultimately, that could lead to a dividend cut. Anything in that sweet spot of 25% to 50% means the company has the earnings to safely sustain its payout without doing so at the expense of other investments or expenditures.
Dividend yield
The dividend yield, the percentage a stock pays out in dividends relative to its share price, is often the first thing income investors look for. But if you are looking for a safe, stable dividend stock, keep in mind that some yields are high enough to stand out as a red flag.
Again, there are exceptions, particularly with REITs and BDCs, but when a yield gets unusually high -- say, above 5% to 6% -- you should do a little digging to find out why. Often, it means that the stock's price has tanked, so the dividend payout represents a higher percentage of the lower stock price. That, in turn, could signal that dividend cuts are coming to put the payout more in line with the performance of the stock. Often, when you see that yield shoot up, the payout ratio jumps too.
Obviously, high yields are attractive, but you want to make sure they are also sustainable, so do that extra research when you see a yield that's abnormally high, or one that has suddenly surged upward.
