Five Ways to Select High-Dividend Stocks

Companies can do either of two things when they make profits. They can reinvest it back into the company so that it grows at a higher rate, or they can distribute it to their shareholders. Many choose to do a mix of both, to ensure that the company grows and shareholders are happy.

Some shareholders are happy when companies reinvest their profits into the business since it will mean that their share prices will go up in the future. Others are content to get a slice of the profits in the form of dividends.

Investing in high dividend yielding stocks can pay off in the long run and help you in wealth creation. The top dividend paying stocks are often those of companies that have had stable and consistent growth over time.

The challenge before an investor is to pick the top dividend paying stocks. Here are five ways to find the highest dividend paying stocks.

Study the industry:

A lot of the time, you can find top dividend paying stocks by studying various industries. For example, the banking sector at the moment is weighed down by NPAs (non-performing assets), so may not be a good prospect for dividends, but the IT and pharmaceuticals sectors are growing. So, what you’re looking for essentially is an industry that is on a good growth curve. This is where the dividend payouts are, and the wealth creation opportunities.

Company’s fundamentals:

Studying an industry gives you a broad idea about where you should look for picking the best dividend paying stocks. To narrow in on the prospects, you will need to study company fundamentals such as business prospects, sales, assets of the company and company performance, and compare them to peers in the sector. This will help you identify companies that have strong growth potential. It’s more likely that such companies will pay a dividend to their shareholders.

Earnings and payouts:

Two important ratios will help you ascertain whether a company is among the best dividend paying ones are not. Those ratios are a price to earnings (P/E) ratio and dividend payout ratio.

The P/E ratio gives an insight into the market’s valuation of the company. If the company’s P/E ratio is less than the industry P/E ratio, the company is undervalued, or it is doing very well relative to past performance. A high P/E means that investors expect higher growth in the future.

The dividend payout ratio is calculated by dividing the dividend per share by earning per share or EPS. A payout ratio of 100% means that a company is distributing all its profits to shareholders. That’s not a very likely scenario. It is best to pick a company that pays out a moderate dividend, with a payout ratio of around 50-60%, leaving some amount for reinvestment in the business. Shares of companies with high dividend payouts can tend to get volatile.

Other ratios

You should look at other ratios to determine which company figures in the top dividend paying list. These include operating ratio, current ratio, quick ratio, as well as free cash flow.

Operating ratio is operating expenses divided by net sales. A falling operating ratio is considered desirable since it means the company is getting more efficient and thus able to pay dividends.

The current ratio is the ratio of current assets to current liabilities. This indicates whether the current assets will be enough to meet current liabilities. The quick ratio indicates a company’s short-term liquidity position. A company with inadequate liquidity will not be able to pay much dividend.

Free cash flow is the amount of free cash that a company has. The higher the free cash, the more will be available for the company to pay out as a dividend.

Dividend history:

Lastly, a company that has a history of paying a good dividend and increasing it over the years is a stock you should invest in.

A dividend is an excellent way to earn tax-free income since dividend income is exempt from tax up to Rs 10 lakh. If you can find good dividend-paying stocks, you can reap the benefit of both price appreciation and steady income.

Nirav Singhaniya is a Financial Advisor and Share Marketer with 10 years of experience. In his free time, he likes to research on stock trading and share market trends.