It’s easy to find plenty of websites willing to share a “top ten” list of good dividend stocks for the year. Yet it’s much harder to find actual useful lessons that will help you in the long term.
This frustrates me. Getting a quick tip about one good dividend stock won’t help anyone towards their financial goals.
Sure it feels good temporarily, but relying on new dividend stocks lists every year isn’t a reliable investment strategy.
So instead of give you what you’re looking for, presumably good dividend stocks, I’m going to teach you how to find good dividend stocks with 3 common metrics. I have no doubt this will be far more beneficial for you in the long term.
And it’s the long term that really matters.
Good Dividend Stocks: P/E
Let’s start with the most basic dividend metric. Price to earnings, or P/E ratio.
This ratio is simple to understand when explained correctly. It is the price you are paying for the earnings a company is giving you.
Look at it this way. If you buy a rental property for cash flow, the success of that investment depends on the price you paid for it and the cash flow it gives you.
A property that you paid $200,000 for might be a great deal if you can make $2,500 a month from it, and not such a great deal if you only make $1,500 a month from it. It’s not the dollar amounts, per se, but the ratio of price to earnings.
Buying dividend stocks works the same way. The lower the price to earnings on a company, the better deal you are getting on the company. It’s the simplest measurement of value.
Price to earnings works really well in helping you avoid extremely unfavorable situations. When a company is losing money, that stock will have a negative P/E ratio. You want to avoid negative P/E ratios at all costs because it indicates a company that is in serious trouble.
P/E also helps you avoid stocks that reach “bubble” territory. This is when Wall Street gets so excited about a stock that investors will literally pay anything to have it. A situation like this is so dangerous because the bubble always pops. We see it time and again.
For a good dividend stock, find a P/E less than 25.
Here’s the free tool I use to sort dividend stocks by P/E. It’s called FINVIZ, and it lets you sort from a wide variety of metrics. Simply select P/E: “Under 25” in the “Fundamental” Tab.
Good Dividend Stocks: D/E
The next dividend metric will help you avoid stocks that suddenly go bankrupt like Lehman Brothers did. I’m talking about the Debt to Equity ratio.
Debt to equity ratio works just like anybody’s personal finances. When people end up in bankruptcy court, it’s because they’ve accumulated too much debt on their credit cards, mortgages, and more. For stocks, it works the exact same way.
After studying the 30 biggest bankruptcies of the 21st Century, I found that the ratio most correlated to bankruptcy was a high debt to equity.
This means that the higher a stock’s debt to equity, the greater the chance of eventual bankruptcy.
Bankruptcies like Lehman Brothers caught investors by surprise because most investors don’t look at debt to equity. It’s not a popular metric.
However, my research showed the power of this metric. And it makes sense intuitively as well.
Companies can go a very long time with a high debt to equity ratio, and usually this creates stronger earnings for the company. But when times get tough in the market, it’s these same companies with heavy liabilities are the ones that make headlines and destroy investors.
The last thing I want you to do today while seeking a good dividend stock investment is to get caught in a stock that loses most or all of your money.
For a good dividend stock, find a Debt to Equity less than 1.
Of course, like the P/E ratio, you can use the same tool to sort through dividend stocks. Again, it’s called FINVIZ. Under the “Fundamental Tab”, select Debt/Equity: “Under 1”.
Good Dividend Stocks: Growth
The final dividend metric is something of a secret sauce.
The seductive draw of dividend stocks is that great companies will grow their dividend year after year after year. For the patient investor willing to hold these kinds of companies for a long time, these dividends accumulate and compound into immense fortunes.
I’ve shared about the most successful dividend stocks of the past 3 decades, and how they’ve created millions of dollars from thousands.
This last important dividend metric is consecutive years of dividend growth.
When a company is naturally growing its earnings every year, it tends to also increase its dividend payments. CEO’s and board members are incentivized to grow dividends every year because doing this attracts shareholders.
If a company has a long history of paying and growing a dividend, it means they also have a long history of solid financial data and a great business model.
Value is important, and debt must be avoided, but ultimately you want to be buying the greatest companies. A metric like this helps us identify the best performing stocks.
My research above about the best dividend stocks clearly showed that investors didn’t need to be early to the party to enjoy the steady ride of growing dividends.
In fact, investors could’ve jumped into stocks after 10-15 years of dividend increases and still seen another 10-40+ years of continued dividend payments!
This compounded into substantial sums that absolutely crush average stock market returns.
So, find stocks that have at least 10 years of consecutive dividend growth.
You can find an updated list of such stocks at Dividend.com, or you can alternately check any stock’s dividend history with the search bar.
Now, you won’t be able to select a dividend stock champion every single time, which is why diversification is also crucial.
But I’m confident these 3 dividend stock metrics give you the best chances at doing that.
A power like this useful.
Far more useful than a “Top 15 Dividend Stocks for 2016” list of random stocks, companies, and sales pitches.