Did you know that, since 1925, around half of your total return as an investor will have comes from dividends? For self-select Isa investors, who don’t mind doing a bit of homework, here are three ways to spot reliable income-payers.
Rising cash returns
You want to find stocks that have announced an increase in dividends per share over the past year.
High cash levels
The next step is to determine how much cash a firm has. Start by comparing a firm’s cash levels to its market capitalisation – this is to check that cash levels are high relative to the firm’s size.
Next, check the cash isn’t swamped by debt. A firm with large debts, like a man with a big mortgage, may be tempted to use its cash to clear it, which threatens future dividends. Avoid any stock where net debt (cash plus short-term investments, minus short-term debt) is above 50% of shareholders’ equity.
A low payout ratio
The payout ratio is the proportion of a firm’s profits that it pays out as a dividend. If profits are £100m and the annual dividend is £50m, the payout ratio is 50%. The higher the ratio, the less scope the firm has to raise dividends in the future.
This is vital today, given that, in the current tough economic climate, no one expects firms to grow profits significantly. That’s why a historically low payout ratio is attractive: it suggests a firm is able to boost its dividend returns to shareholders, even if profits stagnate.