Hi, I'm Jimmy in this video,
I'm going to walk through some
simple steps to help us get a better
idea if a stock's dividend is
safe, going through these steps
will help us protect our money and
give us the best chance of
increasing the amount of passive
income that we can bring in from
stock dividends without
doing too much extra work.
Okay, let's jump right in.
So there are five things we can look
for when we first start researching
a company that pays a dividend.
That will tell us if there's a good
likelihood that the company's
dividend is safe.
Now I'm going to use the company,
AbbVie ticker symbol ABBV
as our primary example to
help us demonstrate our research
process behind determining
aaa, how safe is stocks dividend is.
Okay, so here are the key numbers we
want to watch for to see if a
company's dividend is safe.
And personally, I like doing them in
this order because I think it paints
a picture nicely for us and leads
us to as to the best direction
for us to research next.
But feel free to mix them up if you
think there's a better way of doing
it. The first one to look at
is the dividend coverage ratio.
Now, to calculate the dividend
coverage ratio, we simply take the
earnings per share.
We divide that by the dividends per
share. The higher this number
is, the better off we are.
Now, if we reverse this formula,
well, the new formula gives us
the dividend payout ratio.
And obviously we're going to want
this one to be as low as possible.
But for our purposes, it can use
either one, whichever one you think
is easiest, whichever one makes most
sense to you. They really tell us
the same story, just in opposite.
One where you want high the other
one you want low.
So that's step one.
Can the company afford to pay their
dividend?
Now, one thing that we have to be
careful about is putting too
much power in any one
number.
For example, if a single quarter
perhaps they didn't cover their
dividend that quarter or even in a
single year if they didn't cover
that dividend.
Well, that doesn't necessarily mean
that the dividend isn't safe.
They could have the cash to
cover it. There might have been some
reason why their earnings dropped
that particular year.
But if dividend coverage ratio
is consistently low, well,
that probably means that over
the long run, the dividend isn't
going to be too safe.
So that's a great place to start for
the first one.
So next, we want to look at the
dividend growth rate to get the
dividend growth rate.
We simply calculate how much the
dividend changes from one year
to the next.
To illustrate this, this is a chart
of AbbVie's dividend going
over the past few years.
Now we can see that they didn't
start paying a dividend until 2013.
And we may notice that last year
they had a pretty big jump in their
dividend, although they did have a
dip in their dividend from 2013
heading into 2014.
Now, this gives us an idea of
the overall growth that AbbVie
has experienced from a dividend
perspective.
Hopefully this could give us an idea
of what we could expect from their
dividends in the future.
Now, where I find this interesting
is I actually think that this is
more useful if we jump to the next
item on our safe dividend checklist.
So right around the same time, I
would look at these two numbers
together. Number two and number
three on this checklist.
Number three is the growth rate of
earnings or profits per share.
So for this, we do a very similar
thing. And the first thing we may
notice for Avi is that they've done
a great job of consistently growing
their profit per share or
earnings per share.
You might hear called EPS for short.
Now we can see that their 2016
earnings per share were 42% larger
than the 2015 earnings.
Now, if I were researching this
company, I would question what
happened in that year.
Maybe they made an acquisition that
year or did they really
just do a good job of growing their
core business or perhaps
they did a stock buyback.
And that's ultimately what made
their earnings per share look
a lot larger.
Now, some investors don't really
like stock buybacks and they can
certainly be questions as to
how good a stock buyback is,
depending on how they fund it or
how often they do it or what do they
pay for their own company if they
overpay. It's probably not a good
thing, but for dividend investors,
it's not necessarily a bad thing.
After all, if a company buys
back shares or they no longer have
to pay dividends to those shares
that they bought back.
So that would mean that
in theory they could make their
overall dividend payment cheaper,
assuming that they keep the per
share dividend amount the same.
Well, in my mind, that's probably
makes it more likely that
the company will increase their
per share dividend since
it's now, it could cost them in
theory, it could cost them the same
amount spread among less shares.
So to existing shareholders like you
or I? Well, that could increase
our per share dividend and therefore
increase our own passive income.
Okay. That being said, we may still
ask. That's interesting and all,
but how do we tell if the dividend
is safe?
And for that, I think it makes sense
if we combine this chart and our
previous chart.
This is the new chart we get.
And. With this chart, we can
now compare the dividend per
share and the earnings per share.
Now, just looking quickly at this,
well, we can see that earnings per
share seems to be for just
eyeballing it. We can.
It seems that earnings per share is
growing at a faster rate than
dividends per share.
And that's exactly what we want.
But if we want to do some quick
math, well, it may make sense
to calculate the compounded
annual average growth rate,
which turns out that earnings per
share is growing at slightly more
than 19 percent from 2013
to 2018.
Difference per share goosed by
slightly less than 15 percent.
So 19 percent first, this 15
percent, that's a good thing for us.
Now, this is one of the most
important parts to finding a safe
dividend, because if
what we want is for their dividend
to be at least
the same. Ideally, we wanted
to increase.
Well, then we want to know that the
company is going to increase
earnings per share at a faster pace
than they're going to increase
dividends per share, because
when earnings falls, as they
inevitably will at some point.
Well, we want.
We don't want our dividend per share
to be threatened by a temporary
dip in profits.
So I think it makes sense to look
for dividend stocks that sort of
have a buffer zone, sort of like
this is for AD V.
Now, we may ask the question
is earnings per share.
The only number that we should
compare dividends per share to
shore earnings per share is one of
the easiest numbers to get.
It's one of the most popular
numbers. But is it?
It's not necessarily the only number
we should use.
So next on our safe dividend
checklist is to check
free cash flow per share.
Now, with free cash flow per share,
we may notice that's a bit more
volatile in ad vs example here.
And that's actually one of the
reasons that I think it's important
to check both earnings per share
and free cash flow, free cash
flow per share if you can get it.
And I think it's important to check
these two versus dividends to
see if the company has at least
enough earnings and free
cash flow to keep up with their
dividends. Although we may have to
expect a bit more volatility
in the free cash flow number, which
is not necessarily a bad thing, it's
just if we were to switch over
AbbVie versus free cash flow.
Well, we can see that free cash flow
remains. It continues to cover
it, which is a good thing for,
ah, the safety of this particular
dividend.
Okay. Um, before we move on to the
fifth point on the checklist,
I just want to bring out one
interesting thing for Advair.
We calculated that the dividend per
share growth rate, the compounded
annual dividend per share growth
rate of the past few years was 15
percent.
Now, no company is going to maintain
a 15 percent growth rate
in dividends or earnings
indefinitely. It's simply too fast.
So it's important to realize
what we're looking for is the
sustainability of
their current dividend level, not
necessarily the pace of which
they're growing.
To do that, we're gonna have to come
up with a much more reasonable
growth rate, which is frankly going
to be below 5 percent.
My guess, 2, 3, 4
percent.
We could try and make the case for.
But I just want to bring that out
that what we're looking for is the
consistency of the
company ability, the company's
ability to cover the dividend, not
necessarily all.
They're going to grow by 15 percent
every year. We have to watch this
one closely to see what they're
really going to grow by as they get
bigger and bigger.
Okay. Now we move on to the fifth
ratio for identifying safe
dividends.
And this one is the very popular
price to earnings ratio.
Now, with price to earnings,
clearly we're not directly referring
to the sustainability of
the company's dividends, since
dividends aren't even used to
calculate the price earnings ratio.
But with this one, what we're trying
to do is we're trying to
account for the effectiveness
of the total return of each of
our investments.
So the concept here is that we don't
want to overpay for a stock
if we buy a stock that has a very
high price to earnings ratio
relative to, let's say, the market
or the industry or even
the company's own history.
Well, even if we were to go through
all of the other items on this safe
dividend checklist and we
determine let's imagine that we
determine that it seems that
this particular stocks dividend
seems safe.
Well, even if it is if we paid too
much for the stock, even if this
dividend stays the same,
it's likely that the stock price
will eventually get repriced
in with where it should be
in line with whatever the benchmark
is. And that could cost us
potential total returns.
And there's simply no reason for us
to get in and get involved in
something like that.
Now, the price to earnings ratio
isn't the only way for us to come up
with the fair value of the stock.
In fact, my personal favorite
is not to use price to earnings.
I like using discounted cash flow
so we could do that very same
thing.
That would essentially take the
place of price to earnings.
And ideally what we don't want
is to overpay based
on. Our calculation of what the fair
value of the stock is.
So if we look at the sustainability
of the dividend and then we make
sure that we don't pay more than
our calculation of fair value,
I'm guessing we're going to do quite
well in the long run as dividend
investors.
Now, if you're not a hundred percent
sure of how to calculate the implied
fair value of a stock with the
discounted cash flow method.
Well, I actually did a fairly
thorough walkthrough of
how to calculate that and
where to get that information out of
calculated, how to how to apply it.
So that could be a great next
video to watch.
If you're interested in that type of
thing.
Besides that.
Thank you so much for sticking
with me all the way into the video.
I hope you found this interesting.
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button. Thank you.
I'll see in the next video.