When it comes to investing in the financial markets,
it starts with taking a stance to gain control of your
investment decisions. The financial markets can be
volatile at times. To eliminate some of that volatility,
we look for all-star businesses listed on the stock
exchanges that can show us the money in the
form of continuously producing a dividend.
Everyone remembers Tom Cruise’s character in
the movie Jerry Maguire. Jerry calls one of his
clients, Arizona Cardinals wide receiver
Rod Tidwell (Cuba Gooding, Jr.), who is
unhappy with his contract. Rod tests
Jerry’s determination through a very
long telephone conversation, in the famed
“Show me the money!” scene. Well, we
need to take the same stance by testing
these companies to find out if they are
going to stand tall and have the firmness
to pump out that steady stream of income
for us in the form of a quarterly dividend.
The Show Me the Money test:
#1-Dividend test:
The company needs to show a solid
10 year history of increased dividends.
#2–The Financial Fit test:
The company needs to show us that
they are an investment grade company
with debt under control.
#3–The Earnings test:
The company needs to show us that
there is sufficient cash flow from earnings
to cover the dividend.
For the past two weeks, I have discussed
the first two tests. This week we will look
at the third test, does the company have
adequate cash flow from earnings to
cover the sacred dividend.
The stack of cash available for dividends
comes from the company’s net income.
The danger signs of any dividend paying
stock is a decline in net income. When a
company’s profitability is shrinking, thus,
creating weaker cash flow, there will be
less money available for you and me.
With a shortage of cash flow, it is possible,
to cover the dividend with cash in the bank
or to raise capital through debt or an equity
offering to keep paying out the dividends
in the short term. However, a red flag will
appear since most companies will struggle
to keep the dividend afloat with this type
of practice.
To not get caught up in the lack of cash flow
available for our dividend, we perform an
Earnings test to make sure the company’s
earnings can cover the dividend payment.
We perform this test by calculating what
is called the dividend payout ratio. You take
the dividend per share and divide it by the
earnings per share.
Dividend Payout Ratio= Dividend per share (DPS)/ Earnings per share (EPS)
A good rule of thumb is to look for companies
that have a dividend ratio of between 40 and 60 percent.
With this breakdown, it is a win for shareholders
as they earn a profit and a win for companies as
they roll over the remaining cash to increase
future growth. The dividend ratio helps investors
determine how sustainable the company and the
payout will be. Furthermore, if the earnings were
to slip, a company with a manageable payout ratio
would still be able to afford its dividend.
Let’s take a look at Coca Cola’s dividend
payout ratio. You can easily find the
(DPS) and (EPS) numbers to calculate
from our good friend, www.finance.yahoo.com.
Dividend Per Share (DPS)/Earnings Per Share (EPS)
$1.12 per share/$1.91 per share= 59% Payout Ratio
Coca Cola passed the test criteria
with a 59% dividend payout ratio.
Companies that have a higher payout ratio
greater than 60% are putting a limit on
future growth. If a company has a dividend
payout ratio around 100% then that means
that the company is paying out all of its
earnings in dividends. This is not a good
recipe for success for the company’s financial
health; it can be sure sign that the dividend
payment will be cut in the future.
The key is to stick with strong companies
that have manageable payout ratios that
have growing revenues and earnings.
You will be putting the odds in your favor
and be rewarded with dividend increases
and less likely to suffer a dividend cut.
Using the dividend payout ratio helps
determine which investments are safe
and consistent. By doing the Show Me
the Money test we are finding companies
to add to our income portfolio with
a built in margin of safety.
The financial markets are not a membership
for the rich only. It is an open membership
to anyone that is willing to do a little work
to find these all-star businesses that can
produce a home run for you in the form of
a solid dividend and grow over the
long term.
Listen to the next Money on Your Terms show
on blogtalkradio.com Thursday July 11th at
8:00 pm PST, I will be discussing the earnings
test to better inform you on how to buy the
best of the best companies in the financial
markets.
If you find yourself struggling with money,
then I am the affordable financial coach for you.
Look at it this way, if you see a personal trainer
for your body, a dentist for your teeth, and a
hairstylist for your hair, doesn’t it make sense
to see a financial coach for the money that
pays them all? I have the tools you need to
fix your financial problems, eliminate credit
card debt, plan your retirement, build wealth,
and obtain the financial independence you
always wanted.
Call (818) 292-2548 NOW to get your
FREE introduction to affordable financial coaching.
If you would like to learn more about
the way to build wealth with dividend
paying stocks then purchase my bestselling
book, Money on Your Terms, on Amazon.com.
I give you the formula to get on the road
to achieve debt-free financial independence.
Remember when it comes to your money,
it’s on your terms and no one else’s terms.
Tim Mann
This blog post is for educational purposes only.
The above should not be considered or construed
as individualized or specific investment advice.
All readers are advised to conduct their own
independent research or consult with a professional,
if necessary, before making investment decisions.
Financial markets involve risk. You should not
rely on any past performance as a guarantee
of future investment performance.