5 Signs Your Dividend’s Going Higher

Kristin Orman By Kristin Orman
Research Analyst, The Oxford Club

Dividend Investing

Since the Great Recession, dividend yield has become all the rage.

Historically low interest rates caused investors to flee traditional “safe” investments like CDs and money market accounts in search of income.

Many investors found sanctuary in dividend stocks – especially those with high yields. And these stocks became the most popular shares in the market.

But this year, yield’s reign is ending…

In 2017, another more important metric will take its place: dividend growth.

As interest rates and inflation creep up, high yields won’t cut it anymore. Unless these high-yielding companies raise their dividends, investors’ real income will begin to decline.

Instead, investors will need dividend growth.

So if you’re ready to trade yield for growth – and add some dividend hikers to your portfolio – here are five signs that a company is about to raise its dividend…

Take a Cue From SafetyNet Pro

Dividend growth and safety go hand in hand. So it’s not surprising that SafetyNet Pro uses three growth signals to rate dividend safety: free cash flow growth, payout ratio and dividend history.

Companies pay dividends from their cash flows. And the more free cash flow they have, the more money there is available to reward shareholders.

So rising free cash flow not only ensures dividend safety, it predicts dividend growth as well.

Payout ratio tells investors if a company’s dividend-paying abilities are stretched. SafetyNet Pro likes to see a payout ratio of 75% or lower. That way, even if free cash flow declines, there are still enough funds to pay dividends.

But if you are looking for dividend safety AND growth, a ratio below 75% is ideal. A company with a 40% payout ratio has plenty of room to pay and even increase its dividend if cash flow heads south.

While past performance doesn’t guarantee future results, when it comes to dividends, there’s a strong correlation.

Companies with long histories of raising their dividends usually increase them year after year. They know shareholders expect the annual hikes and will sometimes sell shares if they don’t receive them. So each year, many companies will increase their dividends – even by just a little bit – to appease shareholders.

Members of the elite Dividend Aristocrats must also bump up their dividends each year to maintain their prestigious statuses.

Conversely, companies that have cut their dividends in the past are more likely to do so in the future. That’s why SafetyNet Pro penalizes the safety ratings of historical offenders.

Dividend history is also a good way to figure out when the next hike is coming. Most companies raise their payouts during the same quarter each year.

Listen to the Dividend Whisperers

The fourth way to predict a dividend raise is to listen to management.

Some companies provide dividend guidance along with their financial outlooks in press releases and on earnings calls.

If a CEO says the company is targeting a 10% to 11% dividend increase in the next year, that sets investor expectations.

To keep investors happy and keep the company’s share price up, management will need to meet it.

Other companies have more formal dividend policies. They’ll tell investors how much of the company’s earnings or cash flow will be used to pay shareholders.

For example, a company’s policy may be to declare a dividend equal to 65% of its earnings per share.

So if earnings are going up, so will the dividend. But remember, if the company’s earnings are volatile, its dividend will be too.

The fifth signal to look out for is debt.

Companies with little or no short-term debt are generally in a better position to raise their dividends. They don’t have to worry about servicing the debt (paying interest) or paying it off anytime soon, which leaves more cash available to hike the dividend.

If a company has a lot of debt on its balance sheet coming due in the next few years, raising its dividend may not be a priority. Instead, the company will likely focus on paying off that debt or refinancing.

Yields in Low Places

Dividend growth benefits investors in two ways: It accelerates compounding and boosts income.

The faster a stock increases its payouts, the more money you have to buy more shares. And the more shares you own, the more dividends you’ll collect.

But what’s even better is that the more income the stock produces, the more your investment is worth.  So dividend growth also drives share price appreciation… which further increases your returns.

And as the dividend grows, the yield on your cost basis will grow too. And it will be higher than the yield new investors receive.

Your cost basis is the price you paid for the stock. As the dividend and the stock price rise, your cost basis stays the same. So your yield on cost basis rises.

For example, if you buy a $10 stock paying a $0.50 annual dividend, the yield is 5%.

If the stock price rises to $20 and the company’s dividend grows to $1, new shareholders will also receive a 5% dividend yield.

But since you purchased the stock at $10, your yield on cost basis rises to 10%.

That’s how, over time, a stock purchased with a 2% yield can grow to 4%, 5% or even higher.

While a 4% yield is nice today, if the dividend doesn’t grow, it’ll be worth less in the future.

When you are searching for income, don’t forget to look for these five signs that your stock will give you a raise this year and next.

With a growing dividend, less yield today can be more tomorrow.

Good investing,