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3 factors to consider when buying dividend stocks

3 factors to consider when buying dividend stocks

Dividend investing is always an attractive option for equity investors. Here, you can benefit from a steady stream of dividend income as well as long-term capital gains.

For example, if you bought $10,000 worth of Enbridge stock back in 1995, your investment would now be worth $112,000. After accounting for dividend reinvestments this figure almost doubles to $217,000.

However, similar to any other form of investment, dividend stocks also carry certain risks. Here are the three most important factors you need to consider while identifying dividend-paying companies.

Dividend yield

The dividend yield is expressed as a percentage of the company’s stock price. For example, Enbridge stock pays an annual dividend of $3.34 per share. Comparatively, its stock is trading at $46.30 which suggests its dividend yield is 7.21%. It also indicates that investing in $1,000 in ENB stock will help you generate $72 in annual dividends.

Yield is one of the most important metrics and can also be used to identify red flags. A stock with a high yield might not necessarily be a good investment. Another Canadian company that pays a dividend is Chemtrade Logistics. This stock has a yield of 8.6% which might seem attractive. However, Chemtrade has also lost over 65% in market value in the last three years.

Payout ratio

The payout ratio is calculated as a percentage of a company’s earnings. For example, if a company has earnings of $5 per share and pays $2 per share in dividends, the payout ratio is 40%. 

A low payout ratio suggests that a company’s dividend yield is sustainable. Further, it also provides the company an opportunity to reinvest in capital expenditures or lower their  debt burden.

Earnings growth

Another important metric for investors to consider while identifying dividend stocks is a company’s earnings growth. An entity that has grown its bottom-line at a consistent rate over time has the ability to increase dividend payouts. Canadian Utilities has increased dividends for 48 consecutive years the highest such streak for a Canadian company.

The final takeaway

An ideal dividend-paying company has:

  • an attractive dividend yield;
  • a low payout ratio;
  • sustainable earnings growth.

Investors can look at the dividend-paying history and analyze the financial statements of such companies to shortlist quality stocks that can create long-term wealth.

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