Dividends are an amazing tool for building wealth while also creating a future passive income stream. What they are is a sum of money paid to shareholders out of a company’s profits, often in regular intervals. Therefore, just for having money invested in a company, they pay you a portion of the profits every month, quarter or year. There are also occasionally special dividends that are a one time payment to shareholders, sometimes this happens after a company sells off assets or otherwise gains a windfall of profits.
Not all companies pay dividends, the ones that do are usually “safer” more “stable” companies. For the banks, telecoms and utilities I think this holds true here in Canada. However, not all sectors are as well established, look for larger, older industries. When looking at dividend paying companies I really am most concerned with the sustainability of that dividend. If a company can consistently pay out dividends lower than earnings than they are doing something right. Below are a few factors I use when choosing dividend companies I may want to invest in.
Consider These Factors
Payout ratio – This is a company’s dividend divided by its earnings
Example: RBC (RY.TO) at time of writing pays $0.87 per share quarterly, which translates to $3.48 annually. RBC’s earnings per share is $7.35. Therefore, the company’s payout ratio is 47% (3.45/7.35 x 100). I consider a payout ratio below 50% highly sustainable. Work your own technique with an advisor to decide whats an acceptable ratio for stocks in your portfolio.
Dividend Aristocrats Index – This index is described as:
“S&P/TSX Canadian Dividend Aristocrats Index captures both sustainable dividend income and capital appreciation potential which are both key factors in investors’ total return expectations. The index also offers diversification across all sectors and exhibits both growth and value characteristics.” (Source: www.tmxmoney.com)
My interpretation is that its (at time of writing) 87 of the best dividend paying companies in Canada. This index is created by the company that owns and manages the exchange the companies are traded on, the TSX. This is a good place to start when looking for dividend paying companies to purchase: https://web.tmxmoney.com/indices.php?section=tsx&index=^TXDV#indexInfo
The company’s balance sheet – This is the exact same as the net worth of an individual just applied to a business. Subtract a company’s liabilities from their assets. Ensuring that a company is in the green is a crucial indicator of their ability to continue to pay a dividend long term in my opinion.
Dividend Reinvestment Plan (DRIP)
Some companies and brokers offer Dividend Reinvestment Plans for their shareholders. This service allows investors to automatically reinvest their dividends to purchase additional shares. In some cases companies will award fractions of shares as well depending on the arrangement. Setting up a DRIP with good companies is a great way to build wealth. This method literally requires only semi-annual or annual rebalancing in my opinion. I employ DRIPs in my own wealth building plan when I hold dividend paying stocks or ETFs. This technique helps take the emotion out of investing. It’s a set and forget type set up while being very effective and it avoids trading fees. Some people would be best off just investing with DRIPs rather than trying to more actively manage a portfolio (sometimes myself included).
Best of luck on your dividend investing journey. Remember to always consult an investment professional before purchasing any investment products.