Investors can get caught on the hoof when a company decides to slash its dividends but the signs are often there for months before the cut is made. It is why research matters as disruption to a company’s business or industry will also signal that its share price as well as its dividend will fall, which can be a double blow.
Here are three tips for investors:
When investing for income, look at the level of dividend cover a company has. This is the amount of profit it makes divided by the dividend it pays; the higher the better as it means it can continue to maintain and grow dividends even when it has a bad year. Companies with a dividend cover of two or above are usually seen as a safer choice.
Investors could also look at companies’ cash flow statements to see how realistic it is for them to maintain dividends. What do they need to pay to service their debt, pay their taxes, top up old pension schemes and how much is left to pay dividends?
As ever, a diverse portfolio can soften the blow in the event of dividend disappointments. Diversification is particularly important for income focussed investors as, after a dividend cut investors need to find an alternative source of income but could be forced to sell at a depressed price to get this.
Investors should consider which sector a company operates in. Is the business likely to need expensive capital investment to maintain its relevance or keep up with its competitors?
Utilities often offer good yields as they are mature businesses that have fewer growth opportunities to pursue, therefore they return a good portion of their cash flow to shareholders in the form of dividends.