It’s a difficult time to be an investor…
Stock market valuations continue to break records.
The Fed’s printing machines are working overtime.
And the demand for haven assets has pushed bond yields below the level of inflation.
Which begs the question, “Where should you invest these days?”
As I’ve explained in a recent letter, emerging markets are a solid choice for 2020.
However, if you’re approaching or already living, emerging markets can be risky.
Moreover, at this point in life, you’re probably more interested in cash flow than growth.
Unfortunately, bonds, money market funds, certificates of deposits, and other traditional cash flow investments offer dismal returns.
Which is why I believe the demand for dividend stocks will take off in 2020 and beyond, making this a moment of opportunity to get in.
I’ve selected a few candidates with truly impressive payouts that I recommend you consider adding to your portfolio.
However, before I reveal them, I want to share something first, so you’ll be able to spot these kinds of opportunities yourself.
It’s the three fundamental criteria you must make sure a dividend stock meets before you purchase it.
Dividend Criterium #1 – Business Longevity
As you shop for high dividends, one of the first things you’ll notice is that it’s usually in-decline companies that pay them.
Maybe they’re operating in a dying industry, have failed to adapt their operations in time, or have made poor investing decisions. The overriding point is that they’re slowly but surely going out of business.
And, because of this, their stock values are sinking, resulting in higher dividend yields (remember that we calculate the dividend yield by dividing the yearly dividend payout by the current share price).
Eventually, you can expect such companies to cease to exist, making your initial investment worthless, aside from the few dividend checks you collected.
Which brings me to the second criterium…
Dividend Criterium #2 – Cash Flow Stability
Cash flow is the amount of money flowing in and out of a company.
Free cash flow is what is left when a company pays all operating expenses and capital expenditures.
Management then decides to invest free cash flow in expanding the business or to pay out the leftover money through dividends.
For this reason, you want to see revenues and free cash flow increasing or at least holding steady.
If a company’s revenues are declining, management will soon have to decrease dividend payouts. It flat out won’t be able to afford them.
Dividend Criterium #3 – Financial Discipline
A company can have a great business, but, if it relies too much on debt to grow it, there’s a high probability of financial trouble in the future. When that happens, dividends will be the first thing to go.
Many different ratios help to measure the financial health of a company. However, the two indispensable indicators you should look at are the current ratio and the interest coverage ratio.
The former measures a company’s ability to pay short-term financial obligations with cash and short-term assets.
Ideally, you want the current ratio to be above 1, but as low as 0.5 is acceptable when dealing with a stable business such as, for example, those from the defensive sectors.
The interest coverage ratio measures a company’s ability to meet interest payments on its outstanding debt.
Depending on revenue stability, you want the interest coverage ratio to be at least 2 for defensive stocks and at least 4 for cyclicals.
So, no matter how compelling the results of your analysis overall, make sure a dividend stock meets these three criteria before you buy it.