A checklist for finding dividend shares in a crisis

Stockopedia’s Ben Hobson identifies 10 dividend stocks to keep a very close eye on right now.

When it comes to investing for income, all bets are off right now. The dividend paying capability of companies across the market has been thrown into doubt by the economic impact of coronavirus. Company earnings are going to be all over the place for at least a couple of years. And, at a time of crisis, that’s exactly what you might expect - human and company survival take priority over shareholder payouts. 

In normal times of course, dividends are a vital part of the return that investors get from stocks over the long term. History shows that solid, high-yielding shares are a reliable source of investment profits in good times and bad. 

Whether you're after large-cap cash cows or small-cap growth stocks, dividends can be a pointer to well financed, well managed companies. So, even in all this chaos, it could be worth keeping an eye on dividends as an underlying indicator of company health. In some cases, it may even be possible to capture unusually high yields if those companies keep their payouts intact. But that’s a big ‘if’.

A checklist for finding dividend shares

So, what should you look for? There are several ways of finding attractive dividend stocks, but it's worth keeping in mind a few key rules - especially in very uncertain conditions. 

1. High (but not excessive) dividend yield

Yield is an important dividend metric because it tells you the percentage of how much a company pays out in dividends each year relative to its share price. That makes it easy to compare dividend payouts across the market. 

High yields are obviously appealing but be careful of excessively high yields because they can be a sign of problems. When the market suspects a company might be unable to sustain its dividend, the share price will fall and actually push the yield higher - and this can be a trap. So it pays to be wary of excessive yields.

In normal conditions, attractive yields generally fall within a range of between 3% and 8%. But we’re currently seeing yields very much higher than that. Be careful - they may be traps.

2. Dividend growth

Another important marker for income investors is a track record of dividend growth - and evidence that payout growth will continue. 

Consistent dividend growth can be a pointer to companies that are carefully managing their payout policies - and rewarding their shareholders over time. Rather than aggressively dishing out earnings, dividend growth companies tend to have more modest yields, but are better at sustaining their payouts.

But be warned - a solid dividend track record is no guarantee of continued growth, especially in an economic crisis. Broker forecasts are unlikely to be accurate and the near-term outlook for companies may be highly uncertain. Dividends are often the first thing to be cut when the future looks bleak, be careful of making assumptions. 

3. Dividend safety

Attractively high yields obviously turn heads - but it’s important to know that a dividend is affordable. Solid balance sheets, low (or no) debt and a cash cushion are highly desirable to dividend investors. An important measure here is Dividend Cover (which is the inverse of what’s called the Payout Ratio). This is a go-to measure of a company's net income over the dividend paid to shareholders. It’s calculated as earnings per share divided by the dividend per share and helps to indicate how sustainable a dividend is.

Dividend cover of less than 1x suggests that the company can’t fund the payout from its current year earnings - and might be relying on other sources of funds to pay it. It is often advised to look for Dividend Cover of at least 1.5x - 2.0x.

Screening the market

With these rules in mind, we pulled a selection of companies that currently meet the tests. But with an uncertain outlook, it’s essential to do your own research.

The current dividend growth outlook currently ranges from very small in the case of shares like Epwin (LSE:EPWN), SThree (LSE:STEM) and Belvoir (LSE:BLV), to much more substantial for firms like BHP (LSE:BHP), CMC Markets (LSE:CMCX) and MTI (LSE:MWE). Time will tell whether these firms will be able to meet those forecasts.

The outlook for dividends

As the market starts to absorb the impact of the economic conditions on individual shares, the outlook for dividends will hopefully get clearer over time. One thing for certain is that many firms will be suspending or cutting their dividends in the near future. 

For income hunters, it’s an uncertain landscape, but the long-term importance of dividends won’t change, so it’s worth keeping an eye on payouts and the potential for high-yield opportunities when things start to settle down. 

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