How to find safe investments that pay

Can you find companies that pay a good dividend yield along with the share price going up? Yes, you can achieve both. The key is to find stocks that keep growing their earnings. Earnings are key to dividend safety and capital growth.

Here is a rhetorical question to get you thinking about your stock selection: Would you like a share that is making more and more money on average each year, or would you like a share that is losing more and more money each year? Of course, you want a share making more and more money each year, but you also want the dividends.

Okay, so you are after the company making more and more money each year. Then ask yourself this: Do you think a company that is making more and more money each year will be more likely or less likely to pay dividends versus a company that is losing money each year?

Answer: A company that is making more and more money each year is more likely to be paying dividends. Earnings is the common factor here. Earnings hold the key to both capital growth and dividends.

Why then do so many investors not understand whether their company has rising earnings or falling earnings? It is one of the key things I look for when buying into a company. Maybe you are just buying, holding and hoping that all will be okay? Or perhaps you are holding on regardless because all you want are your dividends at the end of the day. Ask yourself this question: If a company keeps experiencing falling earnings, do you think that company can keep affording to pay out its current dividends?

To answer the above questions, let’s look at two examples. The first one is BHP Ltd.

 

For BHP, notice the correlation between the earnings (blue area line) and the share price. In 2012 through to 2016, when earnings were under pressure, notice how the share price fell. It stands to reason that falling earnings will impact upon a company’s profitability. If you had seen the earnings turning around rapidly in late 2016 leading into 2017, would you have been ready to buy? A lot of investors were totally against mining stocks in late 2016. However, if you were armed with the knowledge that the earnings would turn around, you’d have an edge to make better investing decisions.

The next example is Macquarie Group. The Global Financial Crisis caused many a company’s earnings to come under pressure back in 2008 and 2009. However, what is interesting is that Macquarie Group’s earnings started to power on from 2011 and so too has the share price.

 

Let’s now overlay the dividends paid (in dollars and cents) onto the respective graphs:

 

The dark green line is the dividend paid line. A very strong correlation between the earnings and the dividends paid along with the share price. When BHP was under financial pressure during the mining slowdown in late 2016, the dividends paid were reduced. It makes financial sense to pull back on expenses when times are tougher for a company. Yes, whether we like it or not, dividends are a cost to a company and costs that can  be controlled.

 

Maquarie Group Ltd has a very strong correlation between the earnings and the dividends paid along with the share price. You see, it can be easy to find top earning companies. However, you’d need to spend hours researching your company. Or, you could let VectorVest do the work for you.

One last question? Why do so many people hang onto their falling earnings stocks for the dividends when we can see time and again how falling earnings can reduce paid dividends? One need only look at Telstra Corporation Ltd in recent years to see the effect of falling earnings. At some point a company with consistent falling earnings will be under pressure to sustain dividend payouts at current rates or better …

 

So the last question I will now ask: Do you know the earnings outlook on your stocks?

Let VectorVest analyse your earnings profiles, all for US$9.95 on a 30-day trial.

Here’s VectorVest in action

If you would like to find out more visit: www.vectorvest.com.au or visit www.vectorvest.com.au/blog

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