To determine if a dividend is safe or not, one must analyze the company that’s paying the dividend. There are multiple things to look for.
Is the company financially strong?
Dividend companies with financially strong profiles are less likely to cut their dividends. So, invest in companies with credit ratings of BBB+ or better to improve your dividends’ safety.
For example, Telus Corporation (TSX:T)(NYSE:TU) has a BBB+ S&P credit rating.
Are the earnings stable?
As one of the leading Canadian telecoms, Telus also earns stable cash flows and earnings from its subscribers. It has 12.4 million total subscriber connections, including 8.5 million wireless subscribers (about a third of the market), 1.6 million high-speed Internet subscribers, and one million TV subscribers.
Businesses that are dependent on volatile commodity prices, including oil and gas producers and mining companies, will experience volatile earnings.
Does it pay a growing dividend?
Companies that have track records of raising their dividends are more likely to maintain them.
Telus has paid a growing dividend for 12 consecutive years. In the last five years, it has averaged a dividend growth rate of about 10% per year.
The concern around Telus right now is its slowing growth. In fact, the company’s latest dividend-growth target is 7-10% per year from 2017 to 2019. To be more conservative, let’s forecast a dividend-growth rate of 7-8.5% per year going forward.
At just under $40 per share, Telus yields 4.6%. If it grows its dividend by 7-8.5% through 2019, investors today can expect total returns of roughly 11.6% – 13.1%, seeing that Telus shares are fairly valued today. This return range is pretty good because the market historically returns about 9.6% per year.
Is the payout ratio sustainable?
Telus’s expected 2016 earnings per share are $2.69. Its quarterly dividend is $0.46 per share. Projecting that to an annual payout of $1.84 per share, the company’s payout ratio is about 68%, and it retains 32% of its earnings. So, its dividend is sustainable.
Generally, a lower payout ratio implies a safer dividend, but a company’s payout ratio should be compared to its peers’ payout ratios because payout ratios from different industries can be different.
For instance, telecoms, utilities, and real estate investment trusts, tend to have bigger payout ratios, but grocery stores, such as Metro, Inc. (TSX:MRU), tend to have lower payout ratios.
Let’s compare Telus’s payout ratio to its peers’. At about $59, BCE Inc. (TSX:BCE)(NYSE:BCE) yields 4.6%. Its annual payout is $2.73 per share, and its payout ratio is about 78%.
At about $49, Rogers Communications Inc. (TSX:RCI.B)(NYSE:RCI) yields 3.9%. Its payout ratio is about 67%. However, it has maintained the same quarterly dividend since the first quarter of 2015.
There’s always more one can do to determine if a dividend is safe, but if you buy financially strong companies with credit ratings of BBB+ or better, which also generate stable, growing earnings and or cash flows, has a track record of raising their dividends, and has a sustainable payout ratio, you’re already doing more than many other investors who blindly chase high yields that may be unsustainable.
Here are some books about dividends that readers find useful:
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.Disclosure: At the time of writing, I own TSX:T.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
Get Exclusive Articles from me on Seeking Alpha
- Access my portfolio of high-quality U.S. and Canadian dividend stocks.
- Real-time updates of when I buy or sell from this portfolio.
- Get best ideas of the top 3 dividend stocks from my watchlist. Updated each month.