A stock that pays a safe dividend must first be a safe stock investment. (Yes, businesses can perform badly for years or even go bankrupt.)
So, investors should look for quality stocks, which have strong balance sheets, strong competitive advantages against their peers, and strong histories of profitability.
Do higher profits imply more dividends for you? I mean, shareholders.
Even after you’ve found a great business, it’s up to you to buy it at the right valuation to improve the safety of the investment.
Here’s an example with Amgen, Inc. (NASDAQ:AMGN).
Strong balance sheet
As an overview, Amgen has a high S&P credit rating of A and a reasonable debt-to-cap of 46%.
At the end of Q3 2016, Amgen had current assets of $45.84 billion which were 4.3 times greater than its current liabilities of $10.54 billion.
Moreover, its cash, cash equivalents, and marketable securities were $37.98 billion. It also had long-term debt of $30.5 billion. So, Amgen could essentially repay that debt if it wanted to.
Strong competitive advantages and long-term profitability
Morningstar assigns the biotech company a wide economic moat rating, indicating it has strong long-term competitive advantages.
Its wide moat protects Amgen’s long-term profitability. The company’s quality is showcased in its long-term earnings-per-share (EPS) growth chart.
Long-term earnings-per-share growth
Do higher profits mean more dividends?
This surely seems to be the case for Amgen. Since starting a dividend in 2011, the biotech has hiked it at a double-digit rate every year since. Its last dividend hike was 26.5%. At about $139 per share, Amgen yields almost 2.9% with a sustainable payout ratio of 35%.
Buy at the right valuation
To reduce risk and improve returns, investors should never overpay for a company — even for high-quality companies, such as Amgen.
The fair multiple varies for each industry and company. For Amgen, it’s reasonable to assign it a fair price-to-earnings ratio (P/E) of 15, which suggests a price of about $173 per share.
Now that the biotech shares have dipped to below $139 per share (a P/E of 12.2), it’s a good time to buy it at a discount of about 20%. Morningstar suggests a fair value estimate of $194, which suggests an even larger margin of safety of 28.5%.
To reduce risk and improve your returns, invest in quality companies when they’re priced at the right valuation. You will be rewarded over the long term.
These companies should have strong balance sheets, strong competitive advantages against their peers, and strong histories of profitability. It’d be all the better if you choose companies which pay dividends, as dividends can only add to your overall returns with reduced volatility.
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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.
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