Selecting high dividend stocks
An investor desiring to put together a portfolio that generates high dividend income should place great scrutiny on a company’s dividend payment history. Only those corporations with a continuous record of steadily increasing dividends over the past twenty years or longer should be considered for inclusion. Furthermore, the investor should be convinced the company can continue to generate the cash flow necessary to make the dividend payments; a handgun manufacturer, for example, may have a long history of high dividend payments while generating strong cash flow from operations yet not make a good investment because it faces litigation which, if successful, will bankrupt the business.
Dividends related to cash flow - not reported earnings
This brings up an important point: dividends are dependent upon cash flow, not reported earnings. Almost any Board of directors would still declare and pay a dividend if cash flow was strong but the company reported a net loss on a GAAP basis. The reason is simple: investors that prefer high dividend stocks look for stability. A company that lowers its dividend is probably going to experience a decline in stock price as jittery investors take their money elsewhere. Companies will not raise the dividend rate because of one successful year; so afraid are they of lowering the dividend they will wait the business is capable of generating the cash to maintain the higher dividend payment forever. Likewise, they will not lower the dividend if they think the company is facing a temporary problem.
Debt restrictions
Many companies are not able to pay dividends because bank loans, lines of credit or other debt financing places strict limitations on the payment of common stock dividends. This type of covenant restriction is disclosed in a company’s 10K filing with the SEC.
