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5 Key Metrics To Consider When Buying A Dividend Stock

Updated: Nov 19, 2021

Dividend Stocks are a handy tool to make some passive income, however as with any investment there is an element of risk involved.

If you don't already know what a Dividend Stock is, check out this article first where I explain the basics.

I invest in Dividend Stocks to earn a consistent and reliable passive income. If you're interested in doing that too, then you need to understand what to look out for in a Dividend Stock, and potential risks involved.

Here are 5 key metrics to consider before investing in a Dividend Stock.

Dividend Yield

As a recap a Dividend Yield is simply the percentage of the share price paid back to you every year. So if a share is worth £10 and the dividend yield is 10%, you will receive £1 per year in dividend income just for holding one share in that company.

It is important to know the dividend yield of a company's share so that you know what amount of income to expect to be paid to you.

Also, dividend yields can tell you a lot about a company. High dividend yields could be the sign of a struggling company trying to pull in some extra investor capital. If you do see a company offering a high yield (in other words, a lot more than the competitors in their industry) then I would be very wary about buying their shares.

I think 4-5% is a good benchmark for a dividend yield across multiple sectors. But as always do your own research first before hitting "Buy"!

Dividend Growth Rate

Dividend Growth Rate is essentially the increase of the dividend yield year on year. This can sometimes be a more important metric to consider than dividend yield. A high yield share that remains flat can be outperformed by a low yield share that increases over time due to the compound effect.

Examples of companies that have an excellent DGR are Apple & Microsoft, who have both increased their dividend yields by 10% over the last 5 years.

You can easily find the DGR of a share with a quick Google search.

A strong dividend growth rate over a number of years is extremely attractive to investors as it is a positive sign of the company's long term prospects. In addition to that, it will boost your dividend income.

Pay-out Ratio

Dividend Pay-out ratio is the relationship between the total dividends paid to shareholders and the net income of the company.

For example, if a company makes £1 Million and it pays out £500,000 in dividends, then the pay-out ratio is 50%.

There is no hard and fast rule for what a good pay-out ratio is. A tech company will have lower ratios due to needing higher levels of re-investment into research & development of new technologies. Whereas utility companies do not need to reinvest their profits so much and will therefore have higher ratios.

Anything over 50% is generally considered a red flag. If a company is paying out more profit than it keeps, it's a sign that the company is not investing in its future growth and could therefore be heading towards stagnation or decline.

Dividend Frequency

The frequency of dividend pay-outs is important to some, although out of all the metrics on this list it is the least important.

Dividends are paid quarterly by the vast majority of companies, however some pay annually, bi-annually or even monthly!

It is important to know the frequency of your pay-outs, as you'll find it easier to keep track of your dividend income if you know when it is coming!

Don't ever buy a share just because it pays out monthly, unless the other key metrics look promising of course!

Dividend Consistency

The best dividend stocks to own are the ones that pay out a consistent dividend year after year. Some companies have paid out an annual dividend for over 50 years in a row and are labelled as Dividend Kings. Shares that have paid out for 25 years or more are called Dividend Aristocrats.

These are the type of shares you should be looking into if you want to earn a steady passive income for many years. Of course there is no guarantee that they will keep paying out dividends, but Kings & Aristocrats are the safest dividend stocks to buy.

The bare minimum you should be looking at for dividend consistency is a decade, unless there have been exceptional circumstances (such as the Covid-19 pandemic). This will give you the confidence that you will be paid a dividend regularly for years to come.

Ready To Buy Your First Dividend Stock?

Open a Stocks & Shares ISA with Trading212 via my referral link and you could earn a free share up to £100! Who knows, maybe it could be your first dividend-paying stock ;)


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