The Motley Fool

How to Identify Dividend Champions

There are a lot of companies paying dividends yet some stand out for their ability to be a dividend champion. A “dividend champion” describes a company which is not only able to pay out sustainable dividends over the years, but also constantly increases them over the long-term.

Dividend champions are definitely a rare breed, as not many companies are able to consistently raise their dividends over the years. Investors should hold on tight to these stocks and even consider raising their stakes over time. Though there is no foolproof method to spot if a company is able to become a dividend champion, here are some recommended guidelines.

Constantly generates free cash flow

Some companies are veritable cash cows, generating copious amounts of free cash flow in excess of what the business requires. This usually occurs when the business has stabilised and is not looking to grow or expand quickly any longer, and the company also has a dominant market share. Investors would classify such companies as “yield plays” as growth is usually absent or very slow, and the company can continue spitting out good dividends.

To qualify to be a dividend champion, however, requires such companies to also have pricing power with steady market share. They are usually leaders in their industry or sell products which people are willing to continue paying more for.

Exists in a monopoly or duopoly

Companies that operate a monopoly or duopoly (i.e. only two main players) usually face some form of regulation from authorities. This is to prevent the company from exploiting its dominant position to price gouge consumers.

While regulations usually stifle fast growth, such companies end up generating excess cash flows as they are unable to properly deploy the money for capital expenditure. This allows them to pay an increasing dividend to shareholders.

Track record and history of raising dividends

Some companies grow quickly by expanding their market share and capturing opportunities to extend their abilities and product range into adjacent markets. Fast growth usually equates to lower dividends, as companies hoard more cash to build up the business. However, some companies which are able to grow and also pay out a better dividend, as a result of maintaining the dividend pay-out ratio at a fixed percentage. Thus, when profits rise, dividends also follow suit.

Another good indication of rising dividends are companies who have a long history and track record for doing so. Unless there is imminent disruption or threats to the business, investors can expect the trend to continue for the foreseeable future.

Be patient

There are many companies out there that qualify as dividend champions – investors need to look hard and also maintain a patient, long-term view. There may be occasional “blips” as the company cuts dividends in view of economic conditions, but watch out for the overall trend. Such dividend champions sit well in any investor’s portfolio as they provide a growing amount of cash even without you having to increase your stake.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.