Most investors who choose to include dividend stocks in their portfolios may not think of them as being reliable providers of a regular income stream. There are several reasons why this may be so — experiencing a major cut in dividends due to business decline, fluctuations in dividend payouts due to cyclical factors, or a reduction in absolute dividend levels due to aggressive business expansion.
Whatever the reasons might be, investors can become scarred and get the mistaken impression that dividends are an inherently unstable form of return. In my own portfolio, I have experienced reduced dividends, but this does not imply that we, as investors, are unable to build a portfolio with resilient income. Here are several factors we need to consider if we choose to do so.
Type of business
When investors embark on an effort to build up a dividend stream, they have to be aware of the types of industries where dividends are more likely to be paid. Such industries have more stable and predictable economics and are not subject to constant competition or disruption. Of course, given the current state of the world, I can safely say that probably no business is completely immune to disruptive forces, but some industries are tougher to displace than others.
Investors should choose industries with a proven history of paying consistent dividends, such as utilities and real estate investment trusts.
Stage of the business
In order to determine if the dividend stream is sustainable, check which stage the business is in. There are two ways to do this — one is to observe which part of the product life cycle (PLC) the company’s products are in, and the other is to assess the company using the BCG-Matrix.
If the company’s products are considered mature with respect to the PLC, then it’s likely the company will be generating copious amounts of free cash flow in excess of its business requirements. This implies it should then be able to pay steady, sustainable dividends.
As for the BCG-Matrix, if a company is categorised as a “cash cow,” this means it’s generating a lot of excess cash that cannot be reinvested into the business for higher growth. In effect, the company has shifted from being a growth company to more of a yield company, and investors can rely on such companies for good dividends.
Resilience during tough times
By building a portfolio of these types of companies, investors can then build a resilient income stream and not be afraid of sharp cuts in dividends even during bad times. Of course, as diligent investors, we should continue to analyse the company’s dividend history and observe its business prospects as part of a holistic analysis. But it is definitely possible to build a strong and predictable dividend flow if you’re careful in selecting companies for your portfolio.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.