Okay, seriously. If you ACTUALLY clicked this headline – this is for you.
Stop chasing penny stocks.
Stop chasing unsustainable high yields.
If you think you will find your next great stock on a blog, facebook group, reddit thread or from a friends “hot tip” – you probably shouldn’t be buying individual stocks. I cannot count the number of people I’ve had message me over the last couple of weeks asking about penny stocks, oil stocks, etc. People who have never invested a penny in their lifetime, messaging me telling me they are going to easily double their money in the next few months….
Are there some penny stocks that will double this year? Of course. Do I (or anybody else) know which ones? Of course not. If we did, we’d be billionaires. The amount of people searching for “good penny stocks” or “best monthly paying stocks” or “dividend stocks yielding over 10%” is astounding…and it’s dangerous.
We’ve all been there, starting out trying to figure out what stocks to buy, how to make a quick buck. Almost every experienced investor will tell you they got got burned early on, either chasing yield, listening to a hot tip or speculating/gambling.
Almost everyone agrees getting a dividend payment from their stock is great. It feels good, you can reinvest that money or use the cash – so why wouldn’t you want to find stocks that pay out the biggest dividends? The answer is simple:
Sustainability & Future Dividend Growth
Owning shares in a company that pay a dividend feels great. You know what feels even better though? Having confidence that the dividend will not only be around for years to come, but that it will continue to increase. What good is a 10% dividend yield if it gets cut next month – or if the stock price declines 15%?
Here are some metrics that can help give you confidence in the sustainability of a dividend:
Payout Ratio: This one is pretty straightforward. What percent of earnings is the company paying out to its shareholders as dividends. For an extremely simplistic example, assume company ABC makes $100 this year, and pays an annual dividend of $50. The company would have a payout ratio of 50%. Look for companies that have a conservative payout ratio. Payout ratios will vary between industries, but typically you want to find a company that is paying out less than 40-50% of annual earnings. The big exception here would be REITS – but that is a discussion for another day.
Earnings History & Projections
Another important metric to focus on is earnings per share. Are earnings increasing? A super conservative payout ratio is great, but if earnings are falling each year, that payout ratio, by default will start to increase. If a company is not able to increase its earnings, eventually the dividend is going to get cut. Look for companies that have a history of growing their earnings per share, in good times and bad.
Strong Balance Sheet
Always look at the financial statements for a company before pressing the “buy” button. A lot of metrics could look great, but if a company is over leveraged, it means they could be at risk in the future. Always ensure a company has no problem meeting its debt obligations. If they can’t this means they may need to raise equity (issue more shares/dilute your stake in the company), cut back on costs (cut dividends), or worst case face a possible bankruptcy.
Dividend Growth History
Lastly, look for companies that have a history of increasing their dividend each year. This typically shows they have confidence in the business, and they like to reward shareholders. It is important to do your own research, and just because a company has increased their dividend for 10+ years in a row, doesn’t mean it can’t or won’t get cut in the future. That said, if a company has strong and growing earnings, increasing revenue, a strong balance sheet and a history of paying a growing dividend, you are probably on the right track.
Finally, since you may have been lured here with the click baity headline, and the hopes of finding 3 great stocks to buy, out of pure guilt I will post 3 Canadian stocks below I believe meet the following criteria:
3 Canadian stocks to consider:
As always, do your own due diligence. Happy Hunting.