Qualities of a Good Dividend Stock

Companies use dividends to share extra cash with their investors, so it makes sense that companies who are more flush with cash or lacking short-term debt obligations, would be more likely to deliver a rewarding dividend. Investors track the ratio between the company’s liquid assets and redeemable securities using a measure reported as current ratio. Companies with a current ratio above 1.5 are most likely to spread their wealth with investors, according to Kelley Wright, the author of "Dividends Still Don't Lie: The Truth About Investing in Blue Chip Stocks and Winning in the Stock Market."

An ocean of liquid assets in a company’s holdings doesn’t necessarily mean it has plans to funnel that cash back to investors. Many companies choose to reinvest capital to promote growth or pay down long-term debt. A company’s payout ratio, or P/R as it’s reported on stock quotes, represents the percentage of its earnings that it funnels to dividends. Don’t be lured by high ratios alone, because a P/R of more than 50 percent from a company may be too high, cautions Ben Levisohn of Smart Money magazine. Companies with generally stable earnings, such as utilities and health care, may post higher P/Rs without indicating risk.

Any company can post an occasional dividend, and many make steady payments to their investors on a regular basis. The best bets for future dividends lie in companies with a history of dividends that continually increase with each quarter. These companies aren’t only maintaining their profitability but improving it and passing those increases on to shareholders. Companies that display a history of dividend growth for five or more years are the most solid dividend-stock purchases, according to Money Morning’s Don Miller.

Don’t confuse dividend stocks with bonds. Companies that issue bonds typically pay investors a relatively low rate on their return. Because companies are legally required to pay bondholders as scheduled, they’re considered a low-risk investment. Companies aren’t required to pay dividends to shareholders. Historical dividends and current earnings may be strong indicators of a good dividend stock purchase, but they’re no guarantee that the company will continue to pay dividends. Downturns in the economy or a shift in priorities to reinvest earnings can lead once-profitable companies to cancel dividend payments.