Growth investors use company revenue and earnings growth to select stocks for capital appreciation; income investors use dividends to select stocks for income portfolios. Using a combination of growth and dividends is a common practice for investors who seek stocks that grow at a reasonable rate and provide a rising stream of dividends.
Review a company’s quarterly earnings per share (EPS) by comparing the latest quarterly numbers to those of the same quarter in the previous year. For example, if a company reports 28 cents EPS in one quarter and it earned 22 cents in the same quarter in the previous year, its current EPS growth rate is 27 percent. Quarterly earnings reports are posted on company and financial websites such as Yahoo! Finance. Generally, the faster the growth, the faster a stock can rise and the higher it can go. Compare the current growth rate to the annual rate and the rate in the preceding two or three quarters. You want companies that show growth acceleration, in addition to a high growth rate. Companies can consistently increase earnings only by growing revenue, so it's important to check revenue growth rates as well.
Use current dividend yield (annual dividend divided by current stock price) to determine how much annual dividend income you should expect on your investment. Be careful when comparing dividend yield to returns on other investments such as bond interest: stock price fluctuations can substantially exceed dividend yield, so while you may stand to collect 5 percent in dividends, your stock can drop 20 percent.
Compare the dividend yield to that of other stocks in the group – for example, utilities – and to the historical yields of the stock you are considering. Since dividends can change quarterly while stock prices fluctuate daily; a higher yield indicates a lower stock price, and vice versa. Beware of an unusually high dividend: it may be at risk of being cut or eliminated, in which case the stock price may drop further and you may end up with a principal loss and no dividend income. Check dividend coverage (also called dividend payout ratio) to make sure that the company is earning enough money to continue to pay the dividend.
Consult companies’ and financial websites for historical data on dividends. Some stocks increase dividends over time. The dividend yield may be fairly low but the rate of increase may exceed the rate of inflation. Since companies can increase dividends consistently only if their earnings grow, buying stocks that increase dividends creates an asset that produces a rising income stream and appreciates in value.
Use Online Stock Screeners
Many brokers and financial websites provide online stock screeners that allow you to input your search parameters such as EPS and revenue growth or dividend yield. There are no absolute numbers, and no stock is perfect. Tweak your input parameters to see where the best candidates are.
- How to Make Money in Stocks; William O’Neil
- One Up on Wall Street, Peter Lynch
Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.