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What I look for in a good dividend share

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Investments styles and requirements are as varied as individual investors themselves. One person’s perfect stock is another’s worst. However, in both growth and income investing, there are general principles always worth considering. Here are some things I look for in a good dividend share.

Try to reduce risk

If investing with income as the main goal, risk to the initial capital should be at the forefront of one’s mind. A good dividend share is one that maintains, or preferably increases, the capital invested.

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From a practical standpoint, this usually means looking at large, well established firms. Companies with a strong brand and a long history, like those in the FTSE 100, are generally seen as having a lower risk profile.

Of course this alone is not enough. It is always worth looking at a company’s finances. I look for a steady history of increasing revenue and profit. Depending on the sector, lower levels of debt are usually a positive as well.

Not only does this help mitigate the risk to the invested capital, but should help establish a firm’s ability to pay dividends now and in the future. If a company has poor finances, should it really be handing out cash to investors?

Dividend paying history

Past performance in no way guarantees performance in the future. Nevertheless, I think a company that has historically paid steady dividends is usually a better choice that one with a spotty record of dividend payments. Consistent payouts, over say the last five years, can indicate a firm’s commitment to its shareholders.

Coupled with this, I think it is always worth looking for dividend growth. A company that has seen its revenue and profits increase year on year, should be able to increase its dividends each year as well, in my view. At the very least a good income share should see dividend growth above inflation.

A good dividend yield

Yield is considered by many to be the most important aspect of a good dividend share. I think has to be considered in context. For anyone who is unsure, a company pays out dividends on a pence-per-share basis. This means that the percentage return on an investment – the dividend yield – is based on the share price at that time.

This can be both good and bad. Classically investors will try to buy a share when its price is low for good growth prospects. From an income perspective, investors are also able to ‘lock in’ a good dividend yield if a share price is low.

Of course the reason the share price is low is critical. If a company is fundamentally suffering, the low share price may be too risky. However, there are often many reasons why a company’s share price will be lower than its fundamentals warrant. Fear and greed are key drivers behind share prices, and neither of these emotions is dependent on hard facts.

As I began by saying, the true measure of a good dividend share is one that suits the investor’s needs. However when investing for income, I think these general guidelines are a very good place to start.

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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