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Now’s probably not the time to be betting your house on the stockmarket but that doesn’t mean that you must exit altogether. Regardless of the political wrangling in Europe, China and the US, companies will continue to sell things, employ people and grow. In fact even the die-hard pessimists agree that the weight of money will probably head to defensive investments over the coming year – and defensive stocks will most likely return to favour.

Gary Shilling, author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth,” says that investing in a slow-growth environment means that defensive, capital preservation takes precedence over risk taking. He believes that stock investors will pile into the biggest, strongest and richest corporate companies – while other areas of the market become increasingly vulnerable to price falls; he cites emerging markets, commodities and residential property as big risk areas, or bubbles, that will, like all bubbles in the history of time, eventually pop.

Companies paying above-average dividends that operate in defensive sectors such as consumer staples, utilities and healthcare are less risky and more sensible investment propositions in today’s climate than housing-related shares, stocks in the consumer discretionary sector and banks, according to Shilling.

So how do you pick a successful dividend stock?

Companies pay out dividends to shareholders as a reward for buying shares. Companies rarely pay out 100% of profits as dividends because companies need to retain some earnings to finance growth and acquisitions. Nonetheless, investors like companies to pay out some profits as dividends, and for dividends to gradually increase over time. It gives investors peace of mind that company profits are secure and growing. Even in bad times as profits shrink, a stock that pays out dividends to shareholders may retain shareholders’ vote of confidence, supporting its share price.

Conversely, when a stock cuts its dividends – or skips paying it altogether – investors ditch the stock for fear that the company’s growth rate is slowing.

Dividend Yield

Your dividend yield is the coming year’s expected dividends divided by the price you paid for the shares. The yield would be 5% if you paid $5 per share for a stock that’s forecast to pay dividends totaling $1 over the coming 12 months. When comparing stocks a higher dividend yield is generally more attractive, however be careful about targeting high dividend yield stocks that are only that way because their share price has tanked (remembering that share price is the denominator of the equation here).

Rising EPS

The trick is to spot companies that can afford to pay out a rising dividend, and one such metric is companies with increasing earnings per share (EPS). Understandably in this climate it’s a tougher gig to boost EPS by either organic growth or acquisitions, but companies with well-known brand names, large moats and competent management can achieve it.

Stock Buybacks

Successful companies that generate excess cash flow can afford to buy back some of their stock, reducing the number of shares outstanding. This is good thing for investors when it happens because it makes each share more valuable and means that shareholders effectively own a larger percentage of the company. Stock buybacks also improve EPS.

Dividend Payout Ratio

Dividend payout refers to the amount of money retained in a company for reinvestment purposes compared to the amount distributed to shareholders as dividends or share buybacks. Companies need to retain some money to grow, but they also need to reward shareholders for their support via dividends. A company that pays out too much in dividends one year may face cash flow problems the next – forcing it to take on debt or sell more stock to fill in the hole. Companies that pay too little in dividends may be too focused on growth – leading to useless spending and random acquisitions.

Successful companies tend to exhibit a steady dividend payout ratio over time – as they recognise the amount of money needed to grow the company, balanced with what needs to be put aside for shareholders.

High Return on Equity (ROE)

Stock pickers should always investigate a stock’s return on equity, or ROE, which measures how much profit the company generates with the money shareholders have piled into it. ROE is typically the favoured profitability gauge for stock pickers.

A high ROE indicates that the company is making smart decisions and using shareholders’ money wisely; a declining ROE could suggest that management is taking on unprofitable projects.

Typically high growth stocks will have a higher ROE than more mature dividend paying stocks, however when comparing stocks, a higher ROE indicates a more profitable company.

Large is Better than Small

In this climate, larger companies are generally better placed than smaller ones, however be on the lookout for large companies that are rapidly paring back, slashing staff and selling off businesses. The best measure of company size is market capitalisation.

Price Action  

Take a look at the stock’s recent share price chart, and if its shares have been on a downward trend lately, consider why. Compare the current share price to its moving average, which is the average closing price over 200 days, for example. Stocks that are trading above their 200-day simple moving average are generally regarded as being in an uptrend.

As a brief exercise, we scanned the market for companies with a market capitalisation over $500 million, with a return on equity greater than 10%, a 2 year EPS average annual growth forecast of 10%, and a dividend yield of over 4%. We arrived at the following list of 10 companies (based purely on these fundamentals).

Please note that this is not a recommendation to buy these stocks, just an exercise in how you can put together a watchlist of high dividend paying stocks.

 Company1 year ReturnDividend Yield P/EDebt to Equity Ratio2 Years EPS average annual forecast GrowthReturn on Equity (ROE)
 JB Hi Fi (JBH) -23% 5.4% 11.83 153% 10.5%49%
 Wotif.com (WTF) -20% 5.9% 15.53 0.1% 10.5% 58%
 Carsales.com (CRZ) -3% 4.2% 19.85 0% 14.6% 59%
 Monadelphou Group (MND) 14% 5.2% 17.18 22% 11.8% 56%
 McMillan Shakespear (MMS) 25% 4.6%13.9 113%11% 43%
 Navitas (NVT) 5% 5.3% 18.78 58% 14.8% 45%
 Warehous Group (WHS) -17% 7.4%12.77 55% 11.3%27%
 Mineral Resources (MIN) 8% 4.2% 12.01 16.8% 35.2% 27%
 Coal & Allied (CNA) 11% 5.0% 14.980.9%54.8% 26%
 Brambles (BXB) 7% 4.08% 18.14 128% 24.3% 23%
 Henderson Group (HGG) -12% 5.7% 10.37 50.5% 28.4% 17%

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The publication of this article does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.