Education

find a good income stock

How to find a top ASX dividend stock


In this article, Lincoln Indicators discusses:

  • Why generating an income stream is often important for DIY investors, especially retirees and those with self-managed super funds (SMSFs).
  • How the hunt for investment yield has turned many away from cash and bonds to the Australian Securities Exchange (ASX).
  • The window of opportunity in the current low-interest rate environment, and the high-yield free kick on offer to all investors.
  • Why fundamental analysis is paramount in finding quality income stocks.

For investors needing a reliable income stream, a portfolio of top ASX dividend stocks makes perfect sense.

For Australia’s growing number of retirees, and those nearing retirement, creating a reliable income stream that can last for many years, if not indefinitely, is imperative. As well as being able to meet one’s living expenses and keep ahead of inflation, a good income stream translates to a better quality of life.

For those with a self managed super fund, or any DIY investor really, the Australian share market is a perfect place to achieve that goal.

That’s certainly come into sharper focus in recent years, especially following the Global Financial Crisis, because the dismal interest rate returns on offer from bank accounts and fixed interest products such as investment bonds have been no match for the strong dividend returns from stocks listed on the Australian Securities Exchange (ASX).

As such investors relying on yield have tended to focus on the share market, particularly companies paying high, fully franked dividend yields such as the big banks – ANZ Bank, Commonwealth Bank, National Australia Bank and Westpac – Telstra, and others paying out high income returns. And the hunt for yield has had an added benefit. Because of the strong investor demand for certain income stocks, those holding them have enjoyed good capital gains in the process. The best income stocks have, in effect, become strong quasi growth stocks as well.

But, while high yield returns and growth are always great, the artificial hunt for yield created by low official interest rates won’t last forever. Some stocks may not be able to stay the dividend distance and become what are known as ‘dividend traps’, and as the saying goes, if a dividend yield sounds too good to be true it probably is.

What to look for?

So what companies should you be looking for? How do you as a dividend maximiser investor know whether you are buying into a quality stock or multiple stocks that will be able to maintain a reliable income stream for you over the longer term?

The answer, as always, is about doing fundamental analysis, assessing key financial ratios, to identify the best investments – that is, the best shares to buy.

The three Golden Rules for income stock selection:

At Lincoln Indicators, we define a quality income stock using three very important rules:

Golden Rule #1 – Financial Health: is the company exposed to manageable levels of financial risk? Strong and Satisfactory Financial Health is a must!

Golden Rule #2 – Management assessment: Is there a consistent history of paying dividends per share (DPS) and increasing them? Has this been supported by stable earnings per share (EPS)? If so one can safely conclude the stock is reliable from an income perspective.

Golden Rule #3 – Outlook and forecasts: Will expected stable earnings result in the future dividend continuing to be higher than the market’s yield moving forward?

Outstanding returns for Income focused investors

In Stock Doctor we regard Star Income Stocks as the best place to start in order to achieve a rock solid income portfolio. A Star Income Stock is a financially healthy company that currently pays an annual grossed-up (including franking credits) dividend yield above the market average grossed-up dividend yield and that has been analysed by Lincoln’s in house research team to ensure the likelihood of dividend payments continuing into the future due to its stable earnings (EPS) and consistent dividend distribution policy (DPS).

The performance of Star Income Stocks has been very pleasing for investors since their inclusion in August 2012 proving that healthy quality businesses are best positioned to meet the needs of income seeking investors.

Can they continue to deliver?

As an ASX investor, it’s worth remembering that buying into a company should not be about picking the highest short-term yield. As yield is a function of price, often the historic yield cannot accurately reflect dividend expectations moving forward. Particularly if there have been big swings in share price to the down and upside.

To understand whether an above market yield is sustainable into the future, studying the company’s longer-term form is essential, in particular their ability to generate stable earnings to support the current dividend policy. This is what Stock Doctor does within our list of Star Income Stocks. The end objective is to ascertain whether a company is likely to be able to sustain a strong yield over time.

We will inform our members of any future risk to earnings which may impact dividends by removing it as a Star Income Stock, ensuring that investors are not disappointed with a smaller pay check from their SMSF, and often accompanied by capital decline.

A membership to Stock Doctor will give you:

  • The ability to find the healthiest businesses currently paying dividends.
  • Access to our Star Income Stocks, which including dividends have consistently outperformed the market.
  • Dividend yields quoted on both a pre- and post-franking basis.
  • Detailed historic and forecast dividend information on all stocks on the ASX.
  • Or should you want your funds professionally managed with a specific focus on generating an above-market yield with reduced market volatility and the potential for capital growth over the long term, then consider the Lincoln Australian Income Fund.

 

Financial Health Model White Paper

Portfolio Health Check Tool

^Disclosure – Star Stock Past performance:

 

Disclosure – Star Income Stock Past performance: Star Income Stock Past performance: Star Income Stock past performance is calculated by Lincoln by applying the same performance calculation process as the Star Growth Stocks described above with the following exception.

Dividend distributions are incorporated in the calculations. These are reinvested in the specific investments which generate the distribution on the appropriate ex entitlement dates.