Tips for dividend investing

These are trying times for investors who rely on dividends from share portfolios for income.

Yet income investing can be an attractive strategy.

"In volatile markets the most guaranteed part of your total return is not capital gains - it is dividend income,'' says the director of research at Bell Potter Securities, Peter Quinton. ''So we are seeing [it] become a lot more important than is normally the case.''

The editor of Sound Money, Sound Investments, Greg Canavan, says in this environment ''income investing should become more popular because the market is not rewarding companies that are reinvesting for growth''.

While sustainability of dividends is important, it is not always easy to ascertain. ''You have to do a little homework into each company,'' says the research manager at F.W. Holst, David Spry.

''You have to look at the relevant industry and consider how cyclical is that industry. Because during good times, yes, a company might pay a very good dividend. But during bad times it might drastically cut it.''

Check a company isn't offering a high dividend yield because the market has downgraded the shares, suggesting profits - and the dividend - are about to take a hit.

Classic dividend-investing theory teaches the importance of buying shares in companies that are growing and boosting their dividend yearly. Quinton advises investors to seek stocks paying above-average yields and aim for companies unlikely to report a profit decline over the next two years.

He stresses the need to check that the company offers adequate dividend cover - a ratio that tells how much after-tax profit is being used to finance dividends: a ratio of two times means half the profit is being paid in dividends.

"I look for a dividend cover of at least 1.25 times,'' he says. ''This means net profit can fall by 25 per cent and you still have a chance you will actually get your dividend income. If profits do not decline then that is about as good a 'guarantee' … that you're actually going to get the income you're expecting.''

Most companies will report their financial results for the year to June next month and it's likely those planning to cut their dividend will flag it.

"From an investor relations point of view, it's not a good look if a company is coming out at a results presentation saying, 'Oh, by the way, we're cutting our dividend' … but right now we are in interesting times so it's possible it could happen in the upcoming results season,'' Canavan says. When a company cuts unexpectedly there is little an investor can do, as the share price response will probably be immediate. So which stocks look attractive?

- © Fairfax NZ News