Depending on who you ask, dividends have contributed anywhere from half to two thirds of the total sharemarket return over the past decade.
Clearly dividends have, and will continue to have, a very important role in the portfolio performance of most investors.
So what should you look for in a dividend share?
I believe there are at least four important features investors should look for:
- Strong operating cash flows that will enable the dividend to be paid from real cash profits
- A payout ratio of less than 100% as this ensures the company is retaining profits to grow the business
- A conservative balance sheet that can provide a buffer in case the company encounters short term challenges
- A consistent record of paying dividends, preferably with franking credits attached.
Unfortunately, some of the most popular dividend shares fail to meet all of these criteria. This doesn't necessarily mean they will be bad investments, but it does mean investors should demand a higher margin of safety either through a lower purchase price or higher dividend yield.
With that in mind, here are four dividend shares that I think investors should consider – but only at lower prices:
Sydney Airport Holdings Ltd (ASX: SYD)
Sydney Airport might be one of the best infrastructure assets in Australia but the shares could come under further selling pressure if overseas bond yields continue to rise. The shares currently offer an unfranked dividend yield of around 5.2% and I would like to see this closer to 6% before being a buyer. The potential development of the Western Sydney Airport is also another issue investors should consider.
Transurban Group (ASX: TCL)
Transurban enjoys strong cashflows but it is largely in the same boat as Sydney Airport when it comes to rising bond yields. In light of this, and the fact that the dividend is unfranked, I would prefer to buy the shares closer to $9 per share and a yield around 5.8%. Investors should also consider the huge debt pile currently sitting on the toll road operator's balance sheet.
Telstra Corporation Ltd (ASX: TLS)
Telstra is possibly the most well-known dividend share on the ASX, but I think investors need to factor in the company's medium-term prospects considering the telco has already identified a pretty large earnings hole as a result of the NBN roll-out. Although short-term dividend payments are unlikely to be in jeopardy, it is still unclear how the company will replace its lost earnings in a bid to maintain its generous dividend payment. As a result, I think investors should demand a pretty large margin of safety and perhaps wait until the earnings outlook becomes clearer.
Commonwealth Bank of Australia (ASX: CBA)
Commonwealth Bank is undoubtedly the highest quality bank in Australia but it will not be immune to some of the challenges currently facing the entire banking sector. Not only have credit growth and net interest margins contracted in recent years, but the banks are also facing the prospect of tighter capital requirements that are likely to put a cap on any significant dividend growth. In light of this and the good run the shares have enjoyed recently, I will wait on the sidelines until the shares pull back and offer a dividend yield of at least 6%.
