There is a lot more interest in dividend shares than there used to be.
I don't think that's surprising, interest rates have gone so low that it's very hard to actually find anything other than shares that can offer a decent income these days.
But what types of things should you be looking for? Well, everyone's income requirements are different – some people start with looking for a big yield and go from there. Obviously a yield above 3% is important to be called a dividend share, but I don't necessarily want a big dividend yield, here are the things that I look at:
Is it in an industry where it can pay quite reliable dividends?
If a business is in a cyclical industry, or one that is constantly changing, then I'm not sure it should be considered for your dividend portfolio. If you rely on this income for living then you can't afford for it to disappear just when you need it.
For example, iron ore prices are not consistent, so why would the earnings or dividends be consistent? Fortescue Metals Group Limited (ASX: FMG) has an excellent dividend yield but it could just as easily go backwards.
However, businesses in healthcare, technology, investment, industrials and so on have a much higher chance of paying reliable and growing dividends compared to resource shares.
Dividend growth and earnings growth
Inflation is low but life continues to get more expensive. I want to see that a company is displaying (at least) inflation-beating dividend growth which will give me more purchasing power as time goes on.
Two of the best dividend shares for dividend growth are hospital business Ramsay Health Care Limited (ASX: RHC) and investment house Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), they have both grown their dividend every year since 2000.
But dividend growth has to be supported by earnings growth, otherwise it will become unsustainable eventually.
A healthy dividend payout ratio
Dividends and distributions are paid from profit. If a business has a dividend payout ratio of 100% it's paying out all of its profit and leaving nothing for re-investment back into the business.
I like shares to have a dividend payout ratio of less than 90%, or else it doesn't leave much wriggle room in a tough year or a recession. If a company makes $1 of profit per share and pays out $0.90 per share as a dividend, it can withstand a 10% profit decline and still have a (barely) sustainable dividend payout ratio.
A real estate investment trust (REIT) usually has a high payout ratio, but I think Rural Funds Group (ASX: RFF) has a good balance of distributions and re-investment with a payout ratio of around 80%.
I think one of the main reasons that Telstra Corporation Ltd (ASX: TLS) hasn't grown as much as it should have over the past two decades was because it was too focused on paying dividends rather than re-investing.
Obviously, having a decent balance sheet and cashflow is also important for healthy dividends.
Foolish takeaway
Soul Patts is definitely one of the best dividend shares on the ASX in my opinion. There are plenty of others with long-term growth records and good prospects like APA Group (ASX: APA) and ARB Corporation Limited (ASX: ARB).
