When it comes to choosing a dividend stock, many of us are tempted to look solely at items like dividend yield or dividend growth. A stock with a high yield, or a recent history of big hikes, might seem especially tempting. However, we shouldn’t always just look at how a company is doing now in terms of dividend yield, or the past trends associated with dividend growth. It is also important to consider the fundamentals, including the state of a company’s cash flow and cash reserves. A snapshot of the company’s financials in the last couple of years can be quite telling.
Why Cash Matters to a Company
As you consider different options for your dividend portfolio, it is important to look at what different aspects of a company’s finances say about the company as a whole. Cash can tell you a few things about the strength of a company:
- Cash reserves usually mean that the company spends less than it earns.
- How the company spends money can indicate what is important to it. If a lot of money flows to people at the top, or if more of it goes to reinvesting in the company’s developing, can say a lot about the future success of a company.
- A cash rich company can usually keep paying a dividend – and is less likely to cut payouts when the economy (and the market) is in a downcycle.
Taking a look at the cash habits of a company can provide a good indication of how long it can keep payouts at the same level. If you see cash reserves dropping, it might be a sign that dividends are about to be cut. When there isn’t any cash to spread around to shareholders, it soon becomes evident that dividends will have to cut, and you could find yourself in trouble.
For some, cash isn’t important. If you have short-term goals for your dividend portfolio, it doesn’t matter as much if the company is likely to cut dividend payouts. With a large chunk of capital, you can do well for a year or two with a high yield dividend stocks. Then, you can sell the stock before the price drops and the dividend is cut.
Others, though, find it a better idea to invest in cash rich companies that pay dividends. Companies with sound financial practices and plenty of cash are more likely to provide stable income for you. If you have long-term income requirements for your dividend portfolio, the company’s financials should be carefully considered before m