By Robert Ross
You better watch out. Buying iconic “tried-and-true” stocks might give you a false sense of security.
Take a look at Kraft Heinz.
The iconic brand lost 30% of its value in one day:
That’s despite having one of the world’s most recognizable brands, a seemingly stable business, and the backing of Warren Buffett.
Kraft Heinz had many issues, but the main reason the stock tanked was a dividend cut.
Take a look at what happened to General Electric (GE) when it surprised investors by slashing its dividend 50% in November 2017:
GE shares plunged over 10%.
One year and a second dividend cut later, shares have tanked 57%.
Bigger Is Not Always Better
Many well-established companies don’t grow fast enough to compensate investors for the risk of owning the company’s stock. So they pay dividends as a “bonus” to lure investors in.
In fact, most investors buy these companies just for the dividends. For this reason, the companies go to great lengths to pay them.
Some of these companies even borrow money and use the debt to pay a higher dividend.
That’s exactly what Kraft Heinz was doing. And this strategy often ends up being a disaster for investors.
Lucky for you, I developed a tool that helps gauge the safety of a company’s dividend.
I call it the Dividend Sustainability Index (DSI).
How to Select the Right Dividend Stocks
You must look at three key things when evaluating dividends.
The most important is the payout ratio.
The payout ratio is the percentage of net income a firm pays to its shareholders as dividends. The lower the payout ratio, the safer the dividend payment.
The second is the debt-to-equity ratio.
The more debt a company has, the harder it gets to run a business. This includes—you guessed it—paying the dividend.
The third is free cash flow. This is the amount of cash left over after a company pays its expenses.
If any of these measures is flashing red, you know the dividend is in trouble.
A low DSI score tells me the odds are high that a company will cut its dividend. And you already know what that means…
But you don’t have to worry about it anymore. The Dividend Sustainability Index (DSI) will keep you out of stocks like Kraft Heinz and GE.