10 Crucial Questions to Always Ask Before You Buy a ...

A Dividend Investor Canada Special Report

Yield Signs: 10 Crucial Questions to Always Ask Before You Buy

a Dividend Stock

By Bryan White, Lead Adviser, Dividend Investor Canada

Yield Signs: 10 Crucial Questions to Always Ask Before You Buy a Dividend Stock

"Dividends may not be the only path for an individual investor's success,

but if there's a better one, I have yet to find it."

That quote came from Josh Peters, author of The Ultimate Dividend Playbook, which is a great read for investors wanting to learn more about dividends.

It's pretty hard to disagree with him.

to this low interest rate environment and what impact that has on dividends...

Low interest rates are typically bad news for retirees and savers.

While some investors shrug dividends off as simply being `the icing on the cake' offered by a business, they are so much more than that.

In fact, according to research from Tetrem Capital Management, dividends made up approximately half of the market's total returns from 2000 to 2013 .

They've been more prominent if you look even further back. According to research from RBC Capital Markets, dividend payers have far outpaced the returns of companies that do NOT pay a dividend. From December 1986 to June 2015, dividend paying stocks in The S&P/TSX Composite have delivered a compound annual total return of 9.7% vs -0.5% for non-dividend payers!

So it's fitting that Canadian investors have come to love their dividends...

Why? Because the interest generated from cash in the bank falls as interest rates decline. When you take inflation and taxes into account as well, the returns are virtually non-existent meaning that retirees are forced to dip into their savings more regularly.

Of course, many would argue that the banks should be forced to offer retirees a minimum return, but that's certainly not likely to happen anytime soon...

So what do these retirees do instead?

Many venture into the stock market, hoping to find superior returns in the form of dividends.

While interest rates have headed higher since the elections in the U.S., the 10-year Treasury in Canada still yields well below 2%.

Why dividends matter

To begin with, dividends provide a way for individuals who are approaching retirement to help secure their financial future.

They create a regular stream of income that many retirees rely on to live off, helping them to buy food and pay their utility bills ? especially during this low interest rate environment.

More on that in a moment.

But first, let's not forget the tax benefits...

The Federal Dividend Tax Credit in Canada allows investors that receive dividends from Canadian-based companies to claim a tax credit for the taxes already paid by the corporation.

Basically, this system, known as the `gross up and tax credit system', prevents double taxation of company profits.

It allows you, the investor, to earn income in the most tax efficient way possible. In fact, eligible dividends from companies based in Canada are taxed at a far lower rate than interest and normal income.

Before we move on any further, let's get back

How to find the best dividend shares in Canada

Unfortunately, not every dividend-paying stock is created equal.

In other words, you can't simply throw darts at a list of dividend stocks and hope the one it hits will yield decent returns in the long-run.

Just look at Bombardier (TSX: BBD.B).

Bombardier shares were offering a dividend yield north of 3% at one point, but the business was forced to suspend its payout entirely in February 2015. That's certainly not what dividend investors wanted to see...

In order to avoid such travesties, we've compiled a list of 10 simple items to check before buying any dividend shares.

Read on to find out more...

1. Does the company have the characteristics of a dividend-paying business?

Companies in the high-growth phase will typically retain more cash to fund their expansion. By

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comparison, companies approaching (or in) the maturity phase tend to pay greater dividends.

Notably, companies in their maturity have done most of their growing and, although they still need to raise profits to appease shareholders, it will be at a much slower rate. As such they have a tendency to reward investors instead with greater dividends.

2. Does the company have a good track record of paying dividends?

Companies that have consistently grown their dividends, over time, are typically considered among the most reliable and should certainly be given a closer look by investors. For instance, The Bank of Nova Scotia (TSX: BNS) has been paying a dividend since 1833, and has increased its dividend every year since at least 1996 ? a trend which should continue for the foreseeable future.

3. Are the dividends regular?

Some companies will typically pay a small dividend, and then occasionally pay a special dividend (maybe once every few years). Although special dividends can be nice, they can also be very misleading when screening for potential investments because they inflate the reported yield. In other words, they make it appear as though the company offers a high dividend yield, when really that only applied to one period.

4. Are they sustainable?

It's a good idea to look at the company's cash flow statement, and see where its cash is coming from. Ideally, the majority of the company's cash generation should come from its operations, as opposed to investing or financing activities.

It's also necessary to look at whether those operating cash flows are enough to cover the capital expenditures required to grow, or maintain, the business (for example, roads and buildings can cost a lot to build and require maintenance), as well as cover the dividend payments to shareholders. In an ideal situation, the company can cover all those expenses with some cash leftover at the end of the period.

5. Does the yield seem too good to be true?

If so, it probably is. Just as the proverb states measure twice and cut once. If a widely followed stock is offering an unusually high yield, say 10%. It's extremely unlikely that market participants believe the dividend is sustainable. If they did, they'd likely be aggressive buyers, bidding the stock price up and the dividend yield down to a more normal level.

6. Is the company cyclical?

Companies operating in cyclical industries often experience a decrease in earnings during economic downturns and thus, may find it difficult to maintain their dividends when times get tough. We saw this play out in the energy sector during the downturn in oil prices as ARC Resources (TSX: ARX), one of Canada's largest conventional oil and gas companies, was forced to reduce its dividend by 50%. ARC wasn't the only casualty, Cenovus Energy (TSX: CVE), one of Canada's largest integrated oil and gas companies, was forced to cut its dividend by nearly 70 %.

7. Does the company have a good cash balance?

If times do get tough, companies with a lot of cash on their balance sheet will typically maintain their dividends for longer than a company with little in the bank.

8. Does the company carry a lot of debt?

Highly leveraged businesses can be risky investments at the best of times, and especially for dividend investors. This is because debt repayments take priority over dividends: there is a legal obligation to repay debt but no such obligation to pay a dividend.

9. Is the company based in Canada?

Remember the Federal Dividend Tax Credit only applies for dividend income received from Canadian companies. If you own U.S. dividend paying stocks it may be a good idea to keep them in your registered retirement savings plan (RRSP) if possible. If not, dividend income received from U.S. companies will be taxed at your marginal rate .

10. Finally, does the stock represent good value?

One facet that some dividend investors forget (or blatantly ignore) is to check whether the shares themselves represent decent value. Regardless of whether a company offers a high dividend yield, it's important to not pay too much for their shares. After all, if the company is overpriced, any dividends received could be more than offset by the capital losses as the shares fall to a more reasonable level.

These items are a great starting point for investors to work from when looking for quality dividend-paying businesses.

Now that the hard part is done, you can sit back and watch those dividends role in. Or as John D. Rockefeller ? one of the richest men in history ? once said, "Do you know the only thing that gives me pleasure? It's to see my dividends come in."

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How to take the next step with Dividend Investor Canada...

We hope you enjoyed our "Yield Signs" report, and we'd ask that you please keep these 10 questions in mind anytime you're considering buying a dividend paying stock or trying to decide which account to hold it in.

We'd also ask that you be on the lookout for the full details on our Dividend Investor Canada team's final candidate for Top Dividend Stock for 2017, which will be unveiled on Tuesday, January 17...

As well your invitation to join us for a very special live and interactive pre-launch Q&A session that the team will be hosting Wednesday, January 18 at 1PM EST.

In the meantime, should you have any questions about our "Yield Signs" report, our Top Dividend Stock for 2017 candidates, our Dividend Investor Canada service, or even just dividend investing in general, please feel free to send them to dividends@fool.ca and a member of our team will get back to you as soon as possible.

We're thrilled that you've decided to follow along with all of the festivities leading up to the grand opening of Dividend Investor Canada on Thursday, January 19 -- and we sincerely hope you'll consider joining us as a Charter Member.

Thank you again for your time and interest, and as always, Fool on!

The information regarding tax treatment in this piece is informational only and not intended as tax advice. For information on your individual tax situation and how it could be affected by dividends, please consult your tax advisor.

Disclosure: All figures as of January 5, 2017. All dollar amounts are represented in Canadian Dollars, unless otherwise noted.

This report is: (a) for general information purposes only and not intended as investing advice; and (b) not to be used or construed as an offer to sell, a solicitation of an offer to buy, or an endorsement, recommendation, or sponsorship of any entity or security by The Motley Fool Canada, ULC, its employees and affiliates (collectively, "TMF"). This report represents the opinion of the individual author and does not attempt to give you professional financial advice or advice that relates to your personal circumstances.

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