Six steps to income safety

1) Check the ex-dividend dates

Nothing is more irritating than rushing into a highyielding share to find out that the hefty payment you were after was made several weeks ago, that the ex-dividend (xd) marker has dropped off the screens, and that you have six months to wait for the much smaller interim dividend. Although in theory stocks trading ex-dividend are cheaper by the amount of the dividend lost, that effect can quickly disappear. After all, there are plenty of investors out there who prefer their gains in the form of capital rather than income for tax reasons, and will happily pile in on an ex-dividend stock.

Where to look: The IC has a , and the investor relations section of a company's website will usually have a dividend timetable. Non-web users can check the London share service pages in the Financial Times each Monday, which gives the latest xd date. It is not comprehensive, though, as not every company is willing to pay for its quote to be included.

2) Remember that yesterday's dividend is not tomorrow's payment

Whether you look for high yields the old fashioned way, by combing through the Financial Times or CompanyREFS, or the modern way of employing stock screeners like the IC's or using data-mining software such as Sharescope, you are usually faced with historic dividend data. That means the dividend paid in the last financial period will be the one you see in black and white. Look at BP. Despite the gigantic public coverage of its dividend cuts for the rest of the year as demanded by US lawmakers, most tables and stock screeners are still showing a double-digit yield against its price. They will continue to do so until the figures are superseded in the computers that compile them. Everybody knows about the BP situation, but for smaller companies that are less well-covered, the risk of overlooking a cut or passed dividend is a real one.

Where to look: Check RNS for a company's latest results and management or trading statements for news about the dividend. Some websites and data packages will give you forecast dividend levels, although these are generally compiled from brokers' research and may not be up-to-date, especially for smaller companies.

3) Check dividend cover

Companies naturally don't like to cut dividends, but this may be unavoidable when there really isn't enough profit from which to pay it. The first stage in checking this is to find out what the company's dividend cover is; this is simply the number of times that a dividend could be paid out of available net profits. As a general rule, dividend cover of two or better is pretty safe. Cover of 1.5 or below really should engender some careful checking, while a coverage ratio below one indicates that a company is borrowing to pay its dividend. That may be sustainable for a year, but obviously not for the long term.

Where to look: Very few free websites provide dividend cover information, nor do most stock screeners screen for it, but you can find dividend cover listed for each share in the Monday edition of the FT. It isn't hard to calculate for individual companies, you simply divide cash earnings per share by the dividend.

4) Look at the dividend record

Dividend records not only tell you a lot about the income you might receive, but the nature of the challenges that a company has undergone. Even within an industry, huge differences in the dividend record can be apparent. Vodafone, for example, has since 1999 increased its dividend payout more than sixfold from 1.27p to 8.30p, with an increase every year. Yet fellow telecoms company Cable & Wireless has gone from 13.5p in 1999 to nothing in 2003, 3.15p in 2004 and 8.5p last year. While you cannot guarantee that a steady payer is always going to keep increasing its payout, a company's dividend record provides clear evidence of when a firm is in sufficient control of its destiny to give income seekers the stability they need. Moreover, a company that manages a track record of progressive dividends, or even a long period of unchanged dividends, is likely to fight that much harder to keep the payout. A company such as engineering group Halma, for example, has managed to increase its dividend every single year since 1972 – a record that few companies can match. In the investment trust space, some companies have multi-decade records of dividend increases.

Where to look: Most FTSE 100 company have a dividend record table on their investor relations websites. Their annual reports (available from the IC website) often contain a ten-year financial history.

5) Looking at debts

An unsustainable level of debt is one of the biggest enemies of the dividend seeker. Indebted firms have banks, bond holders and others standing ahead of you in the payment queue. While debt can aid growth where the return on capital is higher than its cost, it can be a high-risk strategy when recession bites.

There are different ways to look at debt, but one useful tool is interest cover. By taking untaxed profit before non-cash charges like goodwill, depreciation and amortisation, it compares the cash physically available at the company to the interest charges it must fund. Creditor banks start to get nervous if this ratio falls below about four or five, and should trigger extra checks from investors. One such check should be on net debt as a proportion of equity (expressed as a percentage of shareholders' funds, which will also need to include any minority interests). The lower it is, the safer the dividend will be. The 'right' level depends on the industry, but even in capital-intensive sectors should not exceed 200 per cent.

Where to look: Debt less cash, divided by total net assets, is exactly how the IC calculates the 'net debt' figure in its share tips and company results tables. You can screen for interest cover using the IC stock screener and most other screening or data mining packages. Annual reports, or analyst research notes are useful, too, for greater depth. If you can't find the debt figure easily, then two profit-and-loss line items – short-term creditors and creditors over one year – should be added together.

6) Find the current ratio

The current ratio, current assets divided by current liabilities, is more complex. Essentially it measures a company's ability to meet its short-term obligations. Finding the figures isn’t easy, but the definitions are common sense. Anything above one is considered okay. Current assets include anything that can be turned into cash within a year, including accounts receivable, inventory, marketable securities such as shares and bonds and cash. Current liabilities include money owed for inventory, rents, interest and principal due on short-term debt and so on.

There is nothing foolproof about it, though. HSBC easily passed this measure during the banking crisis, but it didn't stop the bank cutting its dividend twice since 2007. However, for a small company, a check like this will certainly help you feel more confident that it is able to pay dividends.

Where to look: The IC stock screening tool includes this metric, one of only a few that does. Data mining software packages will also be able to screen for it. Otherwise, you'll have to trawl through company annual reports – to save time, download the PDF versions and use the 'find' function to home straight in on the data you want. Some subscription websites may also provide this data.

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