One investing goal is finding undervalued companies where the dividend is not only safe but has the ability to grow going forward, providing a steady income stream. The idea for this article came after reading David Van Knapp’s article titled, “Modern Dividend Theory Explained Part 2: Risk And Diversification”. David stated:
I am not aware of an analogous mathematical measure of the risk that a dividend stream will be reduced. Clearly, it is a function of the stability and predictability of dividends themselves. For now, I do not have nor am I going to attempt to invent a mathematical function that describes the risk to dividends or to dividend growth. Common experience suggests that the risk to dividends is far lower than price risk, but I don’t know how to quantify that.
The following is certainly not a complicated mathematical algorithm that would make a derivative expert blush but an overly simple visual to measure dividend safety. We will look at a few examples that illustrate the following:
- The dividend is safe with room for growth
- The dividend is safe but growth could be slowing
- The dividend is high risk.