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Dividend Investing: Due Diligence

Once you have your shortlist of potential dividend stocks, with the help of information in the previous chapters in "Dividend Investing: Simplified - The Step-by-Step Guide to Make Money and Create Passive Income in the Stock Market with Dividend Stocks," it's time for due diligence on the relatively few remaining stocks.

Author Mark Lowe began chapter seven by stressing the importance of economic and financial issues that might affect dividend stocks. For Americans, that starts with an overview of the current U.S. economy. There are several resources he recommended:

  • Federal Reserve Board.
  • Research produced by banks.
  • Business media, including newspapers, websites and magazines.



6. Review the balance sheet

Use what Lowe called a "mid-level" analysis; in other words, don't skip over the balance sheet but at the same time, don't get bogged down in it. He recommended focusing on these points:

  • What is the company's capacity to handle short-term liabilities?
  • If there is a high level of debt, is it consistent with the company's business model?
  • Check the ratings of the company's short-term bonds.
  • Does the company generate enough cash to meet its debt obligations and still maintain its dividend payments?
  • What is the company's debt-equity ratio, and how does it compare with the ratios of its peers?
  • Have there been significant changes in the top-line numbers, its total assets, total liabilities or shareholder equity? If yes, why?



If any of these reviews produces a red flag, check the footnotes for explanations.

7. Follow the company's stock-price history

A quick review of the company's stock-price history, via its stock chart, can provide insight to investors. Lowe noted:news bender


"Trace the pattern of the stock price performance. Has it been choppy, volatile, smooth or steady?

"Be sure to also check the stock price in different periods - six months, one year, three years, five years, and 10 years. Is the general trend rising or falling?"



If there are major variations from the overall trend, what happened? Was there a change in revenue, expenses or something else that prompted the market to react the way it did?

8. Check stock options and the possibilities of dilution

Next, review Securities and Exchange Commission filings for outstanding stock options and determine when they will be converted into shares.

As Lowe pointed out, the options may be converted at different price points. This means you can estimate conversions by price levels, and once those levels are hit, the options turn into stocks and consequently dilute the value of current shares.

9. Gather expert opinions

While you will become well informed about a company if you have gone through the due diligence process, there is the potential that you've missed something, or even that you developed tunnel vision.

The remedy is to look beyond yourself: "Step 9 may require a bit of an extra effort on your side because you have to make sense of the general sentiment of stock market analysts when it comes to the profit growth, revenue, and other projections for at least two years from now."

10. Examine risks, both short and long term

Lowe dealt briefly with the risk assessment process within the wider confines of due diligence. Among the points he made:

  • Understand the risks involved with the sector and industry, as well as those of the company.
  • Ask what, if any, disruptions are possibly coming?
  • Develop worst-case scenarios that could affect your investment.
  • Ask if a competitor introduces a better product, can your company survive?



Conclusion

In chapter seven of "Dividend Investing: Simplified - The Step-by-Step Guide to Make Money and Create Passive Income in the Stock Market with Dividend Stocks," Mark Lowe provided a 10-step due-diligence process.

While the specifics he provided are a good guide, in a broader sense, having a process of some kind is essential for any dividend strategy to work.

Disclosure: I do not own shares in any company listed, and do not expect to buy any in the next 72 hours.

Read more here:

Dividend Investing: Choosing Dividend Stocks, Part 2

Dividend Investing: Choosing Dividend Stocks, Part 1

Dividend Investing: The High Dividend Yield Strategy

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This article first appeared on GuruFocus.