There are many quality companies that pay reliable streams of growing, tax effective dividends. These share investments are in particularly high demand currently due to the low yields available on alternative, low risk investments.
In fact the return of many fully franked, high yielding shares is more than triple the return on currently available term deposits.
But just how safe are these high yielding shares. A good start is to look at the history of annual dividend payments. A steady pattern of gradually increasing dividends without any large dividend falls or missed payments over a long period is ideally what we are looking for.
An important consideration for dividend safety is Dividend Cover. That is the multiple of earnings to dividends paid. It describes how much room the company has to keep paying or increasing the dividend given current earlings.
As a rule of thumb, companies aim to hold a dividend cover of at least 2 times in order to maintain sufficient financing through retained earnings while providing a reasonable dividend return on investment. A higher or lower dividend cover may be appropriate depending on the level of stability in earnings of the organizations.
Where dividend cover is consistently below 1.5, it may suggest that the company may not be able to maintain the current dividend in the case of a future earnings decline.
High dividend cover may signal that the company is retaining a higher portion of its earnings to finance requirements for growth which may result in higher future dividends.