Passive or conservative investors looking for a stream of income can look at stocks that pay dividends. Dividends are a means of sharing profits in cash with investors. Usually, a company pays dividends on a quarterly basis—or four times in a year.
Starbucks (SBUX) has a dividend yield of 1.34% as of 3Q14. Wall Street analysts estimate this dividend yield to be higher in 4Q14 at 1.5%.
To understand the health of dividend pay-out, dividend coverage ratio comes in handy. It’s calculated as the earnings per share (or EPS) over dividend per share. Starbucks’ dividend coverage ratio was 2.62 in the second quarter. This is a good sign because a ratio above two is a considered healthy. McDonald’s (MCD) had a dividend coverage ratio of 1.73 and Yum! Brands (YUM) had a coverage ratio of 2.02 over the same period.
Starbucks has a high dividend coverage ratio. This means that it’s retaining more earnings compared to its peers. Also, the dividend growth rate has been declining. In 2011, dividend grew 55% year-over-year (or YoY). In 2013, it grew by almost half at 24% YoY. Starbucks is reinvesting these earnings in further unit growth and expansion. Management stated that it expects to open 1,550 stores globally. Of the new stores, 50 of them will be in the Americas.
Understanding dividend coverage ratio
A dividend ratio below 1.5 is usually considered risky. It may call for a dividend cut. However, it isn’t a common practice for a company to cut dividends because it sends the wrong signal to the investment community. A dividend cut indicates that the company’s income is declining or facing difficult times. It implies that the company needs to retain more of its earnings instead of distributing it out to investors.
During the recession in 2008, 62 companies in the S&P 500 Index slashed dividends. According to Bankrate, this was a loss of $41 billion in payouts.
There are many companies that pay dividends. They can be found in the exchange-traded funds (or ETFs) like the Consumer Discretionary Select Sector SPDR Fund (XLY) and the PowerSharesDynamic Food & Beverage ETF (PBJ).