5 checks we use before buying dividend stocks for income in Singapore

What happened?

Dividend stocks are often seen as one way for investors to build a stream of passive income over time.

Instead of focusing only on the dividend paid today, the appeal is in companies that may be able to maintain or gradually raise their payouts over the years.

A modest dividend yield today may become more meaningful over time if the company is able to grow its earnings and dividends consistently.

However, not all dividend stocks are built the same, as some companies may be able to deliver a growing stream of income while others could cut payouts when business conditions become more challenging.

That is why I think investors need to look beyond the highest dividend yield when choosing stocks for income. 

Within Beansprout's four pots of wealth framework, dividend stocks would usually sit within the Income Pot, where we look for assets that can provide recurring income while still having room for payouts to grow over time.

In this article, we focus on one important part of that process: five simple checks that help us decide whether a dividend stock deserves deeper research.

Why dividend stocks matter for the Income Pot 

A good dividend stock does two things.

It pays you regularly, and it has the potential to increase that payment over time.

That second part is important. 

Over the years, even a modest starting yield can become more meaningful if the dividend per share keeps rising.

For example, a company paying a 4% dividend yield today may not look very exciting at first glance.

But if the company is able to grow its dividend consistently, your yield on original cost may rise over time.

This is why dividend investing is different from simply buying the highest-yielding stock in the market.

Rather than chasing the biggest payout today, the focus is on building an income stream that can stay relatively steady even when conditions change.

This fits into Beansprout’s Income Pot, which focuses on assets that can provide recurring dividends, coupons or distributions while adding more stability to the overall portfolio.

It also matters because inflation can reduce the value of a fixed stream of income.

A dividend that grows steadily may help the Income Pot keep pace with rising living costs, although dividends are never guaranteed.

That is why I would still start with quality.

A company that raises dividends sustainably usually needs growing earnings, a sound balance sheet and enough cash flow to support the payout.

5 simple steps to screen for the best dividend stocks

For me, the screening process should start with the business, not the yield.

A high dividend yield may look attractive, but it does not mean much if earnings are falling, debt is rising or cash flow is weak.

At Beansprout, we look at dividend stocks across three areas: fundamental strength, financial health and valuation.

The order matters.

First, we want to know whether the business is growing its earnings.

Next, we check whether the company has the financial strength to keep supporting its dividend.

Only after that do we look at valuation, including whether the dividend yield offers enough compensation for the risk involved.

I would work through the three areas in this order, because a stock that looks attractively priced but fails on earnings growth or cash flow may not be a bargain.

#1 – Fundamental strength

Step 1: Check whether earnings per share has grown

The first thing I would look at is earnings per share, or EPS.

EPS measures how much profit the company earns for each share.

For a dividend to grow sustainably, earnings need to grow too. 

A company can maintain dividends for a while even when earnings are weak, but that cannot continue forever.

At some point, the payout has to be supported by profits or cash flow.

As a start, compare the company’s latest EPS with its EPS three years ago.

I would prefer to see EPS grow by at least 10% over the past three years, as it suggests the business is still growing rather than relying on a stagnant earnings base to fund dividends. 

Formula: 

You can find EPS in the company’s annual report, financial statements or results presentation, often in the income statement or financial highlights section.

Where available, I would use diluted EPS so that the comparison is more consistent across the years.

#2 – Financial health

Step 2: Check whether debt is manageable

Debt is not always bad. Many companies use borrowings to expand, invest or improve returns for shareholders.

But too much debt can make a dividend less reliable.

When interest costs rise or earnings fall, a company with a stretched balance sheet may have less room to maintain dividends.

A useful starting point is net debt to equity.

Formula:

For many non-financial companies, I would prefer net debt to equity to be below 50%.

However, I would not treat this as a hard rule across every sector. Banks, insurers and REITs should be assessed using different metrics.

For REITs, for example, investors should look at aggregate leverage, interest coverage ratio, debt maturity profile and the proportion of fixed-rate debt.

What I want to know is whether the company can keep paying dividends if business conditions become tougher. 

The trend in debt levels matters too.

A company reducing debt while growing dividends is usually showing good discipline.

A company taking on more debt mainly to support dividends deserves more caution.

Step 3: Check whether the payout ratio is sustainable

The dividend payout ratio tells us how much of a company’s earnings is paid out as dividends.

Formula:

A very low payout ratio may suggest the company is not prioritising dividends.

A very high payout ratio may suggest the dividend has little room for error.

For sustainable income, I would usually prefer a company that pays out a meaningful share of earnings, while still keeping enough profits to reinvest in the business.

As a guide, a payout ratio of at least 40% may show some commitment to shareholders.

But the number should not be viewed in isolation. The direction of the payout ratio also matters.

A stable or gradually rising payout ratio over time may show that management is willing to share more of the company’s earnings with shareholders.

But this should be read together with Step 1, as a rising payout ratio is more encouraging when EPS is also growing. 

If the payout ratio is rising mainly because earnings have fallen, the dividend may become harder to sustain. 

A 70% payout ratio can be sustainable for a stable cash-generative business. 

A 40% payout ratio may still be risky if earnings are falling quickly.

For REITs and business trusts, investors should not rely only on EPS payout ratio.

Distribution per unit, distributable income and adjusted funds from operations may give a clearer picture.

Step 4: Check whether free cash flow is positive

Dividends are paid with cash, rather than just its reported profits.

A company may report profits, yet still have limited cash available if it needs to spend heavily on equipment, expansion or working capital. 

That is why I would check free cash flow.

Formula:

Over time, I would want to see the business generating positive free cash flow to support its dividends. 

It does not need to be positive every single year.

Some businesses may have periods of heavy investment.

But if free cash flow is often negative, the dividend may eventually come under pressure.

This is especially important for capital-intensive sectors such as airlines, shipping, manufacturing, property development and infrastructure-related businesses.

These companies may earn profits on paper, but still require large amounts of cash to maintain or expand their operations.

I would also compare free cash flow against dividends paid.

If a company consistently pays more in dividends than it generates in free cash flow, I would want to understand how the dividend is being funded.

#3 – Valuation 

Step 5: Check whether the yield is worth the risk

The final step is valuation.

A dividend stock may be a good company, but still not attractive if the yield is too low compared with other income options.

For Singapore investors, useful comparisons include Singapore Savings Bonds, T-bills, fixed deposits, high-yield savings accounts and money market funds. 

However, these are not direct substitutes for dividend stocks. 

Dividend stocks can offer income growth and capital appreciation, but they also come with share price volatility and business risk.

That is why I would only consider the dividend yield attractive if it provides a meaningful premium over lower-risk alternatives.

As a guide, I would look for a dividend yield of at least 3.5% for a dividend stock.

Formula:

The exact hurdle should change with market conditions.

When T-bill and SSB yields are high, dividend stocks need to offer a higher yield or stronger dividend growth to justify the added risk.

When lower-risk yields fall, a quality dividend stock may become more attractive, but only if it passes the earlier checks.

That is why yield comes at the end of the process. 

A high yield is less useful if earnings are falling, debt is rising or free cash flow is weak. 

There is another factor to consider if you are investing in US-listed dividend stocks. 

Foreign investors are typically subject to a 30% withholding tax on dividends. This means a stated 5% dividend yield effectively becomes about 3.5% after tax.

At that level, the yield may no longer meet your required return, especially when compared to income options in Singapore.

What would Beansprout do?

When looking at dividend stocks, I would not start with the highest yield.

I would start with whether the business can support the dividend over time.

That means checking whether earnings are growing, debt is manageable, the payout ratio looks sustainable and free cash flow is positive.

Only after that would I compare the dividend yield with options such as Singapore Savings Bonds, T-bills, fixed deposits, high-yield savings accounts and money market funds. 

Here is the simple checklist I would use before putting a dividend stock on my watchlist.

A dividend stock does not need to be perfect across every measure.

But if it fails on earnings growth, balance sheet strength and cash flow, I would be careful even if the yield looks attractive.

If the yield is high mainly because the share price has fallen sharply, I would want to understand what the market is worried about.

If a dividend stock offers a reasonable yield and passes these checks, I may put it on a watchlist for deeper research.

Dividend stocks can play a useful role in the Income Pot, especially for investors who want cash flow that may grow over time. 

But they are still equities, so the share price can fall and dividends are not guaranteed.

For me, the aim is not to find the highest-yielding stock. It is to find companies where the dividend has a reasonable chance of being sustained and growing over time.

A good income stock should help the portfolio feel more stable.

This is also why I would still see Singapore stocks as a core part of a globally diversified portfolio, especially for investors looking for dividend income.

Earlier, we also shared that we would consider looking beyond Singapore REITs to Singapore blue chip stocks for more diversified dividend income, especially when the dividends are supported by earnings growth, strong balance sheets and sustainable payout ratios.

You may also consider combining different sources of dividends to build a more resilient income portfolio over time. Learn how to build a more dependable stream of income that can hold up across cycles here.

If you’d like to screen for Singapore stocks with attractive dividend yields and potential upside, you can explore our Singapore dividend stocks screener.

Learn more about Beansprout's four pots of wealth framework to grow your wealth with clarity here. 

If you are looking for higher-conviction ideas outside the Income Pot, you can also read how we screen for growth stocks in the Opportunity Pot here.

Did any dividend stocks on your watchlist pass these checks? Share your thoughts in the comments below or join the discussion in our Beansprout Telegram community.

Planning to invest in stocks for dividend income? Check out Beansprout's guide to the best stock trading platforms in Singapore with the latest promotions and see the latest promotions and sign-up rewards available. 

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