The 1 Metric I Check Before Buying Any Dividend Stock

There are several details I consider before adding any particular stock to my portfolio. One of them is the ticker's price in relation to its earnings or the amount of revenue that the company is turning into reliable cash every quarter. The organization's past and projected earnings growth are also important starting points for me.

For my income-generating stock holdings, though, there's one crucial measure I consider before any other: their dividend yield. Here's a concise explanation of what dividend yield is, and why you should put it at the top of your list of criteria, too.

What's a dividend yield?

It's not a complicated concept. Dividend-paying companies distribute per-share cash payments to their investors on a regular schedule, usually quarterly.

The dividend yield is just the amount of money that you can expect the company to distribute per share over the course of a year, divided by the price of the stock. Broadly speaking, higher is better.

An example will help illustrate the concept. Let's use beverage company Coca-Cola (NYSE: KO).

Right now, every three months, its shareholders receive payments of $0.53 for each KO share they own. On a full-year basis, assuming that the payout doesn't change, that will come to $2.12 per share. Dividing that amount by the stock's current price of just over $89 per share gives it a dividend yield of just under 2.4%.

That's the forward-looking dividend, meaning it reflects the expected total per-share payments for the coming 12 months, based on the latest payout rate. But plenty of companies adjust their payouts over time. Coca-Cola has now raised its per-share dividend payment for 64 consecutive years, so it's reasonable to assume that management will boost it again early next year.

Companies also show their trailing yields -- based on the total dividends that were distributed during the prior 12 months. In this case, that includes two quarters when its payouts were $0.51 per share and two at $0.53 per share, for a total of $2.08. That gives it a trailing yield closer to 2.3%.

When looking at trailing yields, you'll also want to make sure the yield is based on a payment cadence and size that's likely to be repeated in the future. Some companies occasionally pay "special" dividends or "one-time" bonus dividends. Those are nice surprises, but they aren't reliable, and can temporarily skew a yield to misleading levels.

The rest of the story

Beginning your consideration of a new income stock by looking at its yield is smart, but it's certainly not the end of the matter for me. It's also worth checking to ensure the company in question can actually afford to continue paying its dividend.

This requires per-share profits that at least match its per-share payout, although ideally, those profits should exceed the amount of money an organization is paying out in dividends -- usually by a significant amount. In the case of Coca-Cola, its total per-share profits for the past four quarters were $3.33, meaning its earnings easily covered its total per-share dividend payout of $2.08.

Image source: Getty Images.

Just as important is how a stock's dividend payment has changed -- hopefully grown -- up until the point I'm considering it. Although past performance is never a guarantee of future results in the stock market, it can provide a pretty good indication of what the future likely holds.

Based on this additional information, I sometimes conclude that the highest-yielding dividend stock I'm eyeing for the income portion of my portfolio isn't necessarily the best long-term option for me. I might opt for a lower-yielding stock, knowing that its dividend payments should be more resilient or based on the idea that over time, the total dividends paid by a reliable payout booster will be higher, even though I'm buying in with a lower present yield.

Just bear in mind that you're still buying into an actual business

With all that being said, just remember that when you buy a stock -- even one that you're primarily picking to generate recurring income -- you're still ultimately buying into a company that you hope will be able to continue doing business for the indefinite future. Analysts' outlooks can tell you what to plausibly expect (earnings-wise) for the near term. The underlying company, however, will ideally be timeless, with a perpetually marketable product or service.

Coca-Cola is, of course, such a company. Not only has it been in business for well over a century, but it has also paid dividends like clockwork for decades. And as it's a Dividend King -- one of the few companies that have boosted their dividend payments for at least 50 consecutive years -- it's reasonable to expect it will prioritize keeping that streak alive.

It's certainly not the only solid, all-around dividend stock to consider for your portfolio, though. Poke around a bit. At any given time, you should be able to find several promising dividend-paying prospects.

James Brumley has positions in Coca-Cola. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.