5 Questions To Ask Before Buying Any Dividend Stock
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Here in the newsletter, we talk a lot about the do’s and don’ts of dividend investing. But the more time I spend in this world—and the more experience I get as an investor—the more I realize just how personal this journey really is.
There’s no perfect roadmap. No one-size-fits-all strategy. And as my friend Russ likes to say: “There’s more than one way to get to financial heaven.”
With that said, there are still some key, tried-and-true principles I always come back to. They’re simple reminders that keep me on the straight and narrow—especially when I’m looking at a new stock—and I want to share five of them with you today.
I always ask myself these questions before buying a dividend stock. They’ve been incredibly helpful for me, and I hope they’ll be the same for you too.
1. Do I understand how the company makes money?This is the starting point—and it’s one of the most important questions you can ask.
If you can’t clearly explain what a company does—what it sells, how it earns revenue, stuff like that—then you probably shouldn’t buy it.
Peter Lynch actually has a great rule of thumb for this. He says: “If you can’t explain it to a 10-year-old in two minutes or less, you probably shouldn’t own it.”
2. Is the business actually growing?This one sounds obvious, but it’s essential—especially for dividend investors.
A company can’t keep paying (or growing) its dividend if the underlying business isn’t growing too. Ideally, you’ll want to see consistent growth from top to bottom—revenue, earnings, and free cash flow—like in the screenshot below.
Source: Visa on Snapstock
One of the reasons this matters so much is that, over time, your returns are tied to the company’s fundamentals. If the business is growing and becoming more valuable, the share price will eventually reflect that. And if the fundamentals are declining, it’s the same thing.
3. Can the company afford its dividend?This is where the payout ratio comes into play, which is an extremely quick and simple way to gauge the sustainability of a company’s dividend.
In a nutshell, the payout ratio tells you how much of a company’s net income or free cash flow it is allocating toward the dividend. If a company is paying out most of what it earns just to keep the dividend going—like if the payout ratio starts creeping up into the 80% range or higher—that’s a potential red flag.
Generally speaking, I like to see a payout ratio in the 40–60% range, if not lower. And that’s not a hard rule—some companies, like Altria Group (MO), do just fine with a higher payout ratio because their cash flow is so consistent.
But in general, the lower the payout ratio, the safer the dividend.
4. What could seriously kill or threaten this business?We spend a lot of time thinking about why a company might be a good investment—but sometimes the more important question is: Why might it be a bad one?
What could go wrong? Where is there risk that I’m not thinking about? What is this business’s Achilles heel?
These are all important questions to think about, and this idea of inverting the problem comes from Charlie Munger. It will help you think more clearly about the businesses you don’t want to own, which is just as essential as knowing the ones you do.
5. Would I still want to own this business if the stock market closed for 5 years?This question actually comes from Warren Buffett, and it’s one of those great gut-check questions.
If you couldn’t sell the stock for the next five years—and all you had was the business itself and the dividend it pays—would you still feel good about owning it? If the answer’s no, that pretty much tells you everything you need to know.
Overall, these questions aren’t meant to be complicated (and hopefully they didn’t feel that way). They’re just a simple framework to help you think more clearly and independently about a company—especially in a world where it’s easy to overcomplicate things, follow the hype, or outsource your thinking to someone else.
In my experience, the more questions you ask yourself, the more thoughtful your investment decisions will be. With that said, I’d love to hear from you: what questions do you ask yourself before buying a stock? Write to me here and let me know.
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"Have you ever considered buying a non-dividend stock? Like a stock that has everything you wanted in a company, but it doesn't pay a dividend?"
- Joel | YouTube
I’ve definitely been interested in a few non-dividend-paying companies over the years. Spotify is a good example—I’ve been a loyal user for years and genuinely love the product.
But when it comes time to actually put money into a company, if there’s no dividend, I just can’t pull the trigger. For better or worse, that’s how I roll.
With that said, there are undeniably plenty of phenomenal businesses out there that don’t pay a dividend. But as someone who hopes to eventually live off dividend income, having a dividend is non-negotiable for me right now.
To me, it’s no different than only wanting to invest in companies growing their sales or free cash flow. Just like I look for business growth, I also want that consistent cash flow coming back to me.
Is that going to cause me to miss out on some great investments? Definitely, but I’m okay with that. There are still hundreds of high-quality, dividend-paying companies out there, so I really don’t feel like I’m missing out on much.
In fact, I actually find it helpful to narrow my focus a bit more. It gives me a clearer sense of direction when it comes to digging up new investment opportunities.
Now does that mean I’ll never invest in a non-dividend payer? Not necessarily—never say never. For now, I’m just laser-focused on stacking that cash flow and building up my dividend snowball.
With that said, if In-N-Out Burger or Trader Joe’s ever go public—even without a dividend—I might have to make an exception. Those are two companies I feel like I'd have to own, no matter what.
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