Not sure what dividend stock to buy in May?

Having a dividend portfolio that pays you every month or every quarter is great. Who doesn’t like to get paid for doing nothing right? But before you can have a portfolio that pays you, there is some groundwork that needs to be done in selecting the companies so you can get that passive income.

So at the beginning of every month I look through a list of companies that pay dividends to check whether there is any new stock that I can buy at a reasonable price. The reasonable price part is purely my opinion that I have come up with over time.

Checklist

These are my usual concerns I have before I put any money into a dividend stock.

1. Dividend yield

I look for a dividend yield of 2% or above. Anything below makes me feel like I am not getting the most out of my money.

2. Dividend growth

A high dividend yield is great to start with but if the company doesn’t continue to increase it then inflation is going to eat into it. A baseline line of 5% dividend growth looks good to me and that’s my starting point.

3. Dividend streak

This shows some stability. Have they been giving dividends for more than 10 years? That gives me some faith that they will continue to give dividends. The company could go through bad business cycles and still have a big enough safety net that could continue giving dividends.

4. Payout ratio

Wallet with money sticking out to show dividend payout

Payout ratio of less than 60%. A low payout ratio means that they have earnings to cover the dividend and to invest for the future.

5. P/E Ratio

I use the P/E ratio to determine whether I can buy the stock today at a reasonable price. In the past I used a P/E Ratio of 20 to decide what was expensive. I have come to realize that some stocks usually trade at p/e multiple higher than 20 all the time. So I don’t have a specific number for that anymore. 

Company

Fighter Jet to show the main business segment of Lockheed Martin

The stock that I am looking to add to my portfolio this month is Lockheed Martin (LMT). It’s not a household name. Lockheed Martin is a global security and aerospace company. It’s one of the largest defense contractors with over 70% of their revenue coming from military sales. We are talking about fighter jets, missiles and space equipment for NASA.

From a business standpoint, there are one of the biggest players in that industry with a few competitors. They are the primary manufacturer for most of the contracts they have won with the US government. This is an industry with a high barrier to entry which keeps them pretty insulated from being disrupted. This makes it very difficult for the company to just disappear or be overtaken out of nowhere. They also won a few contracts that’s going to last for the next 10 years.

As with most good things in life, there are some downsides to their business. These risks will play a factor in how successful they will be in the future. 74% of their revenue came from the US government in 2020. These agencies and the government in essence have control on Lockheed’s fortunes as they can delay delivery acceptance or cancel a contract. The F-35 program accounts for 28% of the revenue. Any negative outcome for that project in specific will have adverse effects on the overall company performance.

Now that we have a basic understanding of what Lockheed Martin does and how it makes money. How does it hold up against the checklist I mentioned earlier?

1. Lockheed Martin Dividend Yield

Dividend yield is at 2.53% as of Friday close. So this passes the 2% dividend yield test. Here is a 10 year chart of dividend yield for Lockheed Martin from Macrotrends. The dividend yield was almost 5% in 2013. It’s been below 3% since 2014 and looks to have settled between 2% and 3%.

2. Lockheed Martin Dividend growth

Lockheed Martin has grown its dividend by 9.8% compounded annually for the last 5 years and grown it by 14% compounded annually for the last 10 years. This is like getting a 10% raise everywhere. The dividend payout right now is $10.40 and in 2016 was $6.77 and it was $3.25 in 2011. This is a 53.7% overall increase over the last 5 years and a 325% increase over the last 10 years. For dividend investors who plan on holding for the long haul, the dividend growth rate should be of more importance than the dividend yield itself. Dividend yield is what matters when you invest initially but without a good dividend growth rate, you won’t be able to continue that momentum to grow your passive income.

Money growth over time to show dividend growth

3. Lockheed Martin Dividend Streak

This is for stability and Lockheed Martin is a dividend contender and has grown their dividends for the past 18 years. They went through the great recessions and still increased their dividends during that time. This past dividend streak doesn’t mean they will continue to do that in the future if they run into some major business issues.

4. Lockheed Martin Payout Ratio

Payout ratio is the portion of the earnings begin given away as dividends. Lockheed Martin has a dividend payout ratio of a bit above 40%. This leaves a lot of room for the dividend to keep increasing and possibly maintain that 10% dividend growth rate mentioned earlier. With 60^% of the earnings retained by them, they still have quite a bit of money to keep investing into business for new projects.

5. Lockheed Martin P/E Ratio

 I don’t have one P/E Ratio to narrow down the companies I look at. I look at the current P/E ratio against its historical P/E ratio. This is where I determine whether I can buy the shares at a reasonable price. There is not any magic to it. If the current P/E is close to the average or below compared to the past 5 years, then I would consider it as a good entry point. Here is a 5 year trend of Lockheed P/E Ratio. P/E ratio is at 15.75 right now and that has not changed much in the last 2 years. I look at this and think I am not getting a great deal but I am not overpaying either. 

P/E Ratio over time

Conclusion

Lockheed Martin is a good addition to any portfolio based on my checklist. As long as the US government continues to pour money into military equipment, Lockheed stands to benefit from it. Lockheed stock prices have gone up recently but it is not very far away from its 52 week low so I think this is a good time to seriously look into buying some shares.

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