Investors love dividends, and with the interim reporting season concluding income-seeking investors will be on the hunt for potential buys. 

But creating an income stream through dividends involves more than just picking the highest yielding shares. Morningstar director of equity research Mathew Hodge explains how to help weather-proof your dividend investing strategy for the long term. 

We identify some ASX names worth considering below. 

Reporting season: dividend highs and lows 

It was a mixed bag across sectors, with some companies rewarding investors with solid increases, while others preserved cash ahead of an expected economic slowdown.  

This season's dividend upside was felt in the energy sector where sky-high commodity prices brought revenue windfalls for oil and gas giants like Woodside (WDS), which increased its final fully-franked dividend by 37%. Santos (STO) shares rallied after more than doubling its profit and upping its final dividend by 78%.  

However, uncertainty over the outlook resulted in a slump in mining dividends. BHP cut its interim dividend by 40% and Fortescue Metals (FMG) sliced 11 cents off its interim dividend to 75 cents.    

Dividend favourite Harvey Norman (HVN) also dropped its dividend to 13 cents a share, down from 20 cents a share last year, while supermarket competitors Coles (COL) and Woolworths (WOW) both increased their shareholder distributions on better-than-expected half-year reports.  

For income-seeking investors, however, the stability of dividends, rather than the size, should be a key focus, according to Hodge.  

He highlights three potential risk considerations to help assess if a company’s underlying income stream is likely to continue flowing through to investors in the long term.   

Read about how to build a dividend portfolio.

1. Operating leverage 

Hodge says a company’s ability to operate at an advantage to its peers places it in a defensible position likely to benefit a dividend’s stability when times get tougher. 

“If you've got a high-cost producer with lower margins than their peers in essentially the same business and demand falls, they're more likely to have their margins and profit cut disproportionately relative to the rest of the industry,” Hodge says.  

A company’s ability to operate at a discount is one of the factors that contributes to a stock’s economic moat ranking. Companies with a distinct operating or pricing advantage that will help keep competitors at bay for at least two decades gain a Morningstar Wide-Moat ranking. 

2. Financial Leverage  

Paying close attention to a company’s financial leverage can also provide insight to its long-term dividend potential, Hodge says. 

Debt levels are a key factor in assessing a company’s ability to keep delivering dividends over the long term. 

 “If the music was to pause, that [debt] is now a source of pressure and can force a company to cut back if they don’t have the cash flows for support,” he says.  

3. Capital intensity  

Looking at a sector’s capital intensity levels can reveal its exposure to knock-on effects to the bottom line and resulting flow through to investors, he adds. 

Capital intense businesses require a greater level of expenditure to generate desirable returns. 

“Some businesses are very capital light, and whatever they earn, can be distributed,” Hodge says. 

“Something like insurance broking can be very light on capital versus something like infrastructure, which is very capital intensive, even though the underlying cash flows are steady.”  

Referencing the elevated energy sector dividends this reporting season, Hodge says in the capital-intensive oil and gas sector, the expenditure burden is not noticeable while commodity prices are so high but can become much more relevant as prices fall.  

The bottom line - diversification is key 

Investors should be cautious when seeking dividends, Hodge says, and remain focused on keeping their portfolios diversified and their eyes on the longer-term.  

“Ultimately, it's where a company is going to be in two- or three-years’ time and its longer-term maintainable level of earnings that’s going to drive the majority of the returns and decide whether that investment was worth it or not,” he says.  

“If you’ve got banks and REITs and, say, mortgage insurance making up the majority of your portfolio, well it’s all leveraged to real estate. Alternatively, if it’s all energy and oil, all when a recession comes that can go away very quickly, “he says. 

“You can inadvertently build risk in your portfolio by not thinking about what those drivers are. You want to have diversification not just by sector but also by risk.” 

4 wide-moat ASX stocks delivering dividends 

InvoCare (IVC

Shares in Australia’s largest funerals and crematoria operator fell more than 10% this week after the company revealed a $1.8 million net loss in its full-year report.  

However, Morningstar analyst Angus Hewitt says the outlook for InvoCare remains strong, despite the near-term issues it’s faced.  

“With a portfolio of strong brands and a cost base, which can be spread across a much larger funeral base, we think InvoCare enjoys competitive advantages over smaller competitors, underpinning its wide economic moat,” Hewitt added. 

InvoCare – which is trading at a 38% discount to Morningstar’s fair value estimate – set its full-year dividend at 24.5 cents per share, up 17% on the previous year.  

“They still have a good conservative balance sheet, which means they're in a pretty good spot to continue making acquisitions, continue refurbishments of homes and pay out dividends,” Hewitt says.  

Hewitt says another wide-moat company, The Lottery Corp (TLC) could be another option for dividend hunters. 

“They did have a payout ratio of 70% to 90%, which we said was conservative. But they've just upped that to 80 to 100%. Which is much more appropriate,” he says.  

While TLC shares have traded slightly above their fair value estimate in recent weeks, Hewitt says the lottery runner’s licensing advantages, low capital costs and steady revenue stream makes it one to watch for investors seeking yield. 

ANZ (ANZ) and Westpac (WBC

Wide-moat bank stocks ANZ and Westpac have a history of delivering dividends, with each tallying up a five-year average dividend yield of 5.40% and 5.43%, respectively.

They’re also trading at a discount. Morningstar banking analyst Nathan Zaia says both stocks provide a stable source of dividend income.

“Both banks are rated wide moat, meaning we see durable competitive advantages. We think holding a quality name, trading below our fair value estimate, is always a good place to start when hunting for stocks paying attractive dividends,” he said.

While both companies have displayed some dividend price volatility in the past decade, Zaia says the outlook for bank dividends looks strong.

“There are no certainties when it comes to dividends. But at present, we see Australian banks as the most well capitalised globally, with the potential for cuts to dividends more likely to result from higher-than-expected bad debts. This would likely only be temporary though, as earnings recover, so should dividends,” he said.

For non-bank financial services companies, Zaia says narrow-moat insurance provider Medibank Private (MPL)stands out. 

“Medibank Private trades on dividend between 4.5% to 5% and we think dividends can steadily grow over the long-term,” he says.  

MPL shares are trading around $3.33 and are considered fairly valued by Morningstar.  

Brambles (BXB

Investors in pallet solutions company Brambles received news of a boost to their upcoming dividend earlier this week, after the company revealed a strong half-year performance, driven by the ongoing pallet shortage and price increases being passed on to consumers. 

Morningstar equity analyst Trevor Huynh says positive dividend news could continue.  

Huynh says dividend cuts in the next two years are “very unlikely” but flagged rising input cost pressures or a large fall in lumber input costs as two potential hurdles for investors to look out for.   

Outside these potential issues, Huynh sees a strong outlook for dividends from Brambles, citing ongoing market demand, pallet shortages and the company’s pricing power as strong drivers.  

Brambles shares are trading at around $13.00 apiece, a discount to its fair value estimate of $14.00.