Dividend investing is one of the easiest ways to earn passive income in the comfort of your home. You have all the information you need online. Once you learn the ropes, dividend stocks can be a great way for you to earn passive income.

In today’s environment, you can get safe dividend yields of about 3-6%. You’ve got to filter for the right dividend stocks, though. Not every dividend stock that offers a 6% yield is a safe choice. Keep in mind that in most cases, the higher the yield, the slower the company grows.

Other than seeking juicy dividends from day one for a passive-income investing strategy, Canadian investors should also study the dividend quality and stock valuation and determine the best investing account to use to invest in a dividend stock.

Dividend quality

A dividend stock is already out of question if its dividend quality is not up to par. Its payout ratio should be sustainable. The higher the payout ratio, the higher quality its earnings or cash flow investors should demand. That is, such earnings or cash flow should be pretty stable and grow in the long run. The company should also have a track record of paying out stable and ideally increasing dividends.

Usually, having such a track record is a good indicator that the dividend is of good quality. However, note that occasionally, even long-term dividend-growth stocks can cut their dividends if their operating environment changes drastically and the company wasn’t able to adapt quickly enough.

For example, Suncor Energy was a Canadian Dividend Aristocrat until it cut its dividend by more than half during the pandemic in 2020. Other than operating at a loss that year, it also saw a three-fourths cut in its operating cash flow. In 2016, Suncor also operated at a loss, but it wasn’t as severe as in 2020, and it also only saw a one-quarter reduction in its operating cash flow. So, it maintained dividend growth that year.

A good rule of thumb is to compare the payout ratio of a dividend stock with those of its peers. If the dividend stock’s payout ratio is way higher, it’s probably a good idea to avoid it.

Dividend stock valuation

Typically, the price-to-earnings ratio (P/E) is a good metric to look at to determine stock valuation. You can compare it to the company’s historical P/E or compare it to those of its peers. For dividend stocks that focus on generating cash flows, a price-to-cash flow ratio is a better metric to look at.

You can compare this result to the analyst consensus price target. The stock analysis section of your bank should have this. You can also find a consensus on Yahoo Finance.

Don’t overpay for stocks. In other words, you want to pay a reasonable to discounted valuation. The higher quality the dividend stock, the smaller the discount you might require. For example, for a low-risk dividend stock like Fortis that has a high predictability in its earnings, investors may require a minimum discount of 10% from its fair valuation. Yahoo Finance shows a consensus target of $61.82 for Fortis. So, a maximum buy target would be $55.63.

Investing accounts

Eligible Canadian dividends are taxed at favourable rates in non-registered accounts. However, if you have room in your Tax-Free Savings Account, you can also invest there. If it makes sense for your financial situation to contribute to an RRSP, U.S. dividend stocks that pay high yields should be held in RRSPs/RRIFs so that there won’t be a 15% withholding tax. Note that MLPs are exceptions.

The post Passive-Income Investing: 3 Dividend Stock Tips for Canadians appeared first on The Motley Fool Canada.

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The Motley Fool recommends FORTIS INC. Fool contributor Kay Ng has no position in any of the stocks mentioned.