My dividend investing strategy

My dividend investing strategy

Before I disclose my Dividend Portfolio I would like to explain my strategy. It’s a fairly simple idea advocated by many more people than me. Like we often say in Sweden; why reinvent the wheel?

First of all, let’s clarify why one would want dividends at all. After all, total returns are the most important thing, right? While it’s very difficult to answer that question with a “no”, it’s not the whole truth.

If one had a time machine, one would obviously use a trading buy-low-sell-high-strategy. Reality is a different story though.

The following factors are some of the things important for me and skewing me towards a dividend strategy:

  • With a dividend strategy, you reduce your risk by taking fewer decisions. Normally with this strategy, you buy and hold a company, while a strategy based on buying and selling means you first have to buy a company at the right time, and then you also have to sell it at the right time. This brings me to the next point.
  • With a trading strategy you have to sell to realize the profits! I enjoy investing, and I like to get a feeling for the companies I own. I certainly don’t want to sell my winners.
  • Dividends are a very strong signal of a solid business. Dividends are real money going into your account. It cannot be faked and thus you can rest assured that a good dividend paying company is a great business. Of course, this must be carefully checked against debt, payout ratio, and many other metrics.
  • Dividends are passive. You literally don’t do anything other than holding the stocks.
  • Dividends do not depend on the market. Personally, I like to sleep well at night. I mean I REALLY like it. I can’t be bothered worrying about the market all the time.

Returns

Lets take a look at some returns on dividend stocks. I’m sure it’s possible to get all kinds of results on graphs like these, depending on what you are comparing to, what time scales etc. These two graphs sure appear very positive for the dividend stocks.

This graphs show the returns of S&P 500 stocks, based on their dividend policy. Companies with growing dividends, and companies that first initiated their dividend this period, has vastly outperformed the other stocks.

Graph Source: The Power of Dividends, Hartford Funds, January 2019

This second picture shows the importance of reinvesting dividends. You can clearly see the huge difference. Of course, in order to reinvest dividends, you have to own dividend paying companies…

Also, consider the fact that a company which in a healthy way keeps raising the dividend, must also be making more and more money. A company that makes more money will enjoy an ever increasing stock price. Thus, with a sound dividend strategy, you are able to get all the above AND capital appreciation.

Ok, tell me more…

Now that you are on the dividend hype train, we’ll dive a little deeper into some of the important things to judge the companies by.

Current dividend yield

A company obviously needs to pay a dividend in order to fit into this strategy. The higher the better – in theory. In practice anything above around 7-8 % is really worth a close examination. To be even more concrete with you, I have very few stocks with a yield below 2 %.

Payout ratio

This is a metric to figure out how much of the company’s (annual) money that goes towards paying that dividend to you. The lower the better, both in theory and in practice. This ratio can be calculated either on earnings (most common) or on free cash flow. Anything below 50 % is considered low and leaves the company with a lot of room to grow: either they can grow the dividend, or they can grow their business (or both). Many dividend investors feel like 60 % is a healthy level for most companies. Anything above 90 % warrants thorough research on your part as an investor. It’s well worth remembering that payout ratios can differ for companies bases on for example industry or strategy.

Dividend growth rate

This is the rate at which the company increases its dividend (annually). The higher the better, of course. I would consider anything under 1 % symbolic. 2-5 % is decent depending on the company, market conditions and many more variables. During 2020 with Covid19 raging all over the world, 2-5 % increases are certainly welcome! Over 5 % is a always a good number and anything above 10 % is very good. Many dividend investors combine the dividend growth rate with the current yield, i.e. slower growth rate is accepted if the current yield is high and vice versa.

Revenue, earnings, cash flow, debt and more

Dividend companies are to be evaluated the same way as any other company. You ideally want to see steadily increasing revenues, earnings and cash flow combined with a low debt.

My strategy

Here is my personal dividend investment strategy, point by point.

  • Continually and with regularity buy (and hold!) dividend paying stocks. For me it’s very important to just keep buying dividend stocks without interruptions. Slow and steady wins the race.
  • Buy companies with a healthy business that I like. I evaluate a prospect on it’s industry (stability and room to grow), business idea and the above mentioned financial metrics. I also make sure I get a good feeling about the company. I have no problems admitting to this “emotional” part of my strategy. There are thousands of good businesses out there. In order for a dividend (growth) strategy to work, one has to be a long-term holder. In order for that to work for me, I have to like the company. Check out my presentation of Danone for a good example:
  • Normally buy companies with a 2-8 % dividend yield. Dividend growth should absolutely be there, but I apply the thinking laid out in the section on “Dividend growth rate” above. So in practice, I have a mix of high yielders and high growers. Some companies offer both!
  • Reinvest the incoming dividends. To the largest possible extent I buy more dividend stocks for the dividends I receive. This is to compound my returns.

Compounding

Let’s look at the magic of compounding. Using a dividend growth strategy, you have several levels of compounding which will catapult your money into orbit.

Compounding factor no. 1: Always buy more dividend stocks. See point 1 in my strategy above. This required you to put in more of your own hard-earned cash.

Compounding factor no. 2: Companies keep increasing there dividends. See point 3 in my strategy above. A normal dividend growth in a strategy like mine might be 6 % annually. That means you get that 6 % pay raise every year, without doing any work.

Compounding factor no. 3: Reinvesting dividends. If you put those ever growing dividends to work by accumulating even more dividend paying stocks, you got three compounding factors working for you! This factor also works without you putting in any extra money from outside your portfolio. See point 4 in my strategy above.

In Summary

All of this makes me comfortable having 85 – 95 % of my capital in the stock market in dividend paying stocks. The rest of my capital is in my Rocket Portfolio, which is utilizing a growth strategy. In the weeks to come I will disclose all my holdings in my Dividend Portfolio. Meanwhile, check out the Archive to find both Company Presentations as well as Weekly Action where I document my trades.

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