There are no shortcuts with investments, and it may or may not be a tough road for some depending on which route they choose. Each person has their own rules for trading or investing. Here, we’re going to talk about dividend growth investing. This model is predicated on finding long term stocks or bonds to hold for both long term capital gains and dividend income appreciation. We’re just going to go over the bare bones of what to do in finding good dividend stocks to buy and hold long term through bull and bear cycles.
Before it was paid, Yahoo Finance used to have really great yet simple financial information of companies. But now it is paid to get more in depth information. I still go there to read the income, balance sheet, and cash flows of a company I am potentially going to invest in. Energy stocks such as $DUK, $SO or $D have large amounts of cash on hand, and have monopolies in their respective regions. Electricity as an energy source will never go out of style, and they have enough cash to adapt. The first general rule for dividend growth investing is to invest in companies with large amounts of cash, decreasing long term debt, increasing net income, historically increasing dividends YoY, and history of capital appreciation. Another rule that I personally go by is I like to invest in mostly low beta stocks with moat businesses. Moats are businesses that have historically done well and will continue to do well far into the future because they have huge market share in the industry.
Here is a list of what I typically seek in Dividend Stocks:
- Large amounts of cash in reserves or liquid assets
- Decreasing long term debt
- Increasing net income YoY
- Historically increasing dividends YoY
- Long track record
- History of Capital Appreciation
- Moat businesses
- Low beta stocks
- Low chance of stock splits in the future
- A small % of the portfolio is in speculative, undervalued stocks that pay dividends
Obviously not all stocks will have all of these criteria met. That is why you have to do your due diligence and decide whether it is a company worth investing if it has 75 or 80% of the criteria met. One example of it not being fully met is the historical increasing dividends part. Some stocks have a medium term history of increasing dividends, but cut it maybe 5 or 10 years ago. For these, you have to make a decision whether the company is still valuable, and if they are using the cash they have saved on paying dividends to reinvest back into the company. Another example is when a company has decreasing long term debt near term, but had to increase their debt on the balance sheet for whatever reason. You have to make a decision whether leverage (using debt) is good for the company or is increasing the risk of the stock. Some reasons why companies increase long term debt is so that they can buy back stocks to make sure that they are adequately protected from corporate raiders, no risk of credit default, or etc.
One important reason why I invest in moat businesses is because they show stability and no risk for decline in the immediate, intermediate, or long term future. These companies will evolve with the times and will continue to have business because there is always a demand for it. One example of this is McDonalds. It has been so permeated among American culture that there will be no shortage of demand for McDonalds in the US or globally. Their current business model is ensured for expansion because they have a metric of increasing franchises globally and in select markets at optimal times each year.
Low beta stocks means that a stock has generally less risk than other stocks among its category and also means there will be less volatility for it relative to the index. A beta of 1 means it is in line with the market (or index) and below that means there is less volatility compared to the market. Above 1 means there are more drastic price swings. That’s beta in a nutshell without getting too complicated. I don’t typically focus on Alpha stocks, but I may decide to focus more on Alpha stocks with high paying dividends in the future. Alpha does not always mean it has high beta and vice versa. They are mutually exclusive but can be correlative.
One reason why I do not like stock splits is because it dilutes the value of the share price-wise and also income-wise. If a stock gets split into 2 or 3 pieces, the dividend will halve or triple down. So if there is a 2 for 1 stock split for McDonalds, 1 current share of $MCD will be split into two and the price will halve as well as the dividend payouts each quarter. At the end of the day the share value is still the same because you get the equal amount of par and above-par value with the number of shares given, but it shows risk for corporate takeover or for future scalability of the company’s business. The more shares there are, the more it lowers the potential gains in price for the future along with less dividend increases per year since there are more shares outstanding. Usually when a company raises money through equity, it shows that the business might be suffering somewhere or they might not want to raise any more debt to fund operations. Usually this means that there is not enough liquid cash to reinvest, pay down debts, or pay out dividends to shareholders.
The last rule of thumb is to constantly reinvest the dividends back into the companies (until you choose to take out part of the income for retirement) and buy new companies at great prices. For me personally, I don’t really look at price to earnings ratios because I know that the market is irrational and it will never be efficient. People will gravitate towards a stock and pump the price for decades sometimes because they believe in them. Some examples of this are Amazon, Apple, Berkshire Hathaway, Wayfair, Shopify, and Google. I just like to invest in stocks that I see are at its lows from a technical analysis standpoint, or are on the rise consistently in terms of charts. The goal is to make sure at least 20% of the portfolio’s dividends or sometimes capital gains (if sold for profits) are reinvested back into the portfolio by either purchasing new stocks that you want to get into (with the aforementioned criteria), or back into the stocks already owned.
That’s the bare bones of investing using the Dividend Growth model (without the math). Even so, it is still a complicated subject because there is a lot of technical know how in terms of reading balance sheets, charting with technical analysis, or using fundamental analysis to make sure that the companies are being run properly. If you have any questions, comment below or send me a DM on Twitter @DividendHack
Invest in your dividend growth portfolio today by going to this link: https://mbsy.co/lldLP to head on over to M1Finance (a fee-free partial shares portfolio brokerage). See my friend’s dividend growth portfolio on his personal blog at www.dividendraptor.com. Check it out by going to twitter @DividendRaptor to see real time real estate dials & results, as well as the growth of Raptor’s dividend portfolio compounding from infancy to big d*&$ bag.