Wednesday, February 16, 2011

How to invest in dividend stocks

Most situations concerning dividend investing discuss how a portfolio should be constructed, how different types of non-correlated assets should be included and how to re-balance from time to time. I realize that I have never really written anything about how to handle influx of new funds in a dividend portfolio and how to maintain asset allocations accordingly.

As an investor in the accumulation stage, I tend to invest a certain amount every month. The amount of money goes first to stocks which have passed the following basic screen:

1) The company has raised dividends for over one decade
2) The P/E ratio is less than 20
3) The dividend payout ratio is less than 50%
4) The dividend yield is above 2.50%

This screen decreases the total universe of investable dividend growth stocks from 300 to a more manageable number.

In the next step I analyze the companies which are on the screen and basically look for qualitative and quantitative factors. In terms of quantitative factors, I look for growth in earnings over the past decade and stable trend in returns on equity. The qualitative factors are highly subjective, as they incorporate my stock market experience to date. I try to understand what the company does, whether it has any competitive advantage and whether it would be able to generate earnings growth in the future. Without earnings growth, no company can afford to grow dividends for more than a few years. If I had already analyzed the company, I just review my previous work and use it to compare the last stocks remaining to each other.

After a list of several stock candidates is generated, I check what my allocation in each one of them is. In a dividend portfolio of 40 stocks, I do not want to see a company that has more than a 4% portfolio weighting. Even if such a company is priced very attractively, I would not invest in it, as long as there are other candidates which could be purchased at bargain prices. Most of the times however I end up owning miniscule positions in stocks which were trading at bargain prices a long time ago, but which have since been overvalued. Family Dollar (FDO) is one such type of stock, where I purchased a small starter position in 2008 when prices were much lower than today. Unfortunately, as the price went above my buy range, I have not added to the position.

After comparing stocks against each other, I typically try to select between eight and ten companies to invest in. For example I added to my position in the following stocks in December:

The Procter & Gamble Company (PG) provides consumer packaged goods in the United States and internationally. The company operates in three global business units (GBUs): Beauty and Grooming, Health and Well-Being, and Household Care. This dividend aristocrat has raised distributions for 54 years in a row and is attractively valued at the moment. Yield: 3% (analysis)

Kimberly-Clark Corporation (KMB) , together with its subsidiaries, engages in the manufacture and marketing of various health care products worldwide. The company operates in four segments: Personal Care, Consumer Tissue, K-C Professional & Other, and Health Care. This dividend aristocrat has raised distributions for 38 years in a row and is attractively valued at the moment. Yield: 4.30% (analysis)

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics. This dividend aristocrat has raised distributions for 48 years in a row and is attractively valued at the moment. Yield: 3.60%(analysis)

The Clorox Company (CLX) engages in the production, marketing, and sales of consumer products in the United States and internationally. The company operates through four segments: Cleaning, Lifestyle, Household, and International. This dividend aristocrat has raised distributions for 33 years in a row and is attractively valued at the moment. Yield: 3.30% (analysis)

ONEOK, Inc. (OKE), a diversified energy company, operates as a natural gas distributor primarily in the United States. The company operates in three segments: ONEOK Partners, Distribution, and Energy Services. This dividend challenger has raised distributions for 8 years in a row and is attractively valued at the moment. Yield: 3.50% (analysis)

Kellogg Company (K), together with its subsidiaries, engages in the manufacture and marketing of ready-to-eat cereal and convenience foods. This dividend stock has raised distributions for 6 years in a row and is attractively valued at the moment. Yield: 3%

Chevron Corporation (CVX) operates as an integrated energy company worldwide. This dividend achiever has raised distributions for 23 years in a row and is attractively valued at the moment. Yield: 2.90% (analysis)

Abbott Laboratories (ABT) engages in the discovery, development, manufacture, and sale of health care products worldwide. It operates in four segments: Pharmaceutical Products, Diagnostic Products, Nutritional Products, and Vascular Products. This dividend aristocrat has raised distributions for 38 years in a row and is attractively valued at the moment. Yield: 3.90% (analysis)

This is just a snapshot of what I purchased between December 2010 - January 2011. Market conditions change, which is why investors should always be numble and on the lookout for the next opportunity.

Full Disclosure: Long all stocks mentioned above

Relevant Articles:

- Dividend Investors are getting paid for waiting
- The right time to buy dividend stocks
- Living off dividends in retirement
- Why Dividend Growth Stocks Rock?

9 comments:

  1. Hi D!

    I've followed your blog on RSS for some time now. I must admit that I like what I've read. Your idea of investing is so parallel to mine.

    One thing I like to hear from you is about selling. When and why do you sell a position in a stock? Especially stocks that you have liked and loved for some time. The ones that have generated good returns, but don't fit your buying rules anymore. Does your selling rules differ from buying rules?

    ReplyDelete
  2. two questions.
    (1) how much are you investing each month, and how much in a given item? (I do only $300/mo, which means I need to buy only 1/mo or costs get crazy.)
    (2) how do you handle small holdings? selling costs turn these investments upside-down. Waiting til "someday" when you can buy more?

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  3. What research tools do you use to find these stocks going by your 4 basic screens?

    ReplyDelete
  4. After reading your post I went back and looked at my Dec. and Jan. Only thing I bought was an addition to my Abbott when it dipped under 46 and some Intel at $20. I did sell a few shares of RPM Inc. to do some re-balancing as it was a bigger position than I wanted. Holding some cash at present looking for something to pullback.

    My rules:
    Yield over 3% generally, but that is only a level of interest where I know I can find many above that at present.

    PE.: Generally a worthless indicator used alone. I want the PE to be in the lower 30% of its 30 year relative history vs. the S&P 500 to show some value. PEG is a better gauge of value.

    Dividends: increasing at a faster rate than the long term inflation rate of 3.2%.

    Price: Generally I like to see a price decline, such a ABT or like the purchase of Intel, both price and news of a dividend hike in a decent price area.

    ReplyDelete
  5. Your article is very interesting, giving a lot of inspiration especially for this novice.
    Thank you for sharing with us, keep your great work and good luck.

    ReplyDelete
  6. I am a reader of your blog, and in the past year have begun buying more individual stocks than I did in the past. My question to you is what online stock screener do you use? I have used several, but am unable to find one that has the number of years of dividend increases as a variable. Thanks. Rwiles

    ReplyDelete
  7. I try to understand what the company does, whether it has any competitive advantage and whether it would be able to generate earnings growth in the future. Without earnings growth, no company can afford to grow dividends for more than a few years. If I had already analyzed the company, I just review my previous work and use it to compare the last stocks remaining to each other.

    ReplyDelete
  8. These are great tips for beginner dividend investors. You outline how to determine which to buy, but how do you know when to sell? Do you have a checklist of criteria that you use?

    ReplyDelete
  9. Do you consider the debt load of the company? In my screens, I avoid companies with D/E ratios above ~60%. Otherwise, almost exactly, my method is aligned with yours.

    You have a great blog. I read it everyday.

    ReplyDelete

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