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Sunday, January 20, 2008

My Strategy

My strategy involves buying companies which have a history of consistently increasing their dividend payments going back over as many years as possible . Depending on the period that you are focusing one there's not a lot of companies that might fit your criteria. S&P has several lists which are worth focusing on - companies which have consistently increased their dividend over the past 10 years, S&P Dividend Aristocrats and S&P high-yield Dividend Aristocrats. The positive thing about the last two lists is that they show you stocks that have raised their dividends consistently over the past 25 years! Remember i do not just focus on high-yielding stocks. A stock which shows you a 10% dividend yield when the average yield out there is 2% is most likely a stock, for which the market is telling you that there is a very high chance that the dividend payment would be cut and your yield would decrease. I would rather buy a stock that pays me around 2-3% currently, at a time when fixed income can provide me with a 4.5% - 5.00% yield, BUT which would increase its dividend payments in the future.

There are other lists of stocks which are considered dividend achievers. Another one worth focusing on is the Mergent's Dividend Achievers 50 and High-Growth Rate Dividend Achievers. The issue with those lists lies in the fact that it gives you only companies which have raised their dividend at least over the past 10 years. There are at least 300 such companies in the US currently, so for a small investor like me, this is a pretty big universe of stocks. The S&P Dividend Aristocrats and the High-Yield Dividend Aristocrats on the other hand contain 50 or so stocks each, which is a more manageable list to follow.

In my strategy, I would focus on buying stocks which give you at least the same yield as the broad S&P500 index, as represented by SPY. Furthermore, i would give preference to the dividend aristocrats and the high-yield dividend aristocrats over the other dividend achievers. In addition, I will look for companies, whose dividend payout ratio does not exceed 55-60% at the time of purchase. I would also try to equally weight my purchases. So for example if I invest 100 dollars per week, and I have a list of 52 achievers that fit my criteria, i would buy a different stock each week in a given year. I will not re balance my portfolio though, since this will increase my trading costs; it also runs contrary to the old adage of "cut your losers and let your profits ride".

I will try to diversify across sectors, without being too overweight in a certain sector like financials or utilities, which could prove to be easier to say than achieve. I will also look for an average dividend growth of at least 3% (which is the average long-term inflation rate). However, I might consider buying any stock that shows a growing dividend, even by a single percent per year, provided that the company spots an above average yield. Even though the passive dividend income will rise much slower, your money will compound at a higher rate for a long period of time. A very good dividend stock candidate for purchase would be one showing an above average dividend growth as well as an above average yield.

I would consider selling a stock once it starts decreasing dividends; I won't sell simply because a company whose stock I already own does not raise its dividend, but I might not add any more fresh money into this position.

My goal is to achieve an above average yield on cost in the future. For example if I had invested $1000 on Dec 31, 1989 in MO ( Altria ) you would have bought 24 shares and had a dividend income in 1990 of $35, and achieved a dividend yield of around 3.5%. If you held your stock until Dec 31, 2006, you would have had a dividend income for 2006 of $239 on 72 shares! That's an almost 24% annual yield. Your 24 shares would have turned into 72 shares worth $6179 at the end of 2006. Furthermore, if you had reinvested your dividends the $1000 investment in 1989 would have turned into $18,167!