Tuesday, March 11, 2014

How to invest for dividends when markets are overvalued?

As someone who been dedicated to my dividend investing since 2008, I get to interact with a lot of individual dividend investors. Since the beginning of last year, many of those investors have been unhappy that stock prices on many quality companies are overvalued. As a result, some investors are accumulating cash, waiting for lower prices. Others are expanding their search, and leaving no stone unturned, in their quest for dividend bargains.

In a previous article, I explained why I am not in the camp of accumulating cash and waiting for lower prices. That is because I am in the camp of leaving no stone unturned looking for quality bargains. While the stock market is slightly overpriced, I am not too worried. This is because I focus on evaluating the valuation of individual companies rather than make evaluation decisions on the overall US stock market. I am lucky that I buy individual dividend paying stocks in my taxable accounts, because I only purchase securities when I find them to be fairly priced. I believe that one can always find enough quality dividend paying companies in almost any stock market environment. Plus, I always keep a list of companies to accumulate on dips.

Every month, I add new funds to my portfolio. In addition, I also let dividends accumulate in cash. I prefer to invest my funds as soon as I reach my minimum lot size. Luckily however, I always find several quality dividend stocks to purchase. In fact, I can always find anywhere between 15 – 20 companies that are attractively valued and I like, that are competing for my investment dollars. I then have to check my portfolio allocations, and pick one or two that I like best. As a result, I typically end up purchasing the same stock mostly once or twice a year.

Finding quality dividend stocks on sale is not that difficult, even during periods of market excess such as the 1990’s. Despite the fact that markets were overvalued in 1999 for example, there were some pockets of opportunity. There had actually been some great bargains such as REITs, Financials and many old economy stocks, which otherwise were perceived as boring. Despite this perception, those companies managed to grow profits and distributed higher dividends every year since then. It is important that the investor maintains a regular screening process, and develops a list of companies that would be attractive to consider on dips. It is also important that the investor thoroughly analyzes as many companies as possible, in order for them to be able to pull the trigger at a moments notice.

I also keep a dividend wishlist, where I list out companies I would like to purchase on dips. During the next market correction or if any of these companies misses earnings projections by a quarter of a penny, I might get lucky and snap up some shares to increase my position. Throughout my tenure as a dividend investor, I have had my fair share of wins and losses. One manages to learn from both outcomes, and manage those risks when outcomes are unfavorable. Some of my best winners have been companies which have been overvalued forever, but through careful monitoring, I had been able to buy a small stake in them. Companies like Yum! Brands (YUM), Family Dollar (FDO), Visa (V) come to mind. Unfortunately, my position in each of these companies is really low, because I tend to build my positions slowly.

Dividend investors are lucky, because most of them tend to focus on growing their passive income stream. They ignore short-term price fluctuations, and focus on selecting the fundamentally sound corporations, that will deliver the profits growth that would ultimately lift stock prices and annual distributions. Dividend investors do not purchase a market index, but focus on building a portfolio of quality income stocks by patiently allocating funds every month. By layering their portfolio brick by brick, these investors are creating a solid foundation for long-term results.

So to summarize, no matter what environment you are in the stock market for shares, a dividend investor should not worry because they are purchasing individual businesses. Investors are not purchasing pre-determined baskets of securities, regardless of valuation. A dividend investor shouldn't abandon their approach, especially when speculators are temporarily making a lot of money with riskier investments. The reality is that there are always dividend bargains out there, which require some good work to be identified. In addition, one needs to closely monitor companies on their wishlist, in order to capitalize on any short-term weakness caused by short-term noise, such as an analyst downgrade for example.

Full Disclosure: Long V, FDO, YUM

Relevant Articles:

Five Dividend Stocks which beat Index Funds
Why I am a dividend growth investor?
How to accumulate your nest egg
Frequently Asked Questions (FAQ) About Dividend Investing
How to invest when the market is at all time highs?

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