Friday, April 4, 2014

When to buy dividend paying stocks?

Dividend investors should not view every stock they purchase as a price that fluctuates on a computer screen however. On the contrary, they should view each stock purchased as a share in a business. Therefore, the most important thing to focus on is the underlying strength of the business you are investing in, and not day to day fluctuations in security prices.

Once an investor has a list of quality businesses, he needs to be able to decide at what prices to purchase them.

Fluctuations in security prices should be utilized by the enterprising dividend investor to his or her own advantage. In order to be rational and allocate their money in the most efficient manner, the intelligent dividend investor should have devised a system for buying. This system would allow the investor to acquire shares of quality companies at a reasonable price.

The intelligent dividend investor should know that even the best company in the world, is not worth purchasing at any price. Therefore, they should realize the value of being patient, and only buy securities when they are available at attractive valuations. The number of quality companies selling at cheap prices would vary depending on the conditions on the stock market. During times of Irrational Exuberance, it would be almost impossible to find securities, whose prices are not bid up in the frenzied environment. The opposite happens during stock market panics, when doom and gloom circles the common psyche of scared investors, who rush to unload their holdings at rock bottom prices. During these panics, the number of bargains could typically be overwhelming.

However, these environments on both ends of the spectrum of extreme circumstances are relatively rare in occurrence. An investor is much more likely to experience an environment which is somewhere in the middle, with quality securities being available from some sectors, but not in others. Again, having the entry system and the patience to wait for those opportunities is of utmost importance.

For example, I usually run a screen at least two times per month on the list of dividend champions. I use the following parameters:

1) A company raising dividends every year for at least a decade
2) A price to earnings ratio of less than 20.
3) Annual dividend growth exceeding twice the annual rate of inflation
4) A dividend yield that exceeds 2.50%, which is slightly higher than the yield on S&P 500
5) A dividend payout ratio below 60%, in order to ensure sustainability of distributions

Note: For REITs and MLPs, I look for FFO and DCF information, rather than earnings. As those as more advanced securities, they are not the point of this article.

The output of this screen only provides with a quantitative view of a list of businesses. It should not be an automatic signal to buy, especially if the investor knows nothing about the businesses that are produced by that screen. If the investor has analyzed the companies that are on the screen already, he or she can put their money to work by acquiring shares in these enterprises.

It is important to also take into account existing portfolio weights and holdings, after screening for attractively valued quality dividend growth stocks. When presented with the results of the screen, investors should first always initiate positions in quality companies that are rarely undervalued. Then, they should add to existing positions, as long as they are not taking a prohibitively high portfolio weight. Again, this paragraph assumes that the investor already has knowledge of the company they are buying, and finds it to be a quality company.

It is very common for the investor to see the same companies on the screen for months or even years to come. Therefore, it could be wise to be on the lookout for candidates that are new to the screen results. In addition, it might also be important to get into the habit of monitoring companies you are interested in for steep drops on negative news, which could also present an opportunity to buy a quality company at a bargain price. Unfortunately, these usually do not come out with a consistency that a twice monthly regular screen would produce. Therefore, keeping an open view could prove to be profitable.

In addition, I also like it when the companies I am investing in have a plan to grow earnings per share. Examples include IBM’s (IBM) strategy to grow earnings per share to $20 by 2015.

Full Disclosure: Long IBM

Relevant Articles:

How to be a successful dividend investor
How to identify your dividend investment goals
Where to search for investment opportunities?
Diversified Dividend Portfolios – Don’t forget about quality
Not all P/E ratios are created equal

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