How To Approach The Beginning Days Of A Long-Term Dividend Strategy

Includes: BP, COP, CVX, JNJ, KO, RDS.B, TOT
by: Tim McAleenan Jr.

When you look back at the secular bull market that occurred from 1980 to 2000, one of the takeaways is this: it was not exactly a time of national focus on dividend-paying stocks. This is largely understandable. When stock prices seem to be rising by 10% every year, it becomes easy to ignore the effects of those "puny" 2-3% dividends when substantial wealth is being created by rising stock prices, seemingly like clockwork year after year.

This is probably the biggest deterrent to starting a strategy that focuses on accumulating a portfolio of dividend growth assets. If you're starting with $10,000 and buy a stock that yields 3%, you only have $300 of first year annual income. That fact alone may deter many from pursuing an income investing strategy. To develop the perseverance that is necessary to start a dividend strategy from scratch, an investor must train himself to think in terms of "dividend rights" [term courtesy of David Van Knapp] rather than present dividend income. When you buy a well-chosen blue-chip stock that pays dividends, you have just become the owner of a cash-generating machine that is going to give you automatic 7-11% dividend increases each year, provided you monitor the earnings growth to make sure the dividend is well-covered.

When you are first starting out, the $5 and $10 dividend checks that arrive in the mail or appear in the brokerage statement may seem underwhelming. It may seem like you need a $500,000 starting portfolio to get rolling with a dividend-focused strategy. But that doesn't have to be the case. Instead, it is much easier to conceptualize the early days of dividend strategy by thinking of it as planting a tree, one at a time. Maybe in 2000 you planted a Chevron (NYSE:CVX). In 2001, a BP (NYSE:BP) tree. In 2002, a Total SA (NYSE:TOT) tree. In 2003, a Royal Dutch Shell (NYSE:RDS.B) tree. When you break your investment process down into concrete steps with an eye on the future dividend income, it can become much easier to see how the starting days of dividend investing can turn into something meaningful if you give it a bit of time.

Chevron went from paying out $1.30 in dividends in 2000 to paying out $3.60 for each share today.

BP went from paying out $1.43 in dividends in 2001 to paying out $2.16 per share today. That's not bad considering that the company experienced terrible losses from the Gulf oil spill, yet still managed to raise the dividend by a decent amount despite having to cut it in half along the way.

Total went from paying out $0.87 per share in 2002 to over $3 today.

Royal Dutch Shell went from paying out $1.95 per share in 2003 to $3.44 today.

In fact, these are the reasons why it is easy to think like a long-term shareholder and stick to a dividend-focused strategy once you get the ball rolling. When you own an asset that keeps feeding your checking account more and more money each year, it gradually becomes easier to become committed to a dividend strategy because those $100 checks turn into $108 checks without any additional effort on your behalf. The only thing you have to contribute is the initial capital. From there, the company does the rest, and the annual increases are automatic. It is usually the recognition of that fact that allows someone to commit to a dividend strategy if they are starting with a small sum.

There is a reason why folks use David Fish's CCC List as the starting point for many of their stock selections. There is a reason why long dividend growth streaks get cited with the kind of reverence you'd expect from someone citing Scripture. Once you acquire a high-quality cash generating asset, it's hard to let go of something like Coca-Cola (NYSE:KO) or Johnson & Johnson (NYSE:JNJ) that has been raising dividends through wars, periods of high inflation, high unemployment, tech bubbles, more wars, and financial crises ever since JFK was the president. If you take it one investment at a time, and make realistic dividend growth assumptions about the coming five to ten years, the motivation to get through the early days of the strategy can become much easier.

And by the way, this comes with one unexpected benefit. When you place your primary focus on the dividends, it becomes much easier to hold a stock during a 30% stock price correction. If you own a business that keeps giving you raises each year, why would you feel compelled to sell it to someone that is trying to take it off your hands for 30% less than it is worth? It is the development of this kind of thinking during the early stages of executing a dividend-focused strategy that can make it worthwhile from a total return perspective, because it should drastically reduce your compulsion to sell during severe stock market declines. The reason why individual investors usually lag the market indices is because they sell out low, and if you train yourself to focus on the growing dividends, you can drastically reduce the likelihood that you'll fall victim to the misfortune of selling during market bottoms.

When I point out the advantages of a dividend strategy, a common response that I have encountered is this: "If it's so great, why doesn't everyone do it?" There are a lot of potential answers to that question, but the main one is that the early days of dividend investing may appear underwhelming. It takes a certain kind of wiring to get excited about the initial $5 and $10 dividend checks. You often have to approach from the perspective of someone planting a tree each year, with the realization that the tree waters and grows itself after you plant it. If you buy 100 shares of ConocoPhillips (NYSE:COP), you should not just think of the $264 in present income that you have bought. Rather, it is helpful to keep in mind that you have bought the rights to the dividends that those 100 shares will be generating ten years from now. It is this eye towards future income that gets the dividend investor through the early days of the strategy.

Disclosure: I am long JNJ, COP, BP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.