One of the expressions that is being used increasingly in all types of discussions is sustainability. Wikipedia describes it as the capacity to endure, to remain diverse and productive over the long term.
I think the concept is as relevant to personal finances as anything else. Why? Because as individuals, we have limited resources both in terms of time, money to invest, resources to buy, etc. It becomes key to successfully build a long term portfolio that can be productive over long periods of time without spending dozens of hours every week.
Some of us, including myself, enjoy financial markets so much that we don’t mind spending time every week tracking what is happening, how it impacts the financial markets and our own portfolio. That is not the majority however as you can imagine.
What Defines a Sustainable Dividend Portfolio?
- Income Consistency: Recently, I discussed dividend aristocrats and how they have been able to keep paying - and even increasing - dividends for 25 years and counting. That is an amazing achievement, and one that gives us confidence in receiving income for decades to come. More than anything else, a sustainable dividend portfolio should give us confidence that payouts will remain at a given level and increase over time. Quite a few of the 20 things that we look at when judging dividend stocks help us determine if a stock fills this criteria. For example, a stock that low debt and a low payout ratio has better odds of maintaining its dividend payout.
- Income and Capital Growth: As we’ve discussed in the past, dividend consistency is not enough. One of the big reasons why we rarely determine that the top dividend stock yields are worth the investment is because of their limited future increases. Over the long term, being able to increase sales, earnings and dividends is key and is certainly the second most important factor to consider when judging a dividend stock.
- Steady Returns No Matter How the Market and Economy Perform: While some companies, such as those in the technology sector, or cyclicals, have a lot of volatiliy in their earnings, many others are able to do well no matter how everything else is. The recent credit crisis was a good test for companies in order to see how well they could weather the storms. Any good sustainable dividend portfolio will have a few more risky names but the overall portfolio should be able to keep stable earnings/cashflows/earnings no matter how the economy performs, which will translate into steady dividend payouts.
- Protection From Blow-Ups Such as Sino-Forest and Enron : While there is no way to completely escape being caught in such nightmare investments, there are good ways to diminish the likelihood of that outcome. One such way is to avoid having a large concentration of your portfolio in one stock. Another is to stick to simple businesses, similar to what Warren Buffett would recommend. While that does not eliminate the possibility, it does diminish it.
How to Build a Sustainable Dividend Portfolio
- Focus on Dividend Growth: One of the key elements that we look at is dividend growth. Specifically, how much the dividend has increased over the past 1 and 5 years. Also, we generally take a look at the dividend for the past 10-20 years when available. That gives us a good idea what to expect.
- Buy Companies That Will Be in Business 50 Years From Now: Companies that are conservative (low debt) and have simple products that should be around for a long time are companies that can easily be included in a sustainable dividend portfolio. Companies such as Caterpillar (CAT) and Coca-Cola (KO) will certainly remain a big part of the world economy for decades to come.
- Buy Companies That Can Afford Their Payments: Paying out money is easy. Affording to do it is much more difficult. Ideally, we look for companies that can also invest back into the company. A company that pays out 80% or more of its earnings is unlikely to keep it up in the long term.
- Diversify Your Investments: Any sustainable dividend portfolio should include companies from different industries (in order for example to avoid too much exposure to one sector such as the financial sector) but also different sizes. While mega cap corporations can be very stable, it is unlikely that they will be able to maintain growth as high as smaller corporations. In a similar manner, a company like Intel (INTC) is likely to have more growth (but more volatility) than a company like Procter & Gamble (PG).
- Buy Enough Different Stocks to Limit Exposure: Finding the right quantity of stocks to hold is not a simple question. The more you have, the easier it becomes to be diversified and avoid concentration in a specific industry or to to certain stocks. However, adding names means added trading fees and also more time required to analyze, research and track your dividend investments, which defeats the purpose of a sustainable dividend portfolio.We had written about this subject in the past and while it is certainly something we will revisit, you can get our first thoughts on the subject here.
Maintain Your Sustainable Dividend Portfolio
- Save Money: As we wrote in the past, starting a dividend portfolio can be done with as little as $5000 and a sustainable dividend portfolio is exactly the same thing. Start early! After that, it becomes about setting up a regular savings program, making the right choices and being consistent.
- Buy the Right Stocks: In our articles, we take a look at quality dividend stocks in order to determine if they are good candidates. We generally use the same list of 20 things that we look at when judging dividend stocks and will certainly be writing more about sustainable dividend candidates in the coming weeks and months.
- Stay Informed: There are many different ways and following this blog is certainly one way to do this. You can also use free services such as Google Finance to enter your portfolio and get news relevant to those stocks. What you are looking for are long term trends that would make one or several of your stocks unfit for your sustainable dividend portfolio.
- Keep Your Eyes on the Goal: It’s important to keep in mind what you are aiming for, which is generally a passive income lifestyle. Having long term objectives in investing, as in almost everything else, has proven to be one of the - if not the - most important factors. That is even more important for a sustainable dividend portfolio which is built on the concept of long term investing.