A while back, Five Plus Investor wrote an article titled: "Sleep at Night Investments: Utility Prefered Shares," in which the author made a distinction among the various forms of dividend/income investors. I won't repeat what she wrote, as the direction of this post is built around the idea of Dividend Growth Investing. Here's the definition of DG investing as offered by Five Plus:
Dividend Growth – This method is considered the surest path to a secure and growing dividend stream. Dividend growth stocks are primarily common stocks with a “sweet spot” yield between 2% to 4% and a dividend payout that increases at least once per year. This method is addressed often on Seeking Alpha and has many faithful adherents. For retirement purposes, this method works best when starting young and investing much, or when starting later with a large capital base. The motto of the Dividend Growth Investor is: “slow and steady wins the race.”
To be sure, there are always variations on the theme and some have a little nuance to their own definition. But suffice it to say, this definition is a pretty good one, in my opinion.
Whenever DG investors run into criticism, it is usually from people who do not follow this style of investing. Those same people will often offer up criticisms that have little or nothing to do with the investment philosophy of the DG investor. I guess because there's so many variables in DG investing, the waters get muddy very quickly. Here's my own take:
1. Thou shall seek and identify companies that have a committment to paying dividends and have done so for long periods of time.
A great place to find a list of these companies is at David Fish's site.
2. Thou shall invest in companies that have increased their dividends annually and have done so consistently.
If a company has not maintained its dividend over time, it is no longer a Champion, Contender, or Challenger. It's just a "stock."
3. Thou shall invest in companies that have a low payout ratio for those dividends, related to their earnings.
Now there are times and companies that pay out a large share of dividends relative to earnings. Your call, but with few exceptions, I like companies that keep the payout ratio under 60%.
4. Thou shall invest in companies that can sustain those dividends by having the earnings growth to continue paying them.
Sustainability. That goes back to the payout ratio. Can the company continue to raise that dividend or not?
5. Thou shall not chase yields without identifiying value.
However, there are folks that like to set a target purchase price, relative to yield. I do it all the time. I recently bought some more T at a 6.25% yield. Price pullbacks are often a time for additional purchases.
6. Thou shall only invest in companies that have great fundamentals.
We look for quality and value though careful analysis of P/E ratios, PEG ratios, FCF, ROE, Earnings Growth, Debt to Equity. We are not looking to buy everything. I am talking about some boring companies like Procter & Gamble (PG), Coca-Cola (KO), Colgate-Palmolive (CL), McDonald's (MCD), ConocoPhillips (COP), AT&T Inc. (T), etc.
7. Thou shall be patient.
Time and patience are the key to DG investing. Starting young is great! When you start young, your earnings power compounds. The yield grows year after year, the actual dividend increases, you are reinvesting and adding to your position. My positions in KO and CL are 20+ years old. MCD, T, and PG have been in my portfolio for 15+ years. They and others in the portfolio have increased my YOC numbers and provide a large income stream that grew every year.
8. Thou shall not be a "buy and hold forever" investor. Instead, "buy and monitor."
The reason you initiated a position in a particular company can change. Things change over time. If the reasons you made an initial purchase are still in place, but the stock has declined in price, it may be time to increase your position in that stock. Recently added to PG at $58. Bought some additional T at $27, just last week.
9. Thou shall build a core group of companies in your portfolio.
By selecting a core group of companies, we are able to diversify throught the investment universe. That core should be made up of those companies that you deem the "best in breed" for that particular sector. While my core is made up of S&P 500 dividend growth stocks, I also have companies that are more value buys than they are long term holds.
10. Thou shall focus on creating an income stream that will allow you to retire comfortably.
That doesn't mean necessarily quitting work and becoming a couch potato--but if that's your goal, good for you. You may decide to take on a new career of service. One that may not pay much. Something you've always wanted to do. Now you can, because you have supplemental income. So, what's holding you back?
I am sure that many of you can come up with additional thoughts.
Disclosure: I am long KO, T, PG, CL, MCD, COP, PG.