6 Types Of Dividend Investment Strategies, Part I

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Includes: ANH, AZN, BMA, CTL, LLY, LMT, MO, NHI, NLY, NNN, NPK, NYCB, OHI, PNNT, SAN, SCCO, T, TCAP, TEF, TRTN, VGR, WBK, WIN
by: Stocks 1

Dividend investing can take many different forms. The ever-present trade-off between current dividend yield and dividend growth rate can create puzzling decision making situations for investors. They are faced with the eternal dichotomy of: is it better to concentrate on higher current dividend yields or opt for lower current yields and higher dividend growth rates (DGR)?

To further complicate matters, there is also the question of: is it better to go with individual stocks or dividend paying funds, or some combination of all of these? In this article I present six types of dividend investing strategies along with a portfolio based on each strategy.

The Six Types

  1. Income Investing (High / Very high current yield; lower DGR)
  2. High Yield Investing (Very high current yield; lower DGR)
  3. High Growth Investing (High / Very high DGR; lower current yield)
  4. Long Term Growth Investing (Mid-range current yield; mid-range DGR)
  5. Dividend Diversity Investing (A combination of the first four types)
  6. Income Through Funds Investing (Very high current yield through funds)

My objective is to construct and offer what I consider the best 10-stock portfolio for each of the six types. Considerable thought went into each of the six portfolios. I explored hundreds of stocks and went through a rigorous sequence of selection steps to pick each single stock. They had to conform to strict criteria in order to be chosen.

Criteria include the essential metrics such as return on equity, free cash flow, sales and earnings growth potential, debt to equity ratio, and many other financial, valuation, and performance metrics. Every portfolio was examined from various points of view, including constituents, diversification, correlations, volatility, and more.

Undoubtedly the readers can come up with other types, but here for the sake of article size I settled for these six broad types, which should cover most strategies.

The article is divided into three parts, each part covering two strategies.

REITs, BDCs, and MLPs

I have utilized REITs and Business Development Companies (BDCs) in some of the portfolios as appropriate. But in order to keep the portfolios usable by most readers, I have left out MLPs. Even though they can be an important component of income portfolios, they may not be suitable for or desirable to all investors due to their different US tax treatment. I will cover MLPs in a separate upcoming article.

As for REITs, It's best for US investors to hold them in a tax deferred retirement account, since they are classified as pass-through entities where income flows to shareholders directly without being taxed at the corporate level. For this reason their dividends are non-qualified, so if held in a taxable account, they are taxed at regular income tax rate. Also keep in mind that starting 2013 all dividends will be taxed as ordinary income.

The Potency Score System

The last column of each table provides you with the Potency Score. If you have been following my articles you have a good idea what it is, but for those unfamiliar with it, please see the articles here, here, and here for the original System presentation and its successive improvements and enhancements. But I'll give you a one sentence description here:

The Potency Score encapsulates the most important metrics about a company's long term dividend growth potential, and thus its overall growth, into a single rating, allowing easy comparison between companies.

The scores listed in this article were produced by the Version 3.0 System.

The Definitions

For the purpose of this article I use the following ranges as a guideline for dividend yields and growth rates. However, these limits are not absolute and will be liberally crossed on either side when otherwise desirable or appropriate.

Low

Mid-Range

High

Very High

Dividend Yield %

2.00 - 2.99

3.00 - 4.99

5.00 - 6.99

7.00+

Dividend Growth Rate %

0 - 10

11 - 19

20 - 29

30+

Click to enlarge

Thermostat For Portfolio Adjustments and Diversification

Readers who like one of the portfolios but feel it requires adjustments can use that portfolio as the basis for constructing their own. I have provided alternative stocks for each portfolio to act as a thermostat, so that the portfolio can be made more aggressive or more conservative by switching in one or both alternatives. If a reader feels this is still not sufficient or desired, they can pick and choose from the portfolios of any of the other types, or add their own picks.

I should also point out that a portfolio of only 10 stocks can not be made sufficiently diversified. So the picks here are intended to be a foundation to build upon.

Type 1 - Income Investing (High / Very high current yield; lower DGR)

Investing in high and very high yield stocks encompass two different strategies. While both strategies seek high/very high current yields, they have diametrically opposing goals. They are divided into Type 1 and Type 2. A high dividend growth rate is not expected.

The Income Investing Strategy is a conservative strategy in which, despite requiring a high current yield, it is expected that the yield be fairly stable and reliable. The yield is often looked at as income and used for living expenses. Generally, but not necessarily, this strategy is most suitable for a higher age range with a real or perceived shorter time horizon. To some extent, this strategy is used for bond replacement.

One of the sectors that is particularly popular with Type 1 is utilities, particularly electric utilities. The main reason I have avoided them here is that they have had a huge run up since the March '09 market bottom, due to low interest rates and market volatility -- thanks mostly to the practitioners of income investing strategy themselves. Many are at 52-week highs and even at all-time highs. I believe this is not the time to buy utility stocks. Once their P/E ratios contract to reasonable levels, utility stocks including, AEP, EXC, SO, DUK, D, and others could be selectively added to the conservative portfolios.

Income Investing Portfolio

Data as of close Friday, 12/16/2011

All the tables are sorted by the % Dividend Yield

Sym

$ Price

%

Dividend

Yield

P/E

Forward

% ROE

5 Year

Avg.

Price/FCF

5 Year

Avg.

$ Mil

Market

Cap.

Potency

Score

TEF

16.63

12.77

7.56

42.79

10.20

84,163

27.66

WIN

11.58

8.85

14.10

107.11

6.30

5,896

10.81

OHI

19.00

8.69

20.50

11.39

13.59

1,812

8.65

CTL

35.26

8.20

13.81

10.98

8.54

21,759

18.66

WBK

101.51

8.83

9.20

18.77

15.09

61,211

12.81

NNN

25.96

6.19

24.86

10.01

-10.54

2,370

4.08

AZN

45.25

5.98

6.26

39.32

10.20

59,293

19.38

T

28.85

5.97

11.64

12.48

13.73

172,331

7.42

MO

29.14

5.71

13.41

57.79

14.74

57,873

17.79

LMT

77.10

5.24

9.95

56.51

11.89

24,810

28.86

For a more Aggressive

Portfolio switch in:

For a more Conservative

Portfolio switch in:

TCAP

LLY

NLY

NHI

Click to enlarge

Type 2 - High Yield Investing (Very high current yield; lower DGR)

The High Yield Investing Strategy, on the other hand, is a risk/reward strategy that seeks aggressively very high current yields, but without throwing all caution to the wind. The strategy takes into account the potential big risk involved with the super high yields, so it tries to find the stocks with the best risk/reward profile.

High Yield Investing Portfolio

Data as of close Friday, 12/16/2011

Sym

$ Price

%

Dividend

Yield

P/E

Forward

% ROE

5 Year

Avg.

Price/FCF

5 Year

Avg.

$ Mil

Market

Cap.

Potency

Score

NLY

16.37

14.80

7.04

11.38

-4.29

15,832

20.27

TEF

16.63

12.77

7.56

42.79

10.20

84,163

27.66

PNNT

10.16

11.05

8.28

-0.37

n/a

492

14.92

BMA

19.95

10.78

4.06

23.43

25.93

1,161

14.32

TCAP

18.22

10.35

8.76

7.96

n/a

428

17.44

SCCO

29.46

9.63

10.30

44.36

22.60

23,216

20.42

NPK

93.89

9.09

11.39

15.28

-33.81

634

21.67

OHI

19.00

8.69

20.50

11.39

13.59

1,812

8.65

NYB

11.97

8.44

10.86

6.76

10.61

5,205

6.81

TAL

27.08

7.99

7.15

12.39

-11.93

896

n/a

For a more Aggressive

Portfolio switch in:

For a more Conservative

Portfolio switch in:

ANH

CTL

STD

VGR

Click to enlarge

Conclusion

The objective of the High Yield Investing portfolio is to start with a very high current yield, but at the same time keep sustainability and volatility in mind. The high yield clearly increases risk. To counter-balance the risk, I emphasized a higher level of diversification in this portfolio. As with all the presented portfolios, I went through substantial research in constructing this one.

The result includes picks from a wide range of sectors from mREITs (NYSE:NLY), equity REITs (NYSE:OHI), BDCs (PNNT, TCAP), a foreign copper company (NYSE:SCCO), a foreign telecom (NYSE:TEF), a domestic and a multi-national bank (NYB, TEF), and more. It is my view that the portfolio's level of risk/reward is attractive for a fairly aggressive portfolio that it is.

In Part II, I will explore dividend investing strategies Type 3 and will present portfolios for each.

Disclosure: I am long TEF, OHI, CTL, AZN, T, LMT, NLY, NHI, ANH, STD.

Additional disclosure: I may initiate a long position in one or more of the stocks discussed over the next 72 hours.