By Ben Reynolds
Timothy McIntosh is the Chief Investment Officer and co-founder of SIPCO.
He is an accomplished dividend growth investor. He also runs The Dividend Manager -- a site focused on dividend investing.
Timothy's investment style is explained in brief below (excerpt from The Dividend Manager)
"Over the years, stocks of companies that initiate and consistently grow their dividends have outperformed the broader market, and have significantly outperformed stocks that cut or don't pay dividends. This is known as the dividend growth effect. Once a company enters a cycle of increasing dividends, it is highly motivated to maintain the trend. It is constantly under pressure to increase profits and cash flow every year, because if it doesn't, it will be forced to decrease or suspend its dividend, which usually leads to a sharp sell-off in the stock. The best indicator of a company's ability to grow its dividend in the future is typically its track record of growing it in the past. Companies with a history of growing dividends have proved they can not only sustain but also grow dividends, even during down markets."
High quality dividend growth stocks have historically outperformed the market. The performance of the Dividend Aristocrats Index is an excellent example of this phenomenon. The image below shows this performance:
You can download a full list of all 50 Dividend Aristocrats here.
Timothy's interview is below.
Sure Dividend: You have a varied and impressive background. Please tell us a bit about yourself and your background.
Timothy McIntosh: I started out as a Cryptographic Analyst in the U.S. Army breaking down Morse code.
After my tour in the Army, I went to college in Florida, working on degrees in economics and a master's in public health.
But I always had a love for the stock market and after working at Blue Cross for a few years I switched careers and became an investment manager. I been managing money now since 1999.
SD: What motivated you to write The Snowball Effect?
TM: I unfortunately started my career in 1999 just as the internet craze was collapsing. Then after climbing back through, the bear market 2008 came along.
These two dramatic collapses in the market had a profound effect on my investment strategy for my clients. I began to invest much more in income producing securities like dividend stocks and other assets.
I started the process of this book in 2013. I really wanted individual investors to grasp the concept that the stock market does not always go up and only relying upon capital appreciation is a difficult game.
Once investors find out that the Dow has spent 70 percent of the time going sideways, it makes dividend investing much more attractive.
SD: What are the most common mistakes you see dividend investors make?
TM: Buying high and selling low. Panicking out of the markets when volatility rises and the market falls.
An investor must realize that as prices fall, stocks become more undervalued on a long-term basis and that dividend focused investors can buy more shares of stock when prices are down.
SD: You discuss the advantages of small cap stocks over large cap stocks in The Snowball Effect. Where should investors look to find high quality small cap stocks?
TM: Yes, obviously the book is full of research. That has always been my approach. I wanted to show individual investors that small caps are not as attractive an asset as many financial advisors or companies say they are. At least the ones that don't pay dividends.
The research shows that small dividend companies do provide value, but most of the diversification value comes from micro cap dividend companies (the smallest of all companies on the NYSE). Finding and researching micro cap companies is difficult as Wall Street does not cover many of them. It involves reading through 10ks and really doing your homework. They may find these companies by using online screeners from Morningstar or Yahoo Finance.
SD: The time to sell a dividend stock is not discussed often. When is the right time to sell a dividend stock?
TM: It is always a difficult call. Many of the dividend stocks I have purchased, I have held for over a decade. I generally rely on a few things.
One, is the stock overvalued on a price/yield analysis? If the stock you own has consistently paid a dividend and raised it, but the price has advanced much further than earnings or dividend increases, then it might be time to sell and find another dividend paying company.
I use an example in the book on Pepsi (NYSE:PEP). Pepsi has generally yielded from 2.4% yield to a 4% yield over the last decade. This is based upon the current price and what the annual dividend is.
I would recommend an investor look to buy Pepsi when its yield approaches 4% and consider reducing the position or selling it when the yield drops below 2.5%. Other items that would cause an investor to sell would be a reduction in the dividend, any accounting regularities, changes in management.
SD: Writing covered calls for additional income is a topic that many dividend investors are interested in. What are some good "rules of thumb" for writing covered calls for additional income?
TM: Write covered calls if you don't want to sell but think the value of the company you own is higher than you prefer and above its historical average.
In the book, I use the example of Pepsi again. In many instances, especially where large capital gains are at stake, it might be better to write a covered call against your position than sell. And always pick a higher strike price (when the shares can be called away from you), and a price that you are happy to sell at.
It's a great tool for dividend investors wishing to collect additional income from their investments over time.
SD: Your book covers investing in bonds as well as dividend stocks. When do you recommend investing in a corporation's bond instead of its common stock?
TM: Corporate bonds are actually much like common stock. The correlation of the two (or how they move together) is very high. But they offer more protection as a bond is legal tender against the assets of the firm. It provides enhanced diversification and the downside is less than common stocks.
You also have the protection, if you own individual corporate bonds, of collecting your original investment back upon maturity. This is as long as you choose wisely among the many corporate bonds available.
SD: In your book you list your Top 100 Dividend Stocks. How do you determine these stocks? Do you use a quantitative, metrics based approach, or is your analysis qualitative, or a mix of the two?
TM: For the book I utilized quantitative analysis. This includes my five favorite metrics: yield, growth rate in dividends, financial rating, beta (or volatility), and price/earnings ratio. A company scores highly if they have an above average yield, above average dividend growth, a strong financial rating, low beta, and low price/earnings ratio.
There are of course lots of other financial metrics to use, but these are the five I used. Its really a starting list for investors. You also have to look at qualitative factors like management team, product mix, consistency of earnings, outlook for sector, etc. But by ranking the firms through this method, you generally get a list of the "best of breed" companies within the large cap dividend paying universe.
SD: What is the most important piece of advice in The Snowball Effect?
TM: I hope the reader understands that stock market returns are fickle and come in short-term time increments. Much of the time, the stock market treads water.
If you are a great stock selector, then terrific. But most managers in the long term underperform the markets. However, dividend investors collect their money each quarter, reinvest those funds, and are much more insulated from stock market declines.
It's not the price of the security that should matter so much, but the income it provides. Look outside the box at corporate bonds, covered call writing, and micro cap stocks also to diversify. Lastly, focus on the long-term and not the short term gyrations of the market. Most investors underperform because they are either lousy market timers or stock pickers. Long-term dividend investors don't have to worry about either.
Timothy's investment strategy and quantitative ranking system are similar to my own -- The 8 Rules of Dividend Investing. His long-term, dividend focused approach should appeal to individual investors.
For those looking to explore this strategy further, see Timothy's new book, The Snowball Effect.