My dividend income investing strategy has four key components. The four components interact with each other to produce a stable and outperforming income stream. The two key portfolio goals are obtaining a high dividend yield on invested capital, and preservation of invested capital. In this article I will focus upon my methodology to obtain these goals.
1. Economic Based Dividend Investments
American Capital Agency Corp. (NASDAQ:AGNC) has provided shareholders a 26.5% total annualized rate of return, each year, due to the historically low interest rates. American Capital Agency, as a mortgage real estate investment trust (mREIT), benefits when the U.S. Federal Reserve chairman emphasizes a low interest rate environment.
American Capital Agency borrows at low yield repurchase agreements and buys longer dated agency mortgage backed securities (MBS) backed by the U.S. Federal government.
American Capital Agency's current dividend is 16.3%. The Treasury Rates will not remain low forever. As a mREIT investor, I will sell American Capital Agency shares when interest rates start to increase. This is a stock for the current economic environment. I will be quick to sell American Capital Agency shares when the business model changes.
2. Dividend Growth Investing
I pay close attention to companies I assign as dividend growth stocks. Many companies do very good for 2 or 3 years, but then the company's dividend stops growing. I want to avoid these flash in a pan dividend growth stocks.
Philip Morris's 5 year performance has provided shareholders with a 17.4% total annualized rate of return. The company, on April 19th, reported an excellent first quarter performance. The earnings were up 17.9% versus the 2011 first quarter results. Management has shown a tendency to raise the annual dividend in the latter half of the fiscal year.
Philip Morris buys back a significant amount of shares. This reduces the total outstanding shares and increases the earnings per share. In the first quarter, the company bought back 18.1 million shares at a cost of $1.5 billion. The company projects to buy back $6 billion in shares during the course of 2012.
3. Cash Cow Dividends
Cash cow stocks are known for their slow growth but predictable dividends. An example is Linn Energy (LINE).
Linn Energy, LLC pays predictable quarterly distributions. Linn Energy finds oil and natural gas properties. The key is the properties are long life and the production stream is hedged to guarantee the current payout.
As the above table shows, Linn Energy has averaged a 15.7% total annualized rate of return . This assumes distributions are not reinvested. The current distribution yield is 7.2%. Cash cow business models typically do not have a lot of surprises. Shareholders receive their quarterly distributions on time and the amount is predictable.
As long as the company is operating on all cylinders, I reinvest distributions into more shares. Compounding plays a significant role in the yield on invested capital.
4. Special Situation Dividends
Special situations, in my opinion, are critical to outperforming the market. Major special situations can provide ample reward for shareholders. An example is ConocoPhillips (NYSE:COP).
ConocoPhillips is spinning off its refinery unit. Conoco will remain as an upstream oil entity. The company is expected to pay a 5% first year dividend, buy back stock, and increase dividends on an annual basis. Creating two business units allows two management teams to focus upon their speciality and excel in their given niche.
I anticipate keeping Conoco shares and selling the refinery shares. Refining has been, in my view, highly cyclical and is not a business sector I want to invest in.
The above strategies focus upon owning the right investments at the right time. My goal is to have a diversified income portfolio. There are some stocks I will own for a few decades. Other names have a far shorter life span in my portfolio. My portfolio continues to adapt to the world around us and my goal is to identify the industry leaders in each strategic income investing sector.