Starting a dividend growth portfolio could be both time-consuming and complicated, but over the long haul, it could be your ticket to financial freedom. I started investing at the age of 23, with no real experience or parents to get advice from; as such, I was forced to learn on the run. I started following the market more closely both on TV and online. I also started reading different investing books in order to gain the basic knowledge of how the market works and how to perform basic research of an individual company. In this piece, I will cover some points that can help you get started with your own Dividend Growth Investing Portfolio.
Making the decision to begin putting your money to work in stocks could be one of the single most important financial decisions you make over the course of your life. The amount you begin with is not important. I began investing with only $2K. Once you have funded your brokerage account, the fun begins, and you can start constructing a strategy on what to invest in. I have had numerous readers and friends over the years express their interest in investing, but they all have the same questions, “Should I invest in Stocks or ETFs, and which ones?” I personally invest merely in stocks. I enjoy the hands-on research and the sense of competition they bring rather than just selecting an ETF, which owns hundreds of stocks, and forgetting about it.
ETF investing may be your selected route, and there is nothing wrong with that, but for me, I enjoy diving into the individual companies. My answer to you is it all depends on the risks you are willing to take and at what point in life you are at. A retired investor that counts on the passive income each month, I would recommend ETFs and extremely safe stocks with dividends and low volatility. ETFs are also good investment for those looking to invest minimal time in managing a portfolio, where they can invest their money and forget about the research part. Someone in college on into their 40s and 50s, I would say stocks would add more value with more risk. With higher risk comes the opportunity for higher rewards. The answer for you could be both, but in this piece, I will cover as if we decided to go the way of individual stocks.
Now that we have determined our direction, it is time to figure out the types of stocks to invest in. My general answer when readers ask which stock to invest in is generally always the same, "Invest in quality companies with a strong historical track record." This is my answer whether it is your first stock or 100th stock. You tend to know what to expect with these types of companies, thus offering fewer surprises along the way. The companies tend to have weathered the storm during downturns and thrived during times of growth. These types of companies are not a "get rich quick" approach, rather a conservative approach for long-term gain. The great Warren Buffett describes a key to investing as follows:
"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage."
Another point I would make is for investors to invest in companies they can relate to. I have a good grasp on many different areas, but for example, I do not relate much with biotech companies; as such, my portfolio will not be heavily invested in this industry. Now that does not mean I will have no biotech firms within my portfolio, but in order to maintain a diversified portfolio, which we will discuss more about below, I will have less exposure to the industry. By selecting industries you are familiar with not only makes following the company’s progress easier to understand but also you feel more connected as well.
Dividend Growth Investing (DGI) is a long-term conservative approach I tend to follow with my Big Ticket DGI portfolio. One must have this approach in order for you to reap the rewards it has to offer. The power of compounding dividend increases is what a DGI portfolio is all about. For example, if you buy a share of Coca-Cola (NYSE:KO) today, you will get paid a dividend yield of 3.26% compared to over 40%, which is the annual yield for Warren Buffett, who first purchased the shares in 1989.
Narrowing Down My Selections
Now you may be asking yourself, "Ok, I want to invest in a quality company with a strong track record, but how do I narrow them down, as there are numerous?" Great question! First thing I would do is look at stocks that are included in the Dividend Aristocrats list. In order to be included in this prestigious club, a company should:
- Be included in the S&P 500
- Increase dividends 25+ consecutive years
- Maintain a minimum market cap rate of $3B
As of August 2017, the Dividend Aristocrat list included 51 different companies meeting the criteria mentioned above. A stock with a market cap above $3 billion and trading in the S&P 500 index is the mark of a large company, hence lowering risk in a way. A company that is in the S&P 500, has a market cap in excess of $3B, and has raised its dividend for 25+ consecutive years checks the boxes for a quality company. So this list is a great start to find your dividend anchor or maybe to add another dividend anchor to your up and running portfolio. A company does not have the ability to consistently raise dividends year after year without growing earnings. Dividends at times may grow more quickly, but that is not sustainable over the long term. The key to dividend investing is to feel confident in a company’s ability to pay a dividend in the years to come and to be aware of unstable yields that appear to be sucker yields, which are high yields that a company will not be able to pay going forward.
In order to further reduce the number of stock selections, one must learn the art of value investing. This means investing in a company at a quality price and not overpaying for a stock. This is not something learned overnight. I continue to pick up on new valuation metrics to this day and I have been performing stock research for a number of years now. The best researcher is a continuous learner. There are several ways to find value in high-quality dividend growth stocks. Stocks with low price-to-earnings (PE) ratios are a good place to look for value, but just as a starting point. Compare the PE ratio to that of the S&P 500, the company’s 5yr or 10yr historical PE average, and its competitors' current PE ratio. Businesses that have suffered from negative one-time events but with fundamentals still intact may present an opportunity as well. Once you get more familiar with other valuation metrics, such as: PEG ratio, Price to Free Cash Flow, FFO and AFFO (when comparing REITs), etc., you could include these as well in your comparable metrics to find stocks at quality prices.
Now that we have narrowed down our selection of stocks, it is time to begin building our portfolio. You might be asking yourself, “How many stocks should I start with?” My answer to that is, it depends. It depends on the funds you have available. It depends on the time you have to monitor your investments. Also, it depends on what your goal is. If you are like me when I started, and only starting with $2K, I would say two stocks is probably fine. Due to fees involved with trading, you do not want to extend such amounts of capital to five or more stocks and have to pay the brokerage fees for each transaction. Now if you have funds available, but not the time to track your portfolio, I would refrain from investing in numerous stocks. Ideally you want a diverse portfolio, with investments in different industries, but at the same time you want to maintain a focused portfolio. The key to dividend growth investing is to invest for the long haul, but at the same time, following events such as quarterly earnings to ensure the fundamentals still exist. Holding a portfolio of over 100 stocks would virtually be impossible to keep up with in my opinion. My goal is to keep my portfolio in the 20-30 stock range.
Before we dive into potential stocks to build our portfolio around, I want to take the time to briefly discuss the importance of diversification. When I mentioned above about having a 20-30 stock portfolio, an investor must ensure those 20-30 stocks are diversified amongst various industries. If 75% of my portfolio was invested in Financials, I would have taken a HUGE hit during the recent financial crisis in 2008/2009. For example, below is a list of the breakdown by sector for stocks on the Dividend Aristocrat list:
Source: Simply Safe Dividends
As you can see, if this were a portfolio, there is a good mix of industries, which helps lower investor risk. What the chart above also portrays is that there are numerous high-quality companies that exist in every industry for an investor to choose from.
Building Block Stocks
Now what you all have been waiting for, some stock ideas to start or add to your DGI portfolio. I like to refer to these stocks as building blocks or foundational stocks. All stock investments are important, but if you are just getting started, you want that first investment to be of the highest quality, as you do not want to fail right out of the gate, which could happen with anyone. Here are a couple of stocks I would start my DGI portfolio with along with a short explanation why. The stocks are not listed in any particular order.
Johnson & Johnson
Procter & Gamble
Johnson & Johnson: The company has paid a dividend for 50+ years and is a dividend staple that should have a position in every portfolio. JNJ is a mature company in the healthcare industry that continues to grow at a slower pace, but is expected to launch numerous new products in the next couple of years that should reignite growth. One could find a JNJ product in almost every household. The company is stable with a dependable dividend with the trailing twelve month (TTM) payout ratio only being 57%. The payout ratio measures the amount of earnings the company uses to pay the dividend. A low payout ratio like this means the company has plenty of room to not only continue paying the dividend but also continuing to raise the dividend. Johnson & Johnson products are found in almost every household and have stood the test of time.
Source: JNJ Investor Relations
Procter & Gamble: PG, like JNJ, is what people refer to as a Dividend King, meaning it has paid increased dividends for 50+ consecutive years. This prestigious group is higher than a dividend aristocrat. The company is in a slow growth mode right now with 2017 organic sales growing only 2% during the year, with diluted EPS increasing 19%. The company is looking to deconsolidate the amount of brands it has to just 65 in order to reignite growth and refocus on the brands that got it to where it is today. Lowering the amount of brands should help streamline costs as well going forward. The company is looking for 2-3% organic growth in 2018. Looking at the payout ratio for PG, it is sitting around 75%, which is a little high, but based on the company’s dividend history and the restructuring it is going through, I have confidence management will continue its impressive dividend increases.
Source: PG Investor Relations
Coca-Cola: KO has paid an increased dividend for 55 years, which puts it in the prestigious Dividend King list, along with PG and JNJ. KO is the leader in the beverage industry with brands such as: Coca-Cola, Powerade, Vitaminwater, Sprite, and Dasani. KO has been under pressure as of late due to health concerns over the company’s products, which it has addressed with lower calorie and lower sugar drinks. Year to date, the company’s stock has increased over 10% while paying a 3.3% dividend. The TTM payout ratio currently sitting at 80%, meaning management does not currently have a ton of room to grow the dividend, but I have confidence it will continue to increase the dividend slowly while restructuring takes place. The company is currently restructuring operations away from bottling and focusing more on syrups, which should increase shareholder wealth over the long haul, and an investor should look to initiate a position on any pullback. Another reason one could invest in KO is they would be investing alongside one of the very best, Warren Buffett, who holds KO as one of his largest holdings.
3M: MMM is an industrial giant with a diversified portfolio that can make for a solid dividend anchor in any portfolio. The company has increased the dividend for 59 consecutive years. With a current dividend of 2.3% and a payout ratio of only 54%, the dividend increases should continue going forward. As mentioned, the company is extremely diversified amongst various industries. It is divided into five segments, which include: Healthcare, Safety & Graphics, Industrial, Electronics & Energy, and Consumer. The stock has been on an impressive run the last two years, as it has increased approximately 44% in value. I feel at current levels the stock appears overvalued, but with any pullback an investor should look to accumulate shares. MMM has a strong pipeline of products set to be released and demand for its electronic products will continue to drive growth going forward.
Source: MMM Investor Relations
Verizon: VZ is not an exciting stock play, but the slow and steady grower with a yield over 4% can be a safe, conservative play for an investor looking for a stable dividend anchor stock to start their DGI portfolio. The stock is intriguing as the dividend yield is close to 5% with a payout ratio of 59%, leaving a lot of room for management to continue increasing the dividend going forward. Over the last two years of trading, the stock has only increased 4.75%. It has seen increased competition in the telecommunications industry from not only AT&T (NYSE:T) but also T-Mobile (NASDAQ:TMUS). The company has increased its dividend for 10+ years, and based on its strong cash flow, I do not expect this to stop now due to the increased competition. As the next generation of mobile wireless rolls out, 5G, the company should continue to be a market leader. In addition to 5G coming soon, the company also will be looking to its Internet of Things to add growth going forward. Though the stock may be boring, the company has room to continue growing the dividend and the roll out of 5G should help increase income going forward along with its recent acquisitions to enhance the Internet of Things business.
Realty Income: Realty Income is one of the most popular publicly traded REITs on the market. The company is also known as “The Monthly Dividend Company” as it does not pay a quarterly dividend like most dividend paying companies; instead, it pays a monthly dividend. The company is a member of the S&P 500 as well as the S&P High Yield Dividend Aristocrats index for having increased dividends every year for over 20 years. As of June 30, the company’s portfolio consists of 5,028 properties located in 49 states and Puerto Rico leased to 250 tenants. It currently pays a dividend yield of 4.5% with a payout ratio of 85%, which is normal for a REIT, which must pay out 90% of their taxable income in order to maintain their REIT status. The stock currently trades at a premium and appears slightly overvalued, but on any pullback, an investor could be smart to accumulate shares of O in order to have a footprint in the Real Estate sector with one of the most well-managed real estate companies in the world.
In conclusion, I hope you will find this article helpful to get started investing and beginning your journey to financial freedom. When getting started, it is important to have a strategy, so you can determine if you have time to track your portfolio and would like to invest in stocks, ETFs, or both. Then you must have an idea on the funds you will begin with to determine the number of companies you would like to invest in to get started. Next we discussed some potential dividend anchors that we believe would be solid foundations to start a DGI portfolio. In the section where I discussed quality stocks to build your DGI portfolio around, I tried to give you a diversified selection of stocks to choose from. As we discussed, dividend growth investing may not be the most exciting form of investing, but with compounding growth in dividends, time is your friend. If you are able to let the money sit, the dividends will continue to grow over time paying you a higher yield, so invest in your future today.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.