Getting Started With Dividend Investing
I’ve recently started investing in dividend growth stocks and my portfolio can be found under my portfolio section. But so far, I’ve found a few things that are important when building a dividend growth portfolio. I am not a professional financial adviser and the suggestions provided below are my own strategy. You may use this strategy to mimic my portfolio but remember to make your own decisions.
For my dividend portfolio, I currently use a regular brokerage account with TD Ameritrade. They charge a transaction fee of $9.99, which may seem a bit high but I love it’s layout and tools that they offer. If you would like lower transaction fees, you can use Fidelity or Scottrade. If I’m not mistaken, they charge $7.99 for each transaction fee.
The first thing to know is that being diversified in all 10 different sectors is a good idea but don’t overly emphasize too much on it in the early stages. I’m building my portfolio where I have at least 1-2 companies from each of the 10 sectors (eventually 5-7 in the future) but selecting companies at a bargain is the better strategy.
Try to find companies that are at a discount at the time of the purchase. Right now, I believe the companies in the industrials, utilities, and materials sectors to be at bargain prices since the recent drop of the market. Not only are these sectors great right now, but I strongly believe that consumer staples (aka defensive stocks) should make the bulk of your portfolio. If you don’t know, consumer staples are called defensive stocks due to the low volatility that they have during a recession. Some even do well during this period.
I like to imagine my portfolio as a pyramid and to build from the ground up. Just like the food pyramid, I think a healthy dividend portfolio will be very similar in nature. The base of the pyramid should mostly consist of big blue chip stocks such as the Dividend Aristocrats in all 10 different sectors. Dividend Aristocrats are companies that have paid and raised their dividends for more than 25+ years. Most of these companies will be large cap in size and I would like to invest in the companies that have at least 15+ billion dollars in market cap and dividends yielding around 2% to 5%.
The mid tier of the pyramid should consist of mostly mid cap companies spread over all 10 sectors. This part of the pyramid would be a little more riskier than the bottom of the pyramid but these companies have a greater chance of growing in the future. I am also an advocate of gold and silver mining stocks. Some of my holdings are GG, GDX (ETF), ABX, and SIL (ETF). I believe that the gold mining stocks are at the cheapest level that it has been in a very long time and it is at a heavily discounted price right now. Not only is gold at a discount, it’s always good to have a hedge against inflation and to protect your portfolio. Especially knowing that the Fed is delaying an interest rate hike to sometime in 2016. In my honest opinion, I believe that the Fed will not be raising interest rates anytime soon or in the near future. Only if they shrunk their balance sheets would they be able to raise the rates but I guess we shall see. For more information about Gold in your portfolio and my thoughts on this subject, please take a look at my Gold section of this blog.
As for the top of the pyramid, I would like to see mostly small cap stocks also diversified with all 10 sectors. This area would be the riskiest part of the pyramid and these stocks tend to pay higher dividends. I think every investor should have a little risk in their portfolio for the greater reward that could arise in the next couple of decades.
Well for now, this is the best advice that I can offer. I truly think that being diversified is the most important part to building your portfolio as long as you’re buying companies at bargain prices. Each sectors performance changes every year so it is good to be diversified in every sector to help you weather the market storms.
One of the first thing I look at before deciding on a purchase is to calculate the payout ratio. The payout ratio is calculated as follows:
Payout Ratio = Dividends per Share (DPS) / Earnings per Share (EPS).
For example, ADM currently at the time of this writing has a $1.12 dividends per share (DPS) and a $3.61 earnings per share (EPS). So plugging in the numbers into this equation ($1.12/$3.61) we get a 31% payout ratio. When a company has a higher percentage, it means that they’re paying out a much bigger portion of their earnings as dividends to the holder and it could signal that the company could cut dividends in the future but there are exceptions to this rule.
It really depends on the industry to decide if the payout ratio is just right. Companies in the defensive industries such as utilities, telecommunications, and pipelines are more stable in their earnings to withstand a higher ratio. Cyclical companies are the ones to watch out for when calculating the payout ratio. For example my holdings of T (AT&T) has a payout ratio of 184% but I’m alright with this as I know people will always have a need to use their cell phones and the services that AT&T offers.
The only industries that the payout ratio should not be used are towards REITs and MLPs as these sectors are obligated to use most of their earnings to pay out as dividends. It depends on what type of investor you are to decide if the payout ratio is right for you. If you’re a high dividends yield seeker, then you should look for companies that have a high payout ratio but if you’re looking for companies with more growth in the future, then you should look for a lower payout ratio.
I like to be diversified in anything that I own so I add both high payout ratio companies as well as the low for future growth for my portfolio. Since I am a young investor and I have a lot of time on my hands, I generally tend to lean more towards companies with lower payout ratios as I believe that they will ultimately grow much bigger by the time that I retire 25-30 years later.
For my portfolio, I have decided to use DRIP (Dividend Reinvestment Program) from TD Ameritrade and it is also available from Fidelity. Some brokerage accounts offer this but they might call it something else. I believe Scottrade calls this FRIP (Flexible Reinvestment Program).
I’m an advocate for DRIP because it helps you compound your shares every time a dividend is paid. Instead of cash, you will get fractional shares or whole shares depending on how much dividend is paid to you. Some people like to accumulate the dividends into their money market account until they accrue a sizable amount to hand pick the next stock to buy. But I disagree with this method because the transaction fee would cut into your dividend earnings.
The first fractional dividend that I received this month was from ITW (Illinois Tools Works Inc). Although I received a small dividend of $6.60, DRIP allowed me to buy .055 shares of this stock. So on my pay date, I now own 12.055 shares of ITW. Some may still argue against DRIP because they’ll say you might automatically reinvest in a company when the current value of the stock is over valued, but I think in the beginning when you have a small dividend pay out it is the better route.
I’ll probably disable DRIP in the future when my monthly dividend starts to be in the hundreds of dollars or maybe thousands. No matter what the price of each stock, I don’t mind reinvesting into it using DRIP since they are the stocks I picked from the very beginning.
I hope this section helps you with your journey in building your dividend growth portfolio! I will try to add more to this page as I learn as I grow my own.