Due to the world economy still not recovering, many people around the world have to accept the low interest rates that are paid out by financial institution. Seeking out better rate of return means having to invest your money into other financial instrument like ETF, stocks, property or others as investing means asset allocation.
Putting money into stocks is one alternative and investing in companies that pay increasing dividends provide a solid foundation to anchor your portfolio. Therefore, look for good quality dividend stocks and built it to become the core of your portfolio.
Reasons for investing in high quality dividend stocks
1) There are no golden stock investing tips and research has shown that dividend stocks consistently outperform other stocks over the long-term. Dividend payers account for about 30% of total stock market returns.
2) Good quality dividend stocks provide an increasing stream of income over the years. That's a pay raise every year!
3) Dividend stocks offer a level of protection verse pure growth stocks in today's volatile markets.
Here are some key points to help you understand the advantage of the best dividend paying companies. By following these points, you should be able to spot, select and grow your dividend portfolio.
Growth of the Dividend
The lifeblood of investing in Dividend stocks is the growth of the dividend. As with your heart rate, inconsistency can be a sign of a problem. The same holds true when investing in dividend stocks. It is the consistency of the growth of the dividend that is the key point. While the same percentage increase year over year would be great, it is more important that it is raised by a consistent amount each year. Our rule of thumb, look for companies that have a 5-7 year average of raising their dividend by 7-10%. Think of it like this, every year the company gives you a pay raise. For most of us, were lucky to get a 2-3% raise from our employer - especially in this economy.
Company Payout Ratio
By being aware of a company's dividend payout ratio you will avoid purchasing stocks whose yields are too high, and more importantly, unsustainable.
What type of dividend stock companies to avoid?
- Ratios of 75% or higher
- Ratios of 30% or lower
- Inconsistent payout ratios
Owning such stocks usually leads to a lower dividend, followed by a lower stock price and ultimately buyer's remorse.
You should seek out companies that have a payout ratio of between 40% and 60% - the sweet spot. This provides a nice return to shareholders while retaining enough cash to fund operations, grow the business, and grow the dividend (Pumping your passive income up).
Solid Business Structure
Ok, as silly as this may sound, it's about dividend growth, not those hot new stock or product. While you want capital appreciation, this strategy is all about investing for passive dividend income, year in and year out. Having already looked at a company's dividend growth policy and its payout ratio, the third key point is the consistency of the company's business through the economic cycle. Here is where you want to avoid "fad" products or services and "dying" businesses. This is where boring is a good thing. We want to own companies that will be able to sell their products 10 years from now at higher prices no matter what the economic cycle.
Don't Marry Your Stocks
It's OK to "like" your stocks, but don't fall in "love" with them. Emotion combined with money may not break your heart, but it will certainly break your wallet. So be aware of signs that things are changing. For example, earnings are trending down (one missed quarter is ok), but not an overall change in the fundamentals.
Sometimes the market gives you an opportunity to take gains sooner than you had anticipated. While we don't advocate trading, if a stock has increased substantially in a short period of time (say 40% in 6 months) and you hit the upside target, it makes sense to take some of that profit off the table.
The same holds true on the downside. If a stock falls 20% and the fundamentals are still good, it makes sense to add more to your portfolio. However, if things have gotten worse with the company's business, sell your position and look for other opportunities. Like our parents said - there really are plenty of fish in the sea.
Conclusion
The key towards your dividend stock investment is having a strategy, the tools and discipline to capitalize on it. That's the great thing about the market, it always provides opportunities - to buy or sell and allow the dividend compound to do its work.
Therefore, remember the key points. It goes like this...The growth rate is connected to the payout ratio, the payout ratio is connected to a solid business, and a solid business is connected to higher dividend income.
