The 7 Truths: A Dividend Investing Strategy

The 7 Truths: A Dividend Investing Strategy

We hold these truths to be self-evident…

It’s one of the most recognizable lines from the United States’ Declaration of Independence.

Did you know it also applies to a dividend investing strategy?

Ok, that’s a bad comparison, but you get the point.

When it comes to dividend investing, there are 7 truths that, if followed, will build you a strong portfolio.

It’s a strategy that beats the market and provides a secure passive income for years to come.

These truths may not be “self-evident” but they are based on common sense.  Once you know them, they’ll seem all too obvious.

We want to make sure our income snowball is growing as big and fast as possible and this is the best way to do it.

Common sense isn’t always good enough in the world of investing, though.  Common sense may have told you Kodak would be around forever because cameras are going to be around forever.

No one thought Kodak would avoid digital cameras until it was too late.

And that’s why these truths are also backed up by academic research and scenario testing.

Like the scientific method, you have an idea that seems to be true.

Then you come up with a strategy to test your idea.

Based on the evidence, you get feedback with proof that it’s true or it’s not.

Some of the greatest investors from around the world use these 7 truths.

This dividend investing strategy works for them, it works for me, and it’ll work for you.

Truth #1: Quality Always Wins

Common Sense Truth:  Quality companies are going to perform better than bad companies.  Quality companies have a proven track record of providing great service, putting out great products, and having great leadership.

You don’t want to go to bad restaurants, so why would you want to invest in bad companies?

Dividend Investing Strategy:  Invest in companies that have been paying dividends for 25 years or more without a reduction.

Evidence:  The S&P Dow Jones Indices

Dividend Aristocrats perform better than the SP 500

Proof:  The Dividend Aristocrats are companies that have been raising their dividend each year for at least 25 years.  As a group, they have outperformed the S&P 500 by over 2% annually.


Truth #2: Value Beats Price

Common Sense Truth:  If I were to offer you a dollar bill or the first silver dollar ever minted, which would you take?  You’d take the first silver dollar ever minted because it has a higher value.

Both are the same price, but one has a higher value.

Same with purchasing a dividend paying stock.  One may have a lower price, but there could be better value in a higher priced stock.

Dividend Investing Strategy:  Rank from highest to lowest based on dividend yield.

Evidence:  Heartland Advisors Review of Dividend Historical Returns

Higher yield stocks have performed better than low or non-dividend paying stocks

Proof:  The highest paying dividend stocks have outperformed the lowest paying stocks by over 1.5% annually for the last 90 years.


Truth #3: Cash is King

Common Sense Truth:  The company you invest in needs to have the money to pay for their dividends.  Depending on how many outstanding shares there are, that could be quite a lot.

If the company isn’t earning enough to pay the dividends, they’re going to have to dip into reserves.  That’s something which can’t go on forever.  It’s a sign the dividend may be reduced…or even cut.

Dividend Investing Strategy:  Rank based on payout ratio from lowest to highest.

Evidence:  Credit Suisse Quantitative Research: High Yield, Low Payout

Lower payout ratio means better performance from a stock

Proof:  The high yield and low payout portfolios (low payout ratio) generated an annualized return of 19.2% versus 11.16% for the S&P 500.


Truth #4: Slow and Steady Wins the Race

Common Sense Truth:  Some level of risk is good.  Too much of it can be bad.  Having stocks with low risk provides peace of mind to continue investing through the tough times.

Companies that have grown through recessions and economic downturns are the type of companies you want to invest in.  It makes investing easier when everyone around you is in a panic.

Dividend Investing Strategy:  Rank based on the stock beta from lowest to highest.

Evidence:  S&P 500® Low Volatility Index: Low and Slow Could Win the Race

Low risk stocks have outperformed the S&P 500

Proof:  Low-risk stocks beat the S&P 500 by more than 3% per year over a 15-year period ending in September of 2011.


Truth #5: Size Matters

Common Sense Truth:  Growing companies are good.  Companies that stay the same or shrink are bad.  It’s pretty simple.

Companies growing their earnings means things are strong.  They’re doing a good job and will likely continue to.  If their earnings haven’t gone up in a while, that’s cause for concern.

Poor growth while still paying a dividend can’t go on forever.

Dividend Investing Strategy:  Look at the lower of a stock’s earnings per share or dividend increase.  Rank the stocks from highest to lowest based on that value.

You want to look at the lowest of those two because some companies will continue to increase dividends even though they’ve had terrible earnings.

We need to account for the low earnings per share.

Evidence:  S&P 500 Index: Dividend Growers Have Outperformed Over Time

When it comes to a dividend investing strategy, investing in dividend growers is a good choice

Proof:  Companies growing their dividend have annually performed 2% better than stocks that don’t grow their dividend.


Truth #6: Safety in Diversity

Common Sense Truth:  If you’re at the blackjack table, you don’t bet all your money on one hand.  You spread it out over many hands.  Hopefully with most of them winners and only a few of them losers.

Betting everything, on one hand, means you have a higher probability of losing it all.  Same goes for investing in stocks.

Spread the bets around.  Invest in many stocks to lower your risk of big losses.

Dividend Investing Strategy:  Buy 30 stocks with at least 1 stock in each sector.

Evidence:  Some Studies of Variability of Returns on Investments In Common Stocks by Lawrence Fisher and James H. Lorie

Proof:  Owning roughly 30 stocks lowers risk by 95%.


Truth 7: Survival of the Fittest

Common Sense Truth:  Say you worked somewhere for 25+ years and received a paycheck every month.

The check amount always stayed the same or went up.  As long as you could stand the job, you’d keep working there.

Now say after all those years, you get a check with a lower amount.  Or even worse, you stop getting a check.

Month after month it never shows up.

You’d quit the job and go somewhere else, wouldn’t you?

Same with dividend paying companies.

If they’ve been paying dividends for 25+ years and then lower their payment, or flat out stop, something must be going wrong.

Time to sell that stock and move on to a better one.

Dividend Investing Strategy:  Sell when a company reduces or cuts their dividend payment.

Evidence:  S&P 500 Index: Dividend Growers Have Outperformed Over Time

Stocks that have reduced or cut their dividend have performed worse than other payers

Proof:  Stocks that reduced or cut their dividends had a 0% return from 1973 to 2013.


Conclusion

Told you they would seem a bit too obvious once you knew them.

This is half of investing, though.  Leave your emotions on the sidelines.  Simple, smart investments are the way to go.

When you look to earn income, it’s the simple stock pick held over a long time that works out the best.

 

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