Dividend stocks are truly a magical force in the investing world. Warren Buffett was able to utilize both growth and dividend stocks to build his massive $87 Billion Dollar portfolio. The chances of you duplicating that with the strategy is slim to none, but the chances of you bringing home a six-figure income from dividends are exponential. In this article, you will learn the best dividend stock investment strategy, utilizing dividend growth potential. I will be using quotes from some of the greatest investing minds to back my words, and will provide you with a guide to investing safely with huge returns!
“Successful investing is about owning businesses and reaping the huge rewards provided by the dividends and earnings growth of our nation’s – and, for that matter, the world’s – corporations.”- John Bogle
Warren is able to build his portfolio bigger and bigger every three months by reinvesting his quarterly dividend payments. He is able to increase the value of his portfolio a hundredfold. It is a beautiful thing to watch, and I will show you how to utilize the greatest dividend stock investing strategy known.
Before we begin discussing this strategy however, we need to understand some terminology.
- Dividends: Dividends are payments typically delivered every three months by a company. Some companies reward their shareholders for holding their stock for a certain period, and they reward them with a payment called dividends.
- Yield: The Dividend yield is the percentage of the share price that is paid to shareholders in dividend. For example, if a stock is sitting at $100, and the company has a dividend payout of $4, then the dividend yield is 4%.
- Dividend Payout: The dividend payout is the amount paid in dividends. This can be defined with either annually, or quarterly payout.
How do Dividends Work?
Before we understand how dividends work, we need to know why dividends even exist. Companies pay dividends for three primary reasons:
- Dividends create demand for that stock, and creates an attractive stock for potential investors.
- Many shareholders work for the company, and want to be awarded dividends
- Award shareholders for being loyal to the company, and show that they are stable.
When a company consistently and reliably pays a dividend every three months, it can show stability, and reassure investors that the company is strong.
Dividends won’t make you rich immediately, however. You begin with a measly yield between 2-6%, typically. Let’s take Target Corporation for example.
- Share Price: $83.01
- Dividend Yield: 3.2%
- Dividend Payout: $2.56 Annually
This looks terrible, doesn’t it. Why would you even consider investing in dividends if you’re only going to be getting a 3.2% return? You could invest just about anywhere else and receive a better return. That is what I hear from everyone who hasn’t researched dividend investing.
Dividend Growth Investing
How would you possibly profit from investing in dividends?
Companies that pay out a dividend and prioritize dividend payments over capital appreciation try and raise their dividend payments every year.
This is where yield-on cost comes into play. Let’s take a look at Warren Buffet’s portfolio:
Warren Buffett is invested in many companies, but one of his top companies is Coca-Cola. He has been allocating cash to purchase KO (Coca-Cola) assets since 1987. You would think Buffett is earning a 3% yield on his Coca-Cola stock, but in reality, he is earning approximately a 62% annual return from his dividends, and it will only increase. How?
When Warren Buffett first invested in Coca-Cola, the stock costed $2.50 per share. The dividend was a measly $0.08 per share at the time that he purchased his shares.
However, Coca-Cola consistently raised its dividend every year. The yield didn’t go up, because the share price went up, but the payout went up. Slowly but surely, Buffett saw increased returns every year. In 2018, the dividend payout was $1.56 per share. That is essentially a 62% annual return. 62%! Those are amazing returns, and if he continues to reinvest his dividends, and if Coca-Cola continues to consistently raising its dividend as it has for over 50 years, then Buffett wil be on track to reach a 100% return within the next few years. This is effectively known as yield on cost. Warren Buffet’s yield for Coca-Cola is a measly 3%, but his yield-on-cost is an extraordinary 62%!
The thing that makes dividends so attractive is the snowball effect that begins to form after a few years of investing. You start off slow, extremely slow. So slow that many would call you foolish. a 3% annual return is absolutely terrible, and your money would be better allocated in almost any other investment vehicle. However, if you allow your patience to win out, you will begin to see higher returns with your yield-on-cost.
A typical yield-on-cost pattern that is supported by good investments would look something like this:
- Year 1: 3% Return
- Year 2: 3.2% Return
- Year 3: 3.5% Return
- Year 4: 3.9% Return
- Year 5: 4.5% Return
- Year 6: 5.2% Return
- Year 7: 6% Return
- Year 8: 7% Return
- Year 9: 8.3% Return
- Year 10: 9.7% Return
- Year 11: 11.2% Return
- Year 12: 13% Return
- Year 13: 15.7% Return
- Year 14: 18.6% Return
- Year 15: 21.9% Return
- Year 16: 25% Return
- Year 17: 29.4% Return
- Year 18: 34% Return
- Year 19: 39.5% Return
- Year 20: 45% Return
If you follow this philosophy, a snowball effect begins to form. It would take you four years to achieve a 1% growth in the beginning, but by year 20 your rate of return is going up about 45% annually. That is the magic of dividend growth investing, and how worthwhile it can be. This is how Warren Buffett became the most successful investor in the history of the stock market.
How Can You Maximize Profit With Dividends?
You can maximize profit with a Dividend Reinvestment Plan, and with compound interest.
Compound Interest was called the “eighth wonder of the world” by Albert Einstein. The moneymaking potential with compound interest increases tenfold. How do you use compound interest?
With dividends, you need a Dividend Reinvestment Plan. This simply means that you won’t be spending the money you receive from your dividends until you reach a dividend payout that makes you happy.
Instead, you are going to reinvest your dividends into the stock market, and use the money to buy more shares of stock.
For a more in-depth explanation, I wrote an article about the Dividend Reinvestment Plan (DRIP) and Compound Interest:
What is Another Good Reason to Invest in Dividends?
Most potential investors are interested in growth stocks- capital appreciation from rising companies. However, these types of stocks typically show a lot more volatility than the safety net that dividend income provides.
Volatility: liability to change rapidly and unpredictably, especially for the worse.
The reason that growth stocks are more volatile is because investors rely completely on the share price, and their income comes from capital appreciation. Capital appreciation is a lot less consistent than dividend payments, because the charts fluctuate. Dividend investors don’t need to worry about capital appreciation. Buy on the dip, hold for the long-term.
So, What Is The Strategy?
Everyone goes into the stock market with a different strategy. It depends on a variety of factors, such as:
- What is your initial investment?
- How much do you plan to invest towards your portfolio each month, if any?
- How long do you plan to invest?
- How much risk are you willing to take?
These are all questions that need to be answered, but I will share with you the general strategy that would satisfy almost anybody.
I will assume we have someone with an initial investment of $5,000. I will assume they plan to invest $300 a month towards their portfolio. If your situation is more or less than this, it is fine. You can implement the same strategy to your portfolio. This strategy requires at least 20 years to achieve any sort of financial success, and each year after the 20 will yield you a significantly higher dividend payout.
Many wonder, what should I start with? However, first I will answer what NOT to start with:
- Don’t invest in a company based off of the share price
The share price is a commonly misunderstood part of a stock. People view the share price as if that is what the company is worth. That is not true. You need to look deeper into the company, and find out how much it is truly worth. The share price may be undervalued, and it may be overvalued. The last thing you want to do is buy shares of an overpriced company.
“Price is what you pay. Value is what you get.” -Warren Buffett
Focus on the company itself, and ensure it is not overvalued.
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” -Warren Buffett
- Don’t make a decision based on emotion.
Emotion is one of the most detrimental things an investor has to deal with. Excitement and fear plagues many investors, and has caused many to lose everything.The stock they have invested in dips, so they sell before reaping a huge reward. There is a cheap stock on the market that sounds very attractive, and out of excitement they spend a fortune on shares before doing proper research. Even in doing research, bias can cause them to create bias and in short- faulty judgement.
Peter Lynch and Warren Buffett have both said that temperament is the most important characteristic an investor must have in order to succeed,
“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.” -Peter Lynch
“When you sell in desperation, you always sell cheap.” -Peter Lynch
“This is one of the keys to successful investing: focus on the companies, not on the stocks.” -Peter Lynch
“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” -Warren Buffett
- Laziness will NOT Work When Investing in the Stock Market
If your method of analyzing stocks is simply listening to what analysists have to say, then you are setting yourself up for failure. Analysts can make anything sound good or bad, however:
- Their goals are different than yours
- Most aren’t multi-millionaires from their investments
- Many have a bias
- Many write for views, so they choose popular topics and give the popular opinion.
Conduct your own research, learn about the companies. Peter Lynch stresses this in his book, “One Up On Wall Street”.
Do you see a pattern? Seems like the most successful investors aren’t analysts. They conduct their own research. Warren Buffett lives in Omaha, Nebraska because he wants to get away from the analysts. Maybe you should too.
Once you understand that you need to keep emotions OUT of your investing strategy, and DO NOT trust your gut feelings, you are ready to continue.
Once you understand the power that dividends hold, and that you will not be able to reap the rewards of your hard work for decades to come, you are ready to continue.
Once you understand that you will need to research companies and find out how they work and what their goal is, you are ready to continue.
This strategy that has been formulated by many successful investors is extremely basic. This is because the tough part is understanding the fundamentals, but if you made it this far, then you have that down. What you are looking for in this dividend stock investment strategy is:
- Long-Term Growth
“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” -Warren Buffett
This dividend stock investment strategy is focused around long-term holdings. If you are interested in a “get-rich quick” scheme, then this strategy isn’t for you. You can try day trading, or swing trading. However, there is a reason that long-term investing is the most ppular strategy. The other stock market strategies are extremely risky forms of speculating, and very few end up succeeding.
“Our favorite holding period is forever. -Warren Buffett
Don’t view holding a stock as buying something with your money. Another way to look at it is simply changing the form of your cash. You are turning it into a stock, and if you ever nee or want money, you can sell your stock at any time. That is why it is better to hold your money in stocks than in cash- Your cash will always work for you if you invest it in the stock market, you can still take it out at any time as if it were in a savings account.
Consider it a high-yield savings account that grows exponentially over time.
It is important that if you invest in a company, be prepared to hold it forever. That is the end goal. You want the company to continue growing at a rate that you never want to sell. Treat investing as if you can only make twenty stock market transactions in your entire lifetime- I’m sure you will take each investment more seriously then.
- Strong Companies that Pay a Reliable Dividend
Not all dividends are reliable. Some companies are forced to cut their dividend if they cannot afford to pay them out. That is why it is extremely important for you as an investor to pick great companies to invest in. Companies on the Dividend Aristocrats or Dividend Kings lists are typically the best options to go for, because these companies have not only paid a dividend every quarter for over 25-50 years, they have raised their dividend payout every year for over 25-50 years. That is an impressive feat, and this is what you should aim for as a dividend income investor.
- Fundamentals are Everything
There are typically two types of stock analysis strategies: Fundamental analysis and technical analysis
Technical analysis focuses on charts and patterns, and is not a good strategy for long-term investing. This strategy focuses more on day-trading and swing trading. This is the short term analysis strategy.
Fundamental analysis focuses on the company, management, and the numbers. This is what you as a dividend stock investor should focus on.
The greatest minds in the stock market always emphasize how important the fundamentals of a company are. How do you expect a company to last if it has no backbone? If a company lacks good management, would growth not be slowed, or even stopped? If a company has no core fundamentals, they will be all over the place, which is something you as a dividend income investor want to avoid. This dividend stock investment strategy is focused on long-term growth that is consistent over time.
- Mild Diversification
If your dividend portfolio is worth less than a million dollars, you should not be invested in more than twenty companies. Warren Buffett explains this in several interviews: If you are invested in too many companies, you are limiting the potential returns you can have.
Buffett has eighty-seven billion dollars invested in 48 companies. If you are following a similar philosophy to Warren Buffett, there is no reason you should be invested that many companies with a small portfolio.
People typically recommend that you diversify a lot so that you can protect your investments.
-If you’re going to do that, why not just invest in an index fund? Low risk, low reward. If that’s your goal. If you want actual returns, this is not a good solution.
If you know what you’re doing, then there isn’t much risk, as Warren Buffett stated. He also said,
“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”
This is true because the more you spread yourself out, the less returns you get. Find a few good, stable companies that provide a decent rate of return. Buy them at a fair price, and hold on to them for the long-term. This is a philosophy that many of the best have taken to success.
Once you understand that you are in it for the long-haul, and you need to worry more about the strength of the company rather than trying to time the market, you are almost ready to begin. You have the majority of the strategy down, there is just one thing left to discuss: the actual investing.
Where do I Begin?
There are many, many places to begin. As long as you have the ability to find potential stocks, you can then conduct your research from there.
You can find potential stocks to begin analyzing from many places, but finding a good value for in-depth value stock screeners is difficult. I have compiled a list of the best screeners or lists I have come across.
- Stock Screeners
Stock screeners allow you to filter for certain things you want out of a stock, and is a common way for people to identify potential stocks to invest in. Screeners like The Acquirers Multiple allow you to search through many stocks and compare them side-by-side in list format. This is good for people who truly know what they are looking for but still do not want to set aside the time to comb through a bunch of duds, and get straight to good potential stocks.
- Stock Lists
Dividend stock lists like Top Dividend Stocks are another common way that people find potential companies to invest in. Lists like these provide you with the top 100 stocks of every month. As I said before though, don’t just invest in these stocks because it’s on an accredited list! Different companies provide different benefits, and it depends on what your personal goals are. These lists break it down by sector, and explain why each company is at the top of their list every month. This is a great place to go if you don’t have time to search through every company that is on the market, and want someone to help narrow down the list for you to begin your analysis.
I selected Top Dividend Stocks because they are a reliable service that have members analyze over a thousand companies every month. I said avoid analysts, but when it comes to narrowing down potential stocks, analysts are great. Just be sure to conduct your own research when you select a stock you are interested in.
- Stock Picks From Trusted Individuals
If you find people like Grant Gigliotti, you can save time by having someone to pick stocks for you. As I said before, if you use a service like this, don’t blindly follow what they say. Conduct your own research, but use these platforms as a means of saving time and potentially money over time.
Grant has a similar philosophy to us dividend investors, is a trustworthy stockpicker, and has been for years. This is the reason I chose him, but you can find someone that you trust to identify potential stocks to invest in.
There is an alternative to premium services however:
You can do your own research. If you have a lot of spare time, you can comb through all sorts of different stocks on free screeners. They won’t be as in-depth as the premium services, and you will probably find a lot of duds, but this is the free way to identifying potential stock picks. It is always an alternative if you do not want to pay for any services.
All in all, dividend income is a very useful tool that has been used by the best of the best. You have learned today:
- What dividend stocks are
- The potential of dividend growth investing
- What some of the all-time greats have said about investing
- What it takes to be a long-term growth investor – both mentally and emotionally
- Where to begin finding stocks to analyze
- The overall mentality of a dividend investor
- Other tips about dividend investing that will increase your rate of return
If you have any questions at all about this article or dividend investing in general, you can either leave it in the comments or email me at firstname.lastname@example.org! Thank you for reading my Dividend Stock Investing Strategy!