Friday, September 11, 2009

More Principles of Dividend Investing

I read article after article about dividend investing and, in many cases, I hope that no one is really following the suggestions being made. The reason for my concern is that I have tried about every form of dividend investing known to man, including dividend capture strategies, since I became a dividend investor in the late 1980s, and I have found that there is no single strategy that assures success. For this reason, in all three of our dividend investing styles we break the portfolios into three smaller portfolios. These three smaller portfolios each follow one of the following stock selection disciplines: (1) High Yield -- companies with much higher than average dividend yield and very low dividend growth; (2) High Growth -- companies with low dividend yield and high dividend growth; and (3) Balanced --companies with slightly above average dividend yield and growth. Our three styles of dividend investing, then, overweight one of these smaller portfolios. Income Builder overweights the high yield stocks; Capital Builder overweights high growth stocks; and Cornerstone consists, primarily, of balanced stocks. Performance for Capital Builder and Cornerstone goes back nearly 15 years. During this time, they have both outperformed the S&P 500. However, they have accomplished this feat traveling very different paths. As you would imagine, the faster growing companies in the Capital Builder portfolio have a volatility very near that of the S&P 500, while Cornerstone's volatility has been only about 75% of that of the S&P 500. Rising Dividend Investing is the name of this blog and the single ingredient that powers all of our portfolios. Yet, while growing dividends are essential, over the years we have averaged about a company a year that has cut its dividend. Our preference in these cases is to sell the stock right away. Oftentimes, however, that is not wise because a dividend cut is normally associated with a steep selloff in the stock when the news is announced. Our experience has shown us that holding the stock for a few months is usually rewarded with significantly better prices. This year has been the toughest year for dividends I have seen in my 34 years in the investment business. Dividends for the S&P 500 Index will fall for the second year in a row. Having said this, however, it may seem remarkable that in our current portfolio holdings only about 15% of the companies cut their dividends, 10% kept their dividend the same, and 75% of the companies increased their dividends by an average of nearly 10%. Almost all of the banks we held were forced to cut their dividends during the year, either by the government or to save capital. We decided to hold most of the banks because we believed they were being priced as though they were going out of business. Since we did not believe that would happen, we held the majority of our positions and even added to some. That decision has been a good one, with many of our banks stocks having risen 3x to 6x since March. Some of those banks have now repaid their TARP loans; all have repaired their capital ratios; thus, most, in our judgment, are in a position to raise their dividends in the coming years. We continue to do extensive research into the banks. From this point, we will sell any bank that we do not believe will begin raising its dividend in the next couple of years. There are about 212 companies in the world that can pass all of our financial strength and dividend growth requirements for possible inclusion in our portfolios. Of that figure, we rate fewer than 100 stocks as being outright buys. Think of it, in a world of perhaps as many as 15,000 major stocks, fewer than 0.6% can get through all the doors to reach our portfolios. If we can say that over the long run, our brand of dividend investing has been a success, we believe it is due to three important tenets: (1) Investing in companies with financial staying power whose products and services we use everyday, (2) Investing in companies who use the dividend as the linchpin between themselves and their shareholders, and (3) Buying when the markets forget that there are companies in the world who can meet points 1 and 2.