Dividend Investing 101: What To Look For In A Dividend Stock

My last post talked about dividend growth and how it plays a crucial part to any dividend investing strategy and allows you to turn a moderate return into an early retirement pay cheque. Since I've started this blog, a lot of people ask me what I look for when purchasing dividend stocks. It's not an easy process because a lot of things can happen that influence the stock market and a shiny blue chip company can lose it's luster with a cut of a dividend ( Yes, I mean you Manulife). There's so many details and facts to consider, but I've come up with a list of 6 rules to follow when you looking to buy quality, blue chip dividend stocks.

• Strong Cash Flow
• Low Dividend Payout Ratio 
• A Yield of 4%
• Low debt
• Dividend Growth History
• A P/E of around 15 or lower

Strong Cash Flow

Companies are in business to do one thing, make money. If a company doesn't make as much or more then it did the year before, then it's doing something wrong. They say cash is king, and they are in fact correct. Good companies pay their dividends from their cash flow. Bad Companies pay dividends from credit. When looking up a stock to purchase, look at its current and prior years cash flow. If it's steadily decreasing each year with no increases or is consistently in the red, stay clear of it. Cash flow is the first thing I check when looking for dividend stocks. It's very important.

Low Dividend Payout Ratio

A companies dividend payout ratio tells you if the company is making enough money to maintain its current dividend. The ratio should be between 0-70% , anything higher is not healthy. If a company has a big fat dividend and low earnings per share, then they either have to make more money or God forbid, cut their dividend. The lower the ratio, the easier it is to maintain future dividend increases, which is the heart and soul of a dividend growth strategy.  To find the ratio, divide the total dividend by the earnings per share (EPS).

                                                      Dividend/EPS= Dividend Payout Ratio

For example, if we look at BCE's current EPS and dividend from The Globe and Mail Investor Section , it has an EPS of  2.75 and the current dividend is $1.83.

 66.5% is below the 70% level and is an easily maintained ratio. BCE is making enough profit to comfortably pay it's dividend.

A Yield of 4%

When I look at excellent companies to invest in, the yield is always one of the first things I see; not by choice but because it's always automatically calculated and thrown in the open for everyone to see. A high yield at first glance may seem like a good thing, but in actuality, it means a stock's price is decreasing. When a stock price is decreasing the amount of money a company makes on the share is also decreasing which means the dividend it is paying out cannot be maintained. The company either has to make a lot more money, or cut it's dividend. Buying a stock just because it has a high yield will start out well, but when that dividend gets cut it's like throwing a wrench in your dividend growth machine. A low yield on the other hand may have a safe dividend, but why take a risk on an investment when you can make the same return with zero risk involved by using a GIC or high interest savings account. In addition, any profit you make at a low percentage is negated by inflation.

My general rule is to never buy anything with a yield below 4%. If a company is solid, and has decades behind them with proven dividend growth, I will buy at 3.5%. You want to make at least 10% on an investment as soon as you can, and by starting at a lower percent return, it will take a lot longer to get there.

 Low Debt

Debt is bad , no matter how much money you make. When a company needs to borrow money to operate, what happens when interest rates go up and sales slow down? The money they pay in dividends will most likely be used to cover the increased interest. Shazbot! When looking at a company's balance sheet, I make sure they have more then enough total assets to cover their total liabilities, otherwise I steer clear. When in doubt, always look at the cash flow, the more the better.  If a company goes bankrupt, common shareholders are the last to be paid, and usually they are left hanging.

 Dividend Growth History

We all love juicy yields. But if it never increases, eventually that yield of 5% will still read 5%, but the ever annoying, invisible force called inflation is a compounding fiend and will make short work of that 5% yield over time. That's why you want to invest in companies that grow their dividend every year to combat the evil inflation and your portfolio will live happily ever after. I'll use my golden boy stock as an example. Enbridge is a pipeline company that has paid a dividend for 57 years. The yearly average increase is 10%.  That increase of 10% a year negates inflation, leaving some of that growth to increase the yield on your original investment. That extra growth is the heart and soul of a dividend growth machine. It will increase your portfolio a lot more then investing dividends alone. When a company increases its dividend, it shows that the board of directors are confident of the outlook of the well run company, which in turn increases the confidence of investors to buy more stock. When the stock price goes up,the value of your shares go up. It's like getting paid twice. Winner winner, chicken dinner!


So when I see a company cut it's dividend, it means that the company wasn't running at it's full potential. A dividend cut is devastating to dividend investor. Your yield decreases and the stock price plummets as everyone gets out while the getting is good. It also puts your investment back 1 to 2 years depending on how bad it is. I stay clear of a company that cut it's dividend. Manulife comes to mind and it will always be tainted to me. The only way I'll ever own Manulife, is if it increases its dividend for the next 5years. I don't care that it's been around forever and is one of Canada's most lucrative companies, cutting a dividend is a sin in my books.

  A P/E Of Around 15 Or Lower

 

That brings me to P/E ratios. To find the price/earnings ratio, divide the price per share by the earning per share. For example, BCE's current price is $33.37. It's EPS is $2.75 as of Aug 31/2010.    

So BCE has a P/E of 12.13. What does that mean? Obviously it's a ratio between earnings and share price, but it can be used to gauge the volatility and popularity of a stock. It will be argued that a P/E ratio can mean many things, and that it's an investor "assigned" value, so I won't dwell on it too much. I've read that any stock you wish to purchase should have a P/E of around 15. If it's above 15, it could be overpriced. If it's below 15, it could be undervalued and would be a good buy. Notice I said could be undervalued. It might be low for a good reason, as if the stock is losing value because of an oil spill or lawsuit.  A stock with a low P/E also regarded as having low volatility, which is always good for the steady and conservative dividend investor.


A P/E ratio should never be used on it's own to pick a stock. It should be one of many calculations used to determine which dividend stock to purchase. I use it only for comparison between companies I have on my watch list.

I use these rules as a guideline, but there are many more factors to consider when choosing companies to invest in. The best way to learn is finding your own method. Everyone has different ideas on what makes good investments. Find what works for you and stick with it; or change it up if it's not working well for you. 

I apologize for almost the same post as a few months ago, but I'm headed out on a rush trip to Nova Scotia for a family emergency. I planned on changing this post up a bit, but I had to rush through to update before I leave. It might be a week or more until I can update the loonie bin again. Have a good week everyone.

 

Me And My Money

 Just to let everyone know, I was featured in the Globe and Mails Me and My Money article on Saturday.

Me and My Money

I was glad to see a lot of people had the same strategy as me; and the negative comments were minimal. Hope you enjoy the read.

Dividend Investing 101: Dividend Growth

In my last post I explained compound growth and how you can make more money from a smaller investment over a longer period of time. This next post covers dividend growth and how it's the heart and soul of a dividend investment strategy.

Everyone likes getting a pay raise. The satisfaction of being rewarded for your hard work and planning can be very exciting. Imagine getting thousands of little pay raises over years of investing and how it grows your dividend income exponentially. I remember a few days after buying BCE earlier this year and hearing they increased their dividend; it felt great getting a pay raise without doing any work. And now BCE has increased their dividend again. My yield on BCE increased 2% already this year, and I can't wait for my other stocks to do the same.

How do you know which companies to buy that increase their dividends on a regular basis? Well looking back at past dividend increases on company websites is your best bet. Other websites and blogs have made lists comprising of dividend paying companies that regularly increase their dividends over the last few years. I know the Canadian big banks haven't increased their dividends in a while, but there's a lot of speculation that they will early in 2011. I don't want speculation, I want them to show me the money! Once you find a company that you like and puts their money where their mouth is, you can feel a little more comfortable investing in them. Take Enbridge for example.

Enbridge has been paying a dividend for over 57 years and has a dividend growth average of 10% a year. To me, that seems pretty dependable and is why it's my favorite stock to own. I'll even use it in an example of what dividend growth can do to your investment.

If you were to buy 100 shares of Enbridge stock on the day of this post, you would pay $5235 and your dividend paid per year would be $170. Your yield on this investment would be (1.70/52.35) 3.24%. Not the best yield available out there, but what what happens when the dividend increases 10% a year:

Not a bad little investment. After 10 years of dividend growth it's paying you $440 a year. Try and find any mutual fund out there that pays a GUARANTEED 8.42% every year and keeps increasing! And to show you how it grows and compounds over time, here's the next 10 years:

With another 10 years of enjoying life and not even worrying about the stock market ups and downs, you would still be paid 21.85% on your initial investment. By now you investment would be paid for, plus it would have allowed you to purchase other stocks which have also increased their dividends over these last 20 years. Imagine the possibilities of what your portfolio could look like. Just think if you started early enough to get 30+ years of dividend growth, your returns would be insane!

Now not every dividend paying company increases their dividend by 10% every year. But even if it's only 6% its still keeping ahead of inflation and allowing your buying power to be maintained in the future. Having a comfortable retirement is what everyone wants, but most people think it's a lot of work to plan and maintain your own investments. This single investment took 1 min of time to complete with a discount TFSA trading account because there's no taxes involved and there's no upkeep whatsoever as long as you invest in solid, blue chip companies. If anything you would only sell a company if it cut it's dividend, like Manulife, which was all over the news unless you live under a rock.

I read the headlines at The Globe and Mail investor section and it keeps me up to date each day. If spending 5 minutes a day, exercising your brain is to much work, then you might as well stick to mutual funds and pay monkeys to invest for you.

Dividend Investing 101: The Power of Compounding

In my last post I explained the basic principle of what a dividend is and how it plays a part in investing. This next post covers compounding or compound interest and how it plays a huge part in any dividend investment strategy.

I never really paid much attention to compounding interest before. I knew I was paid interest in my bank account every month, and the whopping 25 cents was added to my balance. It wasn't until I started researching to be a self investor that I truly learned the power of compounding. It's a highly efficient, money making machine that turns small amounts of money into a large pile of money over a period of time. When you invest in dividend paying stock, your dividend payments are like an interest payment from the bank, except it comes from the company you invested in. The money is deposited into your trading account and like interest, you can spend it OR you can re-invest the dividends to by more stock which in turn, will pay you more dividends in the future.

Let's say you bought 100 shares of BCE on Jan 29, 2010. The cost of one share would have been $27.71 and the dividend at the time was $1.62 a share, which would yield a return of 5.84%. So you would be paid $162 for an investment of $2771. If you were to re-invest the dividend and buy more shares (for simplicity sake, we will say the stock price stayed the same with no dividend increases) the following year, you would be able to buy 5 more full shares and your dividend payment would be $170.  After 10 years it would look something like this:

You now have 165 shares and are being paid $267 a year. Stock prices never stay the same; they go up and  they go down. For this example it made it easier to see the compounding growth without getting to complicated.

To get the maximum earning potential from compounding, the earlier you start, the better. By maximizing the amount of time you invest, you can make a larger return from a smaller investment. I found this example from Investopedia and it sums up my point very well.

Starting Early
Consider two individuals, we'll name them Pam and Sam. Both Pam and Sam are the same age. When Pam was 25 she invested $15,000 at an interest rate of 5.5%. For simplicity, let's assume the interest rate was compounded annually. By the time Pam reaches 50, she will have $57,200.89 ($15,000 x [1.055^25]) in her bank account.

Pam's friend, Sam, did not start investing until he reached age 35. At that time, he invested $15,000 at the same interest rate of 5.5% compounded annually. By the time Sam reaches age 50, he will have $33,487.15 ($15,000 x [1.055^15]) in his bank account.

What happened? Both Pam and Sam are 50 years old, but Pam has $23,713.74 ($57,200.89 - $33,487.15) more in her savings account than Sam, even though he invested the same amount of money! By giving her investment more time to grow, Pam earned a total of $42,200.89 in interest and Sam earned only $18,487.15. 

So there you have it. Start saving for the future as soon as you can and let interest do all the work so that one day you won't have to. Making money from money, in a powerful yet simple income generating machine is a great step to financial freedom. Is your money working for you?

Dividend Investing 101: The Basics

Now that you've learned about the evils of MERs and how they eat away at your investments, this next post will cover the very basics of dividends, and how they work as an investment strategy.

A dividend is a portion of a company's earnings that is distributed to it's shareholders. It's a way of compensating you for investing in their company and gives incentive to park your money there for a period of time. If the company makes a profit each year, it's likely that they will maintain the dividend that they pay out to their shareholders. If the company has increased profits, they may increase the dividend they pay to the shareholders.

The best part of dividends is that no matter where you are, or what you're doing, your dividend will automatically be paid to you. So you can sit back, relax and have your money work for you.

 

Although many companies pay dividends, there are only a select few that increase dividends on a yearly basis. Blue chip companies are well established with stable earnings and minor liabilities who make it a priority to maintain and even increase dividends year after year. These are the types of companies that dividend investors watch and wait for a good price to buy in.

When you buy shares in a company, the return you get from your dividend investment is called the yield. It's calculated by taking the yearly dividend and dividing it by the share price you paid for your shares.

So if you were to buy shares in Bell, the current price at the time of this post is $32.68 and pays a dividend of $1.83 per year.     

1.83/32.68 = 5.6%

That's a very decent return on a dividend stock. It sure beats any interest rate the banks are paying these days. And the best part is that no matter if the stock is up or down, you are guaranteed that return unless the dividend is cut. More on that in future posts.


As I mentioned before, if a company is having a good year and profits are up, the board of directors might spread the wealth and increase the dividend paid to investors. How much they increase it depends on many things, but an increase to your initial investments return is always welcomed by a dividend investor. Bell increased their dividend a few weeks ago from $1.74 to $1.83. If we divide 1.74/32.68 we get a yield of 5.3%.  It might not seem like a huge increase, but it sure adds up over the years. That's why it's important to find good, blue chip companies to invest in to make the most of any dividend investing strategy.

Dividend Investing 101

A few friends of mine asked me some questions about dividend investing this weekend and I guess it might be easier to start from the very beginning with charts, diagrams and figures. I'll be adding these upcoming posts to fixed tabs that can be easily found for future reference. After all, this blog is all about learning investing basics and if anyone is looking for advanced strategies and material, you got the wrong blog.

The investing world is very complex and is intimidating to the average person. It's full of cycles, markets, commodities, bonds, futures, securities, stops, holds, ripples, ups, downs, bears, bulls, and a lot of other crap that's too long to list. Analysts try and study trends and graphs to predict where the markets are heading but investing in a sense, is like gambling, you never know what's going to happen. To someone who wants to learn investing it can seem very overwhelming and down right scary. But with a little patience and the desire to learn, the investing world can less complex then it's made out to be.

There are many strategies out there, but when I decided to tackle my own investing, I wanted a strategy that's:

1. Proven to work over time.
2. Lower risk.
3. Yields a decent return.
4. Very easy to manage.

    Hello Dividend Investing! 

Ever since I learned about dividend investing, I wanted to shout about it from the roof tops so that everyone can learn about how amazing it really is. I have a lot of examples and from many different angles so I decided to make continuing posts so that each part is full examples and diagrams and is easy to find for future reference.

Part 1: Mutual Funds

Now a lot of people are saying, "Whoa whoa whoa! Investing in the stock market? Are you crazy? That's the fear of the unknown talking and that fear must be conquered. A lot of people invest in mutual funds, so in a way they already invest in the stock market. The only difference is that they pay fees for someone to manage the fund for them. One of my friends said, "I'd rather pay someone who knows what they are doing to manage my investments then to try and do it myself" and that's fine. But what most people don't realize is how much the fees end up costing them. 

Let's say you have $55,000 invested in a mutual fund. It has a MER( Management Expense Ratio) of 2.5%.

Each year it's going to cost you $1375 for someone to manage the fund. If you earned 5% on your mutual fund, you really only earn 2.5% because of the MER eating your return. To further the example, if your mutual fund is up 5%, your investment will be worth $57,750. That profit is locked in according to how well the markets performs. If you wanted any of the profit, you would have to sell units to get it. If in the next month the stock market hits some economic turbulence and the fund is now down -6%, your investment will be $54,285. The stock market can be very unstable and your return on your investment can be up and down all year long .

Now if you did some research and invested in a blue chip dividend paying common stock with the same $55,000. Let's say the stock paid a dividend of $2 a share a year and had a current price of $40. It would yield a return of 5% . You would have purchased 1375 shares and would be paid $2750 in dividends every year guaranteed and the funds would be available to you without selling any shares, allowing maximum return on your initial investment. If the stock price ever decreased, you would still be paid $2750. If you did manage your own trades, the commission fee would be $29 or lower depending on which brokerage you chose. That's a helluva lot cheaper then $1375.

I myself like seeing a guaranteed 5% return on my investment, and the bonus of increasing  stock price on top of it. Some question how hard it is to maintain your investment in dividend paying stocks. If you research a company, and buy when a stock is yielding an ideal return, you might spend an hour a month reading about your stocks, and that's about it. Others would argue that the dividend is not guaranteed to stay the same on common shares. This is true for some companies, but a blue chip company is established and well managed to be able to maintain the dividends they pay out, allowing for peace of mind AND future dividend increases.

If a company ever did decrease its dividend, you could sell the shares and re-invest in another company easily enough and only pay two additional commissions.... still a far cry from $1375 a year for management fees. Even if you wanted some diversification with 10 different stocks, the fees would only cost you $390 to buy 10 stocks. No ones going to work harder to make you money then yourself, so you might as well get paid what you deserve.

Do you have what it takes to manage your own investments and pay yourself the management fees?

Blue Chip or Blue Chimp?

Some big news went down last week in Canadian business. Manulife Financial is a billion dollar insurance company that's had the wind taken out of its sails this week by recording a loss of 2.4 billion. Manulife was one of the bluest of blue chip stocks in Canada at one point, but was hit hard in 2008-2010 as it's stock price went from $39 to just over $9 within 13 months. It's never fully recovered like the other blue chips have.

As an investor, it's important to research a company before investing your hard earned money. I look at how well the company did during 2008 and 2009, and observe how fast they recovered. I also look at past dividend growth. If the dividend doesn't go up each year, I look elsewhere. I don't study charts, ripples or tea leaves for that matter because the stock market is driven by the most unpredictable force on earth... people. That's why I like investing in boring stocks like utilities because everyone has heating and power bills to pay. My other favorites are Canadian bank stocks. Unless you're an eccentric millionaire that keeps your money under a mattress, you're going to have bank accounts and mortgages and the bank is always going to make money off of you. Might as well pay yourself when you pay your mortgage and bank fees.

 Nothing is certain in business and Manulife is the proof. When I started investing last year, Manulife was on my radar as a blue chip to add to my portfolio. As I read more books and articles, I learned that Manulife commited the ultimate sin.... they cut their dividend in half! Now in doing that, they proved that the company was in trouble and as a dividend investor it's the best way to know when to sell off your shares and invest elsewhere. Companies always have bad times, it's unavoidable. So if a company doesn't raise the dividend for a year, it's less offensive then slashing it. Manulife will come back eventually, but until I see some solid dividend growth over the next few years, my money will be invested elsewhere. Now for some good news.


Bell announced they had an increase in second quarter profits and increased their common dividend by 5%. So that means my yield on BCE went from  6.25% to 6.57%. That might not seem like much, but it's one of many dividend increases to come. And since I have 30 years of dividend increases to look forward to, I can patiently wait and watch my yield grow. Is Bell a good company to invest in? Absolutely! Can Bell crash and burn over the next few years? Absolutely! No company is 100% guaranteed to succeed, but your due diligence as an investor is to read the news, find out what's happening and evaluate your findings. It's an important part of self investing and is well worth the price you pay for someone else to do it for you.

Do you own shares in Manulife? Do you plan on buying in while it's this low?

Dividends, take me away!

After a stressful moment at work today, I found myself yelling out "Dividends, take me away!". My coworker laughed because he knows how passionate I am about dividend investing. When I'm having a bad day, I think of little dollar signs trickling down from the sky into my account and it seems to make work a little bit easier. All those little dollar signs piling up so that one day soon, I won't have to be a slave anymore.

I work with people in their early 20's and no matter how much I tell them about saving and investing, I might as well be talking to a wall because they want no part in any of it. "I'm young, I don't care about retirement!" is all I hear and even though I tell them that if they started now, they could double their retirement savings with the extra years they have, they still show no interest. It's almost like people are programmed to reject the "Save" word these days. I remember telling my dad about dividend investing. The first thing he said was "Sounds like a ponzi scheme to me". I'm pretty sure he just heard that term on the news and uses it whenever he can. Investing in dividend stocks that pay you increasing payments every year and if the stock prices drops, people buy more shares which keeps the price from dropping drastically does kinda sound too good to be true. I've given up trying to teach people in my circle about an easy investing opportunity, that's why I created a blog so I can connect to like minded people, and if some of my friends and family tag along, then we all win.

The great thing about dividend investing is that there's no need for secrecy or keeping things on the down low. If there's a great priced stock, I want everyone to know about it. The more people that buy in, the more the stock goes up. The only thing you have to watch out for is yuppy analysts who stare at graphs and ripples all day telling you the latest buy, only to have it fizzle out within the same trading day. Check it out here from Think Dividends

I can't wait till the 7-3:30 shackle is removed and I'll be financially free. Until that day comes, I'll keep thinking of the little dollars signs collecting and start planning the "I've survived the rat-race" T-shirts.