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Strategy – continued

Posted by on 7. October 2013

In the last post we touched on how to best find investment candidates. Not just via a simple throw the dart approach, yet using a strategy that provides both income growth as well as stock price appreciation. Remember, the dividend approach?

In the vast digital realm, a lot of (very smart) people have already written myriads of articles on dividend growth strategies of assorted flavors. The more I read about that kind of strategy, its benefits and potential upsides, the more I am starting to think this is the way to go for our hypothetical investment portfolio.

A company that pays a dividend is well established in the market and has been around for quite a while; thus, it would be unlikely for it to go bust unexpectedly. Its products can usually be classified as every day staples (some might call that ‘boring’ from an investment perspective) or infrastructure companies. Good examples would be Procter & Gamble, or your local utility company or phone company. Just because a company has been around for a long time, we should also look at the company’s plans to stick around in the future. Given the accelerated developments in say the telecommunication market, a traditional phone company simply focusing on landline phone service may not have any chance to make it to the next New Year’s eve party. So we should ask questions such as how the business model will stay in touch with the Internet Age, the cloud hype and the large amounts of data being piped through old copper wires to your home smart TV?

A well established dividend paying company usually also has a fairly stable share price without a lot of sever up and down movements. Over time, that share price though may have climbed and climbed to lofty heights beyond the $50 mark. An example there would be Procter & Gamble. Very stable, very good product portfolio, very good investment choice for the P&G employee (let’s forget the Sox regulations for a minute) in either a stock plan or even a 401k account. Yet, we are trying to start out in the investment world and are interested in a little bit more of a return than maybe $40 / year.

So a possible add-on to this conversation is dividend growth over time. What is that? Well, simply explained, it is the company raising the real money amount being paid out per share over time. For instance, initially, the company pays $0.10 / share for the first 4 quarters; due to good business development and revenue growth, the company decides to raise its dividends from $0.10 / share to $0.15/ share. That is a 50% increase in payout amount!! Calculated at the end of that fiscal year, we, as investors, would have received $40 / Y1 and $60 / Y2. Nice! Not really anything that would allow us to quit our day job, yet nothing to sneeze at either, given the statistical (percentage based) development of our stock choice.

An added bonus in this context is the falling cost basis for our stock shares in this investment. As we continue to hold this stock and accumulate its dividends, our real money basis only goes up (we are re-investing any received dividend payments!), our number of held shares also goes up. Yet the stock price itself does not necessarily move that much. Without going into too much detail (as there are full time paid number crunchers for this mathematical nightmare), our cost / share over time decreases. Don’t expect any large decreases by any means, yet after several years of following this strategy, it is quite noteworthy.

Should our stock (against all odds) take somewhat of a dive (think financial crisis of 2008 / 2009), our holdings in the stock are somewhat insulated from that large price drop. How do we figure that? Well, let’s take a little bit of a closer look: we continue to buy and re-invest stock of company A over several years. On occasion, the stock price is somewhat higher, on occasion it is somewhat lower; due to continually buying, we exercise the concept of dollar cost averaging. Over time, despite fluctuations, our cost of stock remains somewhat stable, possibly even trending down (below actual market price). Hence, the longer we stay invested in a given stock, the less pain we would experience if the actual market price dipped (for a relative short amount of time).

Note: we will discuss the blood pressure and nightly sleep implications of continued buying of such a stock during a bear market (down stock prices) at some point down the road.

Some other (smart) people before us have followed this path before, and established a list of so called ‘dividend champions’ or ‘dividend aristocrats’. Take a look at the below two hyperlinks; one of those is to the DRiP Investing homepage, a most awesome source for anything regarding dividend investment (did you know that most of those dividend paying company also offer the general public, i.e. individual investor, to directly invest with the company bypassing the stock broker entirely? Talk about nifty!).

Wikipedia S&P 500 Dividend Aristocrats

DRiP Investing Resource Center-Dividend Champions

Go ahead, take a look at those two links above. Consider it your ‘homework assignment’ out of today’s discussion. Yeah, I forgot, there will be such required independent reading, quite frequently.