The portfolio's frontline

Adsaff adsadsd By Adsaff adsadsd, 9th Jan 2011 | Follow this author | RSS Feed
Posted in Wikinut>Money>Investing

Part 2 of the series - How to start as a dividend investor.

The portfolio's frontline

This is part 2 of the series - How to start as a dividend investor.

Once the preparations are over and you have a clear idea of what time frame you have and what you want to achieve, it is time to move on to selecting stocks.

Personally, my investment strategy is somewhere between medium and high risk.

I will start with the companies with big dividends from the start. I consider 7% annual dividend, or more to be big dividends. This is the sector where the greatest risk of dividend cuts lie. But this is also the portfolio's frontline. By that I mean that these are the companies that will stand for the greatest income and growth in the portfolio from the start.

When choosing a company that pays high dividends, it is a good deal of things to consider.

1. Why the company pays high dividends?

Sometimes the dividends look high due to a large fall in stock prices. This may be because of internal problems in the company. It helps little to invest in a company that has a dividend of 12% if the dividend is cut to zero the next quarter. An example of this is BP. BP paid normally about 3% annual dividend. When the price dropped very much after the leak in the Gulf of Mexico, it appeared that BP paid out near 12% yield, based on past dividends. But the fact was that BP had major problems and cut the dividend next quarter to zero, and BP still don’t pay dividend.
Extraordinary dividends in some years may also serve to confuse and make dividends look better than they necessarily are. Therefore it is important to look at the dividend history of the company and the statements from the Board regarding dividends. So you are sure that large and regular dividends are part of the company's policy.

2. How much of the EPS (Earning per share) should go to dividend?
Companies that pay high dividends, often pay out most of the EPS as dividend. Therefore it is important to check out how much of EPS that is paid out as dividends in recent years. Some companies pay virtually almost 100% of EPS as dividend. This means that dividends fluctuate almost synonymous with income. Some companies also pay over 100% of EPS as dividend. This means that either the company expects substantial revenues shortly. Or the company have to cut dividends sooner or later. When companies pay almost the entire income as dividends that means they have little or no capital left for new investments. If companies still want to invest and grow they have to borrow to finance virtually all the new projects. This can lead to extremely wide fluctuations in price and dividends.

3. What companies should you then choose?
You should choose the companies that can demonstrate a long history of high dividends and strong dividend policy. It's okay that the companies cut dividends during a recession as long as you know they will start paying dividends again as soon as earnings indicate that they can. Therefore it is important to become familiar with management and the board of the company. Sometimes you can also look at the type of income the company has to know if the likelihood is great for cuts in dividends. Renting out property is a type of revenue source that tends to be relatively stable. If a company rents out properties it is not a problem that 90% of the profits go to dividends and the remaining 10% goes to repay debt and to cover expenses. Such companies often have rental agreements that spans over several decades and which rises by a fixed percentage each year. This means that revenues will increase annually to compensate for inflation and increased expenses. Debt and repayment is also likely to decline with age, so the price and yield will increase with time.

4. How often do they pay dividends?
This is also something you must consider. I recommend investing in companies that pay dividends per quarter or more frequently. Some companies pay dividend per month, some per quarter and some per year. In the long term, this will affect your income and you should choose companies that pay dividends as often as possible.

Let us take an example. If we have 3 companies all pay out 8% annually. One company will pay per month, per quarter and per year.

Company 1
8% over 12 payments.

Company 2
8% over 4 payments.

Company 3
8% over 1 payment.

As you see all the companies pay the same amount of nominal yield each year. However, the effective dividend will as followed:

Company 1. 8.30% eff. dividend.
Company 2. 8.24% eff. Dividend.
Company 3. 8.00% eff. Dividend.

In other words, you get 0.30% higher yield if the payments are per month and 0.24% if it is per quarter at a nominal yield of 8%. It's not all that much, but eventually it becomes a few dollars. Therefore you should choose companies that pay dividend often.

In part 3. I will look at companies with low risk.

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author avatar Denise O
10th Jan 2011 (#)

Great info and well written.
Thank you for sharing.:)

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author avatar La Verne
10th Jan 2011 (#)

great info...thanks...:)

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author avatar Retired
11th Jan 2011 (#)

This is great info. thanks.

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author avatar mountainside
11th Jan 2011 (#)

Hi, This is like a tutorial, thanks very much.

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author avatar Artur Victoria
30th Jan 2011 (#)

Valuable information!

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