Starting to get a little more precise about investing in dividend stocks with a small portfolio, we are looking today at the basics you need to consider before purchasing your very first company. For more experienced dividend investors, this will sound like basic advice but there is nothing better than going back to the basics in weird markets like this.
The company’s fundamentals
Before even thinking about dividend growth and dividend yield, I think that you should select a great company. Dividend investing is only worth it when you actually receive dividends over a long period of time, so you are better off choosing a solid company.
I like to look at the company and its business model. Considering how and where it makes a profit will influence my choice as an investor. I don’t want to have a company that is too concentrated in a specific market. I would rather look at well diversified companies that will rely on many products to assure its future benefits.
A low P/E ratio will also be interesting. I like receiving dividends but if you can also earn capital gains over the long run, it’s a double bonus. A low P/E ratio is also a sign of a good buying opportunity if you can wait long enough. Since dividend investing is all about the long term, it should fall directly into your investing model.
Liquidity and the ability to generate a positive cash flow in the future is also a key point to verify in dividend investing. You won’t get much dividend increases if the company fails to keep a good cash reserve. Since we are stuck in a liquidity trap on the US market, cash has become a very important indicator of a company’s financial health.
Now that you have picked a solid company, let’s talk about what we are interested in; DIVIDENDS!
Since you are about to make your very first move as an investor, I suggest you lean towards the dividend aristocrats. These companies have been increasing their dividend systematically for several years. If you look among these picks, you will certainly find a good company.
Dividend payout ratio
Another important point is to make sure that the company will have enough money to keep its dividend at the current level and potentially increase it. The dividend payout ratio will tell you if the company can maintain its dividend over time. I like ratios under 60% since you play with fire a little bit when you pick stock with a higher payout ratio.
In theory, a company should give its money back to the investors if it can’t produce an interesting yield with it. This is the principle behind paying dividends. However, I would rather have a company that keeps more money in its bank account, even if it doesn’t generate profits right away, than having a company that is always on the line in order to respect its dividend distribution.
This is where dividend investing becomes interesting! Because you can look at 3 different strategies;
#1 Building a high yield dividend portfolio
#2 Building a dividend growth portfolio
#3 Building a dividend portfolio with possibility of capital gains
Depending on if you are chasing high yield or not, you will take different stock picks. For example, you will probably accept a higher payout ratio if you want to build a portfolio giving 4-5% right away.
If you are more patient, you will take a lower payout ratio but with the company’s ability to increase its dividend over time. At the beginning, your portfolio will probably generate a smaller yield (around 3%) but you will aim for a 4-5% distribution over time considering the dividend increase.
What about you, how do you build your dividend portfolio?
In further posts, I’ll do a few stock analyses (I’m opening up my Questrade account for my company right now). In the meantime, I would like to know what you are looking for when you are buying a dividend stock?