Any respectful investor will tell you that you need a solid investment process if you want to be successful in the stock market. I’m definitely part of this category. I strongly believe in fundamental analysis to find the best stocks for my portfolio. I’ve created my own dividend stock analysis template and follow my investing rules religiously. But there are far more than simply ratios and financial data required to analyze a stock. The numbers will tell you a story, but there is a lot more to discover when you read between the lines.
Know What You Invest In
This investing rule has been made famous by Warren Buffett. According to his investment method, you should never invest money in a business model you don’t understand. This is also probably why he keeps most of his investments in “simple companies”. I must admit that it’s pretty easy to understand companies like Coca-Cola (KO), CN (Canadian National – Trains) and Heinz (HZN)!
When you know what you invest in, it’s easier for you to figure out if the company can continue to make a profit over a long period of time. For example, I own shares of Telus, a telecom giant in Canada. The market is relatively closed to newcomers and there are a lot of possibilities. I’m not a techno crack, but I do understand that the population of Canada is not 100% converted to the Smartphone yet and margins on such products are pretty good (especially with the super expensive 3 year contracts we sign!). I also own a few consumer sector businesses in my portfolio as I don’t have to figure out if people will continue to buy soft drinks or not!
Surprisingly, there are a lot of things you can understand from your own perspective. When you mix what you learn from work and from your day-to-day life as a consumer, you have a lot of data to analyze. Most of it can be used to improve your knowledge of a few companies.
Plan Your Investment Return Based on Dividend Yield
Another thing I like about dividend investing is the fact that you can plan a part of your investment return ahead of time. If you treat your stock as bonds instead of equity, you will find retirement planning a lot easier. Let me explain my theory.
Within the next 12 months, 2 years, 5 years, it’s pretty hard to determine the future price of a stock. There is tons of news that can influence the price of your stock. However, there is not much that can influence the dividend payment.
Once you have selected a strong dividend payer (with a growing EPS and a low payout ratio), chances are that your dividend payment will only increase in the upcoming years. This part of the equation is fairly easy to plan for when you look at long time dividend payer.
In my portfolio, I can be assured that companies such as KO, JNJ, CVX, BNS, NA, INTC, T will continue to pay their dividends for a very long time. Their payout ratio is low and their dividend history is impeccable. Unless there is a huge catastrophe, I can plan on receiving my 3-4% dividend yield for several years. I don’t need to know the value of the stock per se; I only need to know how much I will receive in dividends. If the company continues to keep a good ratio, its valuation will come back to par (or even higher) over the long haul; exactly as bonds come back to their par value before maturity.
Then again, if you understand the business model you invest in, you won’t have to worry about the dividend payouts!
Follow the Buzz? Only if You Get it
I’m not too keen on following the market flavor of the month. For all kinds of reasons, good or bad, many investors start to invest in similar stocks in the same sector. We saw it earlier this year with the food industry. I personally picked the techno sector over the past two years with investments in Telus, Intel, Seagate Technology and Apple. I like the buzz around techno stocks because most companies have so much cash in their accounts, they don’t have any other choice but to pay bigger and bigger dividends! I’m expecting Apple to turn into another Microsoft. The growth won’t be astronomical anymore, but the dividend will increase on a steady basis.
Riding a wave while it goes up is always fun. But there is a big risk the wave crashes while you are still on top of it. This is why it’s important to understand why there is a buzz around a sector and if it’s worth it to invest or not. I’ve riden the buzz around oil income trusts in Canada back in the early 2000s. I made a lot of money and, fortunately, I cashed out my investment to buy a house in 2007, right before the crash. There was a huge negative buzz around banks in 2008-2009. Those who analyzed the situation right saw that Canadian banks should not be penalized by that buzz. They made a lot of money!
The reason why I bought Apple this year is also because there is a negative buzz around the company. I believe that with their resources and cash, they will bounce back. I don’t expect the stock to go as high as $800. But I expect it to increase its dividend on a yearly basis!
Finally, Know Why You Are Investing
I think that knowing why you are investing is very important. Some do it for fun because they like the feeling of trading. Others do it because “it is the thing to do when you have money”, they should consult a professional to make sure they are doing the right thing! There is also a big difference if you invest to generate a source of income than if you are in your 30s and trying to build a big nest egg. Beyond the numbers, the reason why you invest in the first place will dictate how you will manage your portfolio and if you will make money or not!
Disclaimer: I own shares of KO, JNJ, CVX, BNS, NA, INTC, T, STX.