High dividend yield in a low risk portfolio? How is that possible? Well there is a way that you can invest your money and earn a high dividend yield without taking much risk.
I think that’s this is basically what we all want as dividend investors: high dividend yield from low risk stocks. But unfortunately, it is rarely the case. If you remember my yellow pages (YLO) analysis you know that high dividend yield is usually followed by dividend cuts (especially if the dividend yield is combined with a high payout ratio!). So how can you find these precious gems on the market? In fact, there are a few steps to build the most solid portfolio with the most impressive dividend yield:
#1 Build some cash in a money market fund
Building a strong portfolio combining high dividend yield and low risk companies requires patience and discipline. The very first step you need to accomplish is to build up enough cash so you can move quickly when you are ready. So instead of gradually buying stocks as you gather a $1,000 or so as I suggest in Dividend Investing, you can also put your money aside and wait a little while.
#2 Build your ‘stocks on the radar‘ list
While you are gathering your cash (trust me, you need a lot for this investing technique to produce impressive results), you will also build a list of 10 to 20 stocks you want to follow. In order to build this list, you should use criteria found in my 15 things I look at before trading a stock. Most importantly, focus on a good dividend yield (between 3 and 5% at the moment would be reasonable) combined with a low payout ratio (under 70%) and with constant sales and earnings growth. You are basically building a list of companies that are already in the mood of raising their dividend payout and that they can sustain this rhythm.
#3 Focus on high Dividend Growth
Among to the 15 metrics I’ve mentioned, I would like to highlight 2 of them: Dividend growth and P/E ratio. While dividend yield, payout ratio and earnings numbers will assure you that the company will continue to pay a good dividend, past dividend growth will tell you more about the intentions of the board of directors. If they have been raising their dividend by 10% on an annualized basis for the past 5 years, chances are that you have a winner in hand.
It means that this stock is not only paying a good dividend to start (3 to 5%) but it will also double its dividend payout within 7 to 8 years. At dividend annualized growth of 10%, it takes 7.2 years to double your dividend yield. Dividend growth is probably the most powerful concept in dividend investing.
I’ve taken a few minutes using my stock websites to find a few examples. I picked the price of each of these stocks on January 4th 2002 and look at the dividend yield at that time. Then, I show you their current dividend payout along with their current dividend yield considering that you are holding those stocks for the past 9 years. Here’s the result:
Original price: $30.14$
Original dividend payout: 0.74$/year
Original dividend yield: 2.46% (not that sexy, huh?)
Current dividend payout: $2.15/year
Current dividend yield (assuming you kept the stock at the original price): 7.13% (now you’re talking!)
Original price: $44.65
Original dividend payout: $1.40/year
Original dividend yield: 3.14%
Current dividend payout: $3.12
Current dividend yield (assuming you kept the stock at the original price): 6.98%
Original price: $29.53
Original dividend payout: $0.96
Original dividend yield: 3.25%
Current dividend payout: $2.84
Current dividend yield (assuming you kept the stock at the original price): 9.61%
As you can see, these 3 stocks pay 7% or more dividend yield only 9 years after being purchased… and I’m not talking about the capital gains you can make by selling them…
#4 Identify undervalued stocks
I agree with you, it’s easier said than done. Nonetheless, this is crucial to find hidden gems. I guess that if you use a combination of P/E ratio that is under the industry with sales & earnings growth perspective, you can identify companies that will do well in the future. However, the best way to find undervalued stocks is through step #5…
#5 Watch for a dip in the stock market
As I just mentioned, it is pretty rare to find great companies at a cheap price. But, it always happens when you are shopping during a market correction. For example, people who bought stocks late 2008 or early 2009 are definitely earning high dividend payouts! There are a few ways to watch for a dip in the stock market. The most common is to read the newspaper 😉 when you read words like “collapse”, “apocalypse”, “market slump”, you don’t even have to check out the graphs and you can jump directly into your brokerage account!
If you want to get more technical, you can use the moving average. Following the 200 days moving average of your stock list combined with the stock market will lead you to identify moment when you can buy stocks for cheap. This is when your liquidity is useful as you can buy more than one stock at the same time. For example, right now seems to be a great time to buy nice dividend stocks!
#6 Give yourself some time… at least 10 years!
The power of dividend investing is proven over time. As you can see with the 3 examples I’ve mentioned, in 9 years, you can build a 7% dividend portfolio with blue chips that will keep increasing their dividend payout moving forward. This also means that your 7% dividend yield can turn into 15% with another 10 years… this sounds like an interesting retirement account, isn’t?