Dividend Investing:  A Technique For Income Investing

Dividend investing is the process of selecting investments that pay out a portion of their earnings to shareholders, and is the most common way to execute an income strategy.

As I mention on my contact page, I believe that you need to use different methods at different times in order to be a successful investor.

There are times when growth investing is best (when you are focused on increasing you capital gains) and there are times when dividend investing is best (when you are trying to generate income from your investments)...and there are also times when no type of investing will work.

When it came time for me to start dividend investing, I knew that I did not want to reinvent the wheel. Using Investor's Business Daily (IBD) made stock selection much, much easier, and added the element of "timing" to the mix.

Timing addressed one HUGE frustration I had with investing; spending a lot of time researching and finding the perfect stock, only to watch the break-out fail and quickly hand you a 7% loss.

I also knew that IBD rules would not work for dividend investing. Why? Because those rules were created as a technique for growth investing.

So I wanted a rule-based method, similar to IBD, but for dividend investing.

The Dividend Growth Investor

I eventually found The Dividend Growth Investor website, and it now acts as my "IBD" for dividend investing.

The author has done a great job laying out the criteria needed for success and his selection method/process. Since safe investing is all about the process, this site is a fantastic resource.

Rather than reinvent the wheel, I leverage the authors knowledge and apply it myself (much like I force you to do by supplying a pdf of a personal income statement, rather than an editable excel file).

Why is Dividend Investing Important?

Conventional wisdom says that investors should focus on generating capital gains early, and switch to dividends as you age, because you can't tolerate the losses associated with growth investing and need to have more income streams (think retirement).

To me, income investing is an important strategy, whether you're just starting out or about to retire; a key step on your road to financial freedom. Remember that financial freedom is covering your monthly expenses using your assets (not using your paycheck).

Factors for Affecting Dividend Investing

Just like growth investing, dividend investing is affected by external and internal factors. But internal factors are more important and should be the focus of your research.

External factors affect all investments. The economy, interest rates, income taxes, unemployment, and all the other stories you hear on the 6 o'clock news impact your ability to make money. The good news is that they are out of your control, and are constantly changing, so they have less impact of dividend investing than growth investing.

The reason the external factors have less impact is because you will be looking for companies that have been able to provide quality dividends for a long time, regardless of market changes.

Dividend investing has a long-term timeframe. Most dividend investments payout on a quarterly (3 month) basis, so market conditions can change dramatically in between payments.

If you can find companies that have done well in all market conditions, odds are that they will continue to do so. Just remember that this is not a guarantee, but does increase the probability of success.

Internal factors are the ones that let you know which companies have done well in all market conditions...sort of like the factors you are monitoring with your personal financials statements. I call them internal because they are internal to specific company.

Again, relying on the dividend growth investor website, these are the things you should be looking at when selecting your dividend stock.

  • Rising EPS
  • High Return on Equity
  • Decreasing number of shares
  • Sustainable Dividend Payout Ratio
  • Dividend Growth History

For more in-depth information, such as how "high" is a high return on equity, check out the Dividend Growth Investor's post on the 5 metrics of Successful Dividend Investing

How to Start Dividend Investing

Now that you know what factors to study, there is the matter of sorting through 7,000 some stocks and find the ones with dividends, and then filtering out the ones that meet the criteria above.

And yes, it does sound like a lot of work, and that is because it IS a lot of work. But my site is about saving you time. So here are three filters you can use to screen potential dividend stocks before you ever start digging through their data.

  1. Dividend Achievers - To qualify as Dividend Achiever, a company must have increased its dividend payout each year for at least the last ten years consecutively AND meet certain liquidity requirements.
    • The term "Dividend Achievers™ goes back to 1979, when Moody's developed a proprietary model to find the best dividend-paying stocks.
    • Four years later, Moody's created the "Handbook of Dividend Achievers™", which listed these companies.
    • Fast forward to 1998, when Mergent, Inc. acquired Moody's Investor Service and rebranded the handbook under the Mergent name.
  2. Dividend Champions - Dividend Champions are stocks that have raised their dividends for 25 years in a row, as defined by Dividend Investing Resource Center.
  3. Dividend Aristocrats - Companies that have increased dividends every year for at least 25 consecutive years and have a market capitalization of at least $3 billion as defined by Standard and Poors.
  4. Dividend Kings - Companies that have increased dividends every year for at least 50 consecutive years.
    • There isn't too much data on who created this term or how the list is monitored and updated. But the last time I checked there weren't many companies (<20) that have managed to make the cut and the list won't change that often.

If you use these lists (Achievers, Champions, Aristocrats, and Kings), a lot of the legwork has been done for you. But you still need to do your homework, because the lists aren't perfect.

Here is a great article from Seeking Alpha on how stocks are selected for the different lists mentioned above and what is meant by "raising dividends"