I’m a dividend growth investor. That means I’m looking for a certain type of growth company that not only pays out a dividend, but the dividend will increase year after year. With the right mix of dividend yield and dividend growth, it’s possible to grow the yield to 10% on my original cost within 10 years.
What does this mean in real numbers?
In July 2011 we rolled my wife’s 401k into an IRA. The beginning balance was $216,508. The goal of this portfolio is to generate a 10% yield in 10 years. 10% of $216,508 equals a dividend income of $21,651 by July 2021.
If the typical dividend yield is 2.5%, then how do we get to 10%?
It’s not enough that a company pays a dividend but, the dividend must grow every year.
We rolled the 401k into an IRA in July 2011 but, we didn’t start converting the cash into dividend growth stocks until August of 2012. The conversion was finally complete in 2013. At the end of 2013 the portfolio had a 2.6% average dividend yield.
With this late start, I will need to reach my 10% income goal in 8 years instead of 10. Starting from 2.6%, I will need to double my income two times - from 2.6% to 5% in the first four years and 5% to 10% in the second four years.
We can use the rule of 72 to figure out how much the dividend needs to grow. 72 divided by 4 years results in a dividend growth rate of 18%. My portfolio will need to have an average dividend growth rate of 18% to double the income every 4 years.
This graph provides a good visual for what my goal trend like looks like and how well I’m doing (or not doing) to meet that goal.
|Actual dividend income (light blue line) versus my dividend goal (dark blue line)|
The graph looks really good up to 2014 but, my income may remain flat in 2015 due to replacing some high yield dividend companies over the past six months. INTC, COH, TIS and TGH were large parts of my portfolio in 2014 but, none had raised their dividends in the last 7 to 10 quarters. That’s grounds to be replaced.
I finished selling off those companies in January 2015 and will be replacing them with companies in the hard hit energy and oil sectors or touched by the energy downturn - CPA, CMI, HP and NOV.
I finished 2014 with a dividend growth rate average of 16.5% and a yield on cost of 3.5%. With some of the changes I mentioned above, I should be able to increase my dividend growth rate to 19%. CMI is one of my two favorite stocks in the buy zone right now. I’m hoping the railroads will take a hit in stock price too so that I can buy more of my second favorite stock - UNP.
|This chart shows actual dividend income results versus my target, as well as my current yield on cost - 3.5%.|
Patience, my biggest lesson learned in 2014
Speaking of waiting to buy UNP, that’s my biggest lesson learned in 2014. I listened to those guys that tell you it’s better to be fully invested than to sit on the sidelines waiting for a stock to fall into a buy zone.
There are two major problems with that theory. First, this theory leads you to believe it’s okay to buy high quality companies even when their prices are at or near 52 week highs. And second, buying into a company that’s at or near it’s highest stock price also means you are buying in at the lowest possible dividend yield.
When you buy stocks at their highs, they eventually fall. On several of my purchases, AAPL, CPA and HP are good examples. I watched stocks drop 30% to 40% or more right after making a sizable purchase. It didn’t upset me that I “lost” money on those buys. What upset me the most is that I left money on the table. I could have waited and bought many more shares at a much better price. Better yet, if I had waited for the stock to move off it's highs, my starting yield would be been 3% or 4% rather than 2.5%. A better starting yield is the best possible way to get a jump start on the 10% in 10 years goal.
I own stock in less than 20 companies but, I have over 50 high quality companies on my watch list. Every month some sector is out of favor so I always have three to five stocks at or below their 200 day average. These are my personal dogs of the dow and the companies I will consider buying when I have cash available.