What makes a good angel investor or business angel? Is it really just blind trust and believing in the business that is proposed? Of course not! It is really more…
How to build a dividend growth portfolio and how much money do you need to invest to get there? Both are equally important in stock market investing, but it can be confusing trying to answer the two questions.
In this article how to build a dividend growth portfolio, we will look at how to go about building a dividend growth portfolio.
Our focus is on income stocks, but we believe most growth stocks can be capitalized at the same rate. This gives us a simple formula to calculate the rate of return or the amount of money at risk.
How To Build A Dividend Growth Portfolio
Number Of Years Of Dividend Payout
Now that we have the formula for how to build a dividend growth portfolio, the fun part begins! To calculate our rate of return, we divide the number of years of dividend payout by the price of the stock.
In our example, we will use Proctor & Gamble (PG) dividend payouts over the last 8 years. The formula is: Dividend payout = (8 years. X $5.00 / $25.00) * 100.
How To Build A Dividend Growth Portfolio
The dividend payout is the dividend amount earned by P&G over the past 8 years.
For this example, we choose 8 years of dividend payout, since P&G has announced 4 consecutive years of dividend increases.
The price is assumed to be $25.00 per share.
Income Stock Ratio (ISR)
The ISR is the company's annual dividend divided by the annual earnings per share (EPS).
The higher the number, the better for the investor. The formula for the ISR is:
Divided dividend by EPS = Divided earnings per share (EPS) by dividend payout.
Now we have our rate of return! The key to success with investing is diversification. Diversification should include income stocks, growth stocks, mutual funds and possibly a money market fund, although we are just looking for steady growth here.
We want the income stocks to be diversified, and the growth stocks to be diversified.
Comfortable In The Market
The Dividend growth portfolio is great for investors who are comfortable in the market. It gives you some return without putting all of your eggs in one basket.
Even though our example is a dividend growth portfolio, diversification is also important in a stock diversification portfolio, and in both cases, our interest in the underlying stock is limited.
How did our model do?
Our rate of return was 5.9%, which is above the 10% risk-free rate of investment.
Important Aspect Of Stock Investing Dividend Portfolio Vs Growth
How to build a dividend growth portfolio, If you want to try out your own version of a Dividend Growth Portfolio, you will need to be comfortable with the basics of stock investing. An important aspect of stock investing that we left out of our example is the risk associated with the underlying stock.
There is risk associated with any stock investment, but the risk is usually limited if we hold a money market fund.
In fact, the risk of the money market fund is often greater than the risk of the dividend growth portfolio because the money market fund pays dividends.
Knowledge Of A Stock's Intrinsic Value
The downside to a stock investing model is not having knowledge of a stock's intrinsic value. A diversified stock investment portfolio will likely be less attractive to potential investors.
Our model performed well when applied to the S&P 500 Index (S&P 500) which represents the 500 largest publicly held companies in the US. The S&P 500 is a strong index that has outperformed the S&P 500's dividend payer portfolio.
That's because dividend payers do not have a portfolio of their own, so we are comparing apples to oranges. In most cases, dividend payers have outperformed the S&P 500, but that hasn't been the case in this example.
The example above is an orange to apple comparison, but if you own the S&P 500 and the S&P 500 Index, you would be better served by holding a money market fund.
If you have more money than the S&P 500 allows, you should opt for a dividend-paying fund.
Companies With Consistent Prudent Management
Our investment approach should be driven by the purpose of the investment. When we set out to determine the best stock investor how to build a dividend growth portfolio, we knew we were looking for a stock investor who buys quality, stable companies with consistent, prudent management.
We wanted to find a stock investor who is disciplined in how they manage their money, which companies would fit the bill, and most importantly, how much risk were we willing to accept.
The return on invested capital is not static. Rising markets make cash flow more difficult to come by. In fact, cash flow is often a lower percentage of operating cash flow, meaning that the stock investor has more money to invest, increasing the potential return. another important factor when asking How to build a dividend growth portfolio.
Dividend portfolio builder, When cash flow is increasing, returns can be dramatic.
How To Build A Dividend Growth Portfolio
Stock Investor Needs To Be Disciplined
That's what we were looking for. The stock investor needs to be disciplined in how they invest so that they have the same return on invested capital. Another factor to keep in mind when asking how to build a dividend growth portfolio.
In order to come up with the return on invested capital, we used a simple formula that takes stock prices into account.
The formula simply takes the stock price into account and adds the price of the underlying stock over the last 2 years and divides it by the stock price over the last 20 days.
Then we apply the rule. When you do this, you have to take into account the changes in stock prices and the underlying company.
The resulting number is your potential return on invested capital.
Determine Risk Tolerance
The first step in our research on how to build a dividend growth portfolio was to determine risk tolerance. From there we looked at other similar companies in the same industry and also in other industries. We wanted to find companies that are high risk and will provide us with what we need for our portfolio.
We wanted to find companies that offer growth, income, cash flow and downside protection. We looked at a variety of variables to come up with our final formula.
The second step was finding the company's historical returns on invested capital.
This proved to be a more difficult process as historical returns are not always indicative of future performance. We looked at the actual years and realized that the return was affected by many things such as tax rates, economic outlook, interest rates, economic growth, market indexes, and many more factors.
We ultimately concluded that we needed to use the next two years of returns as a better indicator of future performance. We also looked at a few metrics. The two most important ones for us are returned on equity and return on invested capital.
From there we determined the P/E ratio, enterprise value to revenue and enterprise value to EBITDA. Once we had those figures, we combined them and came up with our projected return on equity.
Finally, we found the P/B ratio and its relationship to the stock price. Using this as a base, we determined the P/B to be our projected return on equity.
The best technique we found for projecting future growth for the company was to compare its last five years growth to the last ten years growth of the industry.
For instance, if the company grew 10% on average in the last ten years, we assume it will grow 10% on average in the next five years.
Determine Future Growth
We can use this technique to determine future growth in any direction we want. We could assume that the company grew at 10% on average over the last ten years and compare it to the average growth of the industry.
Using this, we can project future earnings per share, earning per share and earning per share to the industry. It's good to be aware of this technique so that we can more confidently place a bet on the company's future growth.
When looking into how to build a dividend growth portfolio, We found that using this technique gave us the lowest risk of assumption in the group of projection techniques. The biggest issue was in projecting future growth.
For the most part, we decided that projecting future growth was the best method. In addition, using this technique removed the uncertainty of low P/E ratios for future earnings and assumed a high P/B ratio for future earnings.
With the above techniques, our projected future growth can be estimated using forward earnings and the current price. Here's a hypothetical example:
Company XYZ is a microcap stock. During the last three years, it grew by 10%. Next year, it will be 10% again. During the past five years, the P/E ratio has been about 9.5. We can use this to project a P/E ratio of about 9.5 to 15 for the next five years and then project a P/B ratio of 15 to 50 for the next ten years.
Then we can estimate an enterprise value to revenue ratio of about 30 to 50. We can also use this to project an EBITDA of 10 to 30 for the next five years. We can also use these to estimate a price to sales (P/S) of about 10 to 15 and an enterprise value to book return (EV/BGRET) of 15 to 50.
What do these numbers tell us?
The lower the S & P multiple the lower the growth projections need to be attractive. The high multiple indicates that there is a high value in future earnings.
High Growth Scenario
Also, we believe the high EBITDA indicates that a high growth scenario is coming.
In addition, the low P/S multiple indicates that the low P/E multiple is good. Also, the low EBITDA suggests that low EV/BGRET indicates that a value play is coming.
We also found that a low EV/BGRET indicates that a low book value is coming. The low EV/BGRET is also low by historical standards.
A low EV/BGRET is often associated with a low growth outlook, as well. With a low EV/BGRET or book value, it is implied that the stock may be overvalued by historical standards.
To further confirm the market's overvaluation, we should look at similar stocks in the index. For example, if the EV/BGRET is 50, we should look at companies with a book value of 50% or more. Also, companies with high EV/BGRETs is unlikely to be overvalued with a low book value.
With low book value, we should also look at companies with low EV/BGRETs, with low EV/BGRETs indicating low growth.
Additionally, if the EV/BGRET is 35 or less, it implies that the stock is undervalued with a moderate growth outlook. another factor when researching how to build a dividend growth portfolio.
How Do You Structure A Dividend Portfolio
Now that we have looked at how to build a dividend growth portfolio.
Next, How do you structure a dividend portfolio now? One of my favourites for a long term portfolio is the dividend reinvestment strategy.
So often people are looking to buy dividend-paying stocks and don't know which ones.
How can you not have a dividend portfolio.
This is one of my favourite types of stocks to own.
The companies that pay dividends are some of my favourite companies to own. They have a very high dividend yield.
I have owned this company for years now. They make some of the finest products on earth.
Buy Or Sell Decisions
I have not let the dividend affect my buy or sell decisions. I like that these companies let their shareholders decide how to spend their money.
My problem with dividend stocks is they can be riskier than many other stocks.
That was my original problem with the strategy. I am not convinced these companies are risk-free. Most of the recent dividend payers are companies I don't want to own for their dividends. Why buy when you can rent.
Risk Versus Reward Ratio
You can buy stocks that pay dividends and get a pretty good return for the risk. But I think it's important to look at the risk versus reward ratio of the risk.
If you own dividend-paying companies and find yourself wanting to sell, you should probably take a closer look at why.
“A dividend strong company is one that produces an above-average dividend that is completely covered by the market, as in all of its markets.
A covered dividend means that the company has a history of returning a dividend every year on a 100% or more plus they have never missed a quarterly dividend payment for the last 25 years, or since records began.”
Dividend Investing Style
This definition is a major key to understanding my dividend investing style. I look at the business and the history of paying dividends every year plus they never missed a quarterly dividend payment for the last 25 years.
I think in a stock portfolio you would want to have at least half your portfolio cover your quarterly dividend. Of course, this is an extreme view. The point is I don't own companies that aren't dividend strong.
I am going to assume the point of a dividend investing strategy is to own companies that are dividend strong plus that hasn't missed a quarterly dividend payment for the last 25 years.
Generate Consistent Income
By looking at these three points you can start to see how I might approach a portfolio of dividend-paying stocks. You should now be able to see how owning these stocks can be a highly efficient way to generate consistent income from your portfolio.
It is important to remember though that it is a slightly different approach to investing than simply buying the stock and holding it forever.
If your focus is on making a profit then stock options are ideal, they give you leverage, and therefore more room to grow, the only problem is that you are exposing yourself to greater risk.
The basic idea is that if you sell an option you are paid 100 shares of the underlying stock, and if you buy the option you get paid the price you sold it for.
Exposing Yourself To Greater Risk
The problem however is that in the above scenario you are exposing yourself to greater risk by selling options and getting paid more than you are buying the stock, and the above scenario is highly likely to happen, you need to sell the option in order to make money.
If you don't then you will be left with nothing, in the above scenario you would have made money if you bought the stock, and nothing if you sold the option.
The solution to this is to keep the premium you get from selling options. This premium is your profit, if you want to reduce your exposure to risk you should always sell options.
However, you also need to ensure you get enough income to offset the loss you take on risk.
There are a number of ways you can do this.
Firstly you can make sure you only buy options where you have a good-sized position, if you have a small position, then you can protect yourself from extreme loss, by protecting yourself with an out of the money call option, as long as you are in the money then you can always make money, in this scenario the premium you can get is very good, but you don't control the price so you need to be careful.
Protect Your Position
The second way is to protect your position, this means buying an out of the money option with a high premium, as long as the stock is less than a certain amount then you make money, as soon as the stock price goes above this amount you are protected.
The third way to reduce your exposure to risk is to set the strike price on the option so that if the stock price goes above the strike price you get to keep the premium you receive from selling the option.
What Is The Fastest Way To Grow Dividend Income
What is the fastest way to grow dividend income? The fastest way to grow income in a low-risk environment is to invest in the stock market.
To invest in the stock market you must know about the best companies to invest in.
The best company to invest in for dividend income is a diverse portfolio of stocks, from several categories, which gives the investor the opportunity to capture dividend income across the market.
As I discussed in a previous article, a diverse portfolio of stocks is one that contains several types of stocks.
Diversity And Flexibility
A diverse portfolio of stocks helps the investor capture the income from a variety of industries, allowing the investor to have diversity and flexibility in the income they receive.
The investor can choose to capture income from one industry, or spread their income across several industries.
This allows the investor to have more options for earning income.
The easiest companies to invest in for dividend income is when there is a small-cap stock as well as a larger more established stock.
By capturing the dividend income of the small-cap stock, the investor is more diversified, and most of the company's earnings can be reinvested in more shares of the stock.
Strategy And The Knowledge
When you combine this diversity with a short sales strategy and the knowledge and skill to make out short trades in the small-cap stock, it becomes the easiest way to make out money in the stock market.
There are certain factors that most likely allow the investor to become a successful stock trader.
These factors are the result of learning from mistakes and being disciplined to the process of learning. The most important thing an investor can do to become a successful stock trader is to know their own limitations and be honest with themselves about their strengths and weaknesses.
Once an investor is able to admit their limitations, and own their weaknesses, they are then able to become an expert at identifying investments they can buy.
Next, the investor must become disciplined in the process of trading, and develop a process of choosing stocks they can trade.
The process of choosing stocks can be simplified by comparing the downside risks of the stock you are considering buying with the potential upside risks.
Short Trades In The Stock Market
Finally, the investor must learn to make out short trades in the stock market and trade their stocks for a living. This last step is critical to becoming successful in the stock market because it is the very essence of a stockbroker.
Being disciplined, and keeping track of stock movements is the foundation for success in the stock market, so never allow your emotions to play a part in putting your money to work where it is not needed.
These are all the lessons most investors learn as they go through the stock market, but to become a good stock investor you must follow these 4 steps to achieve success. If you keep these 4 tips in mind to stay disciplined and make successful stock trades, you will be successful.
Can You Make A Living Off Dividend Stocks
Can you make a living off dividend stocks? I know many people are looking for the best way to make money with dividend stocks, and with good reason.
With the economy at the lowest point in 50 years and all levels of stocks getting whacked,
dividend stocks are a great opportunity to make money and to hedge against a bad economy.
Is it a get rich quick scheme? No, not at all.
It is a long-term strategy that can make you money.
You may not be able to get rich quick, but you can make money, and that's all that really matters.
Here are three steps to finding great dividend-paying stocks.
1. Avoid the too good to be true
Look for stocks that have paid dividends every year for the last 5 to 10 years. These stocks have little competition, so finding a stock that has been paying dividends consistently is easy. It will also help your portfolio to have a few other stocks that have paid consistent dividends.
2. Look for stocks that have a good track record
You can find great dividend-paying stocks by looking for stocks that have a good track record. Look for a company that has a good earnings yield over the last 5 years and a good dividend yield over the last 10 years. You will want a company that has the potential to double its earnings every 2 to 5 years. Check out companies that are growing their earnings faster than the overall market.
3. Look for value
Another strategy is to look for stocks that are currently priced low relative to their earnings. The first two strategies only look at stocks that have a track record of paying dividends.
The price of a stock is just a figure viewed over a period of time.
In the long run, stocks tend to price higher than their earnings. By taking the current price into consideration, you will be able to find stocks that are currently priced very low, but not too low.
You may be tempted to look at the charts of dividend-paying stocks to find some that are even cheaper than these stocks.
Fair Market Value
Sometimes, they are, but you have to look a lot further before finding a stock that is even close. In the past, you could find dividend-paying stocks that were 30% to 40% below the fair market value. It used to be so easy to make money with this strategy, but now it's not so easy.
Earnings are down, and now it's even harder to find a stock with strong earnings. What once was a sure thing to make money in the short run is now a more long-term play.
A 30% to 40% earnings downgrade is much more likely to follow a 5% to 10% earnings downgrade, and then you are better off holding a stock that has strong earnings than a stock that has low earnings.
The good news is that even if a stock has low earnings, there is a good chance it's a growing stock and will eventually pay high dividends.
Long Term Stock Market Investment
Just like the dividend strategy, the value and dividend strategy is a great strategy to use when looking for a long term stock market investment. The first part of this strategy looks for stocks that are currently priced low, which gives you some potential candidates.
The second part looks for stocks that are currently at a discount as a result of a negative earnings surprise, which is a safe haven if this happens.
But you need to keep in mind that the stock market has risks. Stocks with low earnings may be dropped if earnings come in below expectations.
However, just like dividend-paying stocks, stocks with high dividends may be unaffected by earnings downgrades, as they have a strong tendency to follow dividend payments.
You should know that buying stocks for a long term investment may lead to greater returns, but that is not guaranteed. There is nothing wrong with using both strategies, it just needs to be done by careful study and stock selection.
What Is A Good Dividend Yield Payout Ratio
It is a ratio of a company's dividend yield to its share price. In layman terms, it is the company's dividend flow rate divided by its share price. What you get is the percentage of company profits that will come back as dividends.
For example, a company with a 10% dividend yield would have a 10% dividend to be paid out as dividends.
A good dividend payout ratio relates directly to the company's cash flow statement.
By looking at the income statement,
you can see what the company will pay out as dividends, what the company will collect in dividends and also the company's cash flow statement.
A lot of investors don't think about what the dividend yield will be.
They only care about what the company will pay out as dividends.
I don't think any sensible person would compare the company's dividend payout ratio to its core business or the company's net profit.
Very High Dividend Yield
If you look at the core business, you should find that they have a very high dividend yield (20+%), which means that the majority of their earnings will be returned as dividends.
What is a bad dividend yield? What you get is a ratio of a company's dividend payout to its share price.
You can get a very low dividend yield (below 1) by looking at companies with a small dividend history. You can get a high dividend yield (above 2) by looking at companies with a large dividend history.
You can also get a high dividend yield (above 4) by looking at a company that is a REIT or a business that does not normally pay dividends.
For example, let us take one of my favourite companies, ASICS, a SEP company that does not normally pay dividends. ASICS dividend yield is now 50%.
What do you think the dividend payout ratio will be now? Will ASICS payout 50% of its earnings to shareholders or will it pay out less?
The high dividend yield implies that more than 50% of earnings will be returned as dividends. The dividend payout ratio will rise significantly because of the high dividend yield.
Dividend Payout Ratio
The high dividend yield means that almost 70% of earnings will be returned as dividends. The dividend payout ratio will remain the same because of the high dividend yield.
The high dividend yield and the high dividend payout ratio indicate that a large number of earnings will be returned as dividends.
The ratio of the dividend yield and the dividend payout ratio may be a signpost that can help investors determine the next stock they should buy.
But the dividend yield and the dividend payout ratio are not the only ratios that can tell you the future of the company. There are other important ratios that are vital to look at.
Some of these important ratios are the debt ratio and the equity ratio.
The Debt Ratio
The debt ratio tells you the amount of debt the company has. The lower the debt ratio, the less debt the company has. The more debt a company has, the more it is relying on debt to finance its operations.
The equity ratio shows you the amount of equity the company has. The higher the equity ratio, the more equity the company has.
High Equity Ratio
Companies should have a high debt ratio and a high equity ratio. Companies with low ratios of debt and equity are generally young companies. In the long run companies with a high debt ratio and a low equity ratio are reliant on equity to finance their operations.
This means that the shares the company issues will be relatively expensive, but the company will not need to issue a lot of new shares to fund its operations.
The ratio of a company's net profit margin to its enterprise value, or its price to book value, or its asset price to liability, will give you a good idea of how profitable the company is at making its profits.
The lower the numbers the better. For most companies a net profit margin of 5% or less is ideal.
High Enterprise Value
A high enterprise value to net profit margin is a good indication that the company is profiting from its operations. But it is better for a company to have a higher enterprise value to net profit margin than a lower one.
But a lower net profit margin means that the company is not making as much money as it should be from its operations. And that could indicate a preliminary liquidity problem.
Companies should have a very low asset price to liability ratio.
This ratio shows you the degree of financial leverage a company has. Low ratios suggest that the company is financially more stable and low on financial leverage.
But the company might be relying too much on asset prices to finance its operations. So the company needs to reduce its leverage.
Market Value To Book Value
Companies with a very high ratio of their stockholder equity to its net income, or its equity to net debt, or its free cash flow to its debt, or its net equity to its net assets, or its market value to book value, or its P/B ratio should be avoided.
Companies with a high P/B ratio are trading at very high valuations or have high debt levels and the market is expecting heavy growth in earnings.
These companies usually are overextended in their business ventures. They need to cut back on their debt and have very low equity to debt ratio.
Companies with a low P/B ratio can be overvalued in the current market. They are trading at a price that is far above the book value or the intrinsic value of the business.
Book Value Or Intrinsic Value
And companies with low stockholder equity to net debt ratio is trading at a very low price compared to their book value or intrinsic value. They are trading at a price that is far below its book value or intrinsic value.
So your objective is to analyze the current and future price of a company and its stockholder's equity to net debt ratio in order to find the ideal valuation for the company.
What Is The Downside To Dividend Stocks
Dividends are payments that a company makes to their shareholders. Sometimes the amount is predetermined (say 3%) and sometimes it is (more likely) dependant on how much you own the company.
There are two main reasons that people prefer dividend stocks.
First, dividends are a fixed amount of money that you receive regardless of the price of the stock at any given point in time.
The company literally divides your dividend payment up amongst you and does not do this on a quarterly or yearly basis.
This means that if the stock's price goes up and down, your dividend amount is not impacted in any way.
Second, dividends often go up or down more rapidly than the stock's price.
If the stock's price shoots up, your dividend amount should not significantly decrease.
But if the stock's price drops, your dividend amount will increase over time.
Therefore, because the amount of dividend going up tends to be greater than the amount going down, dividend stocks are generally considered a safer choice than other stocks.
Operations And Expansion
But some stocks don't pay dividends and instead use their capital gains to help finance their operations and expansion. Therefore they can be a better long term investment than dividend stocks.
Some people argue that dividends are important because they are supposed to be a measure of the underlying earnings of the company.
But in reality, it's very hard to determine what the actual underlying earnings of a company are.
Advantage And Disadvantage
Basically, it's a guessing game. Some people consider this more of an advantage than a disadvantage because it makes it harder for the company to mislead the investor with false statements.
However, some investors believe that this makes it easier for the investor to get misled by the company's statements.
Either way, one thing is for certain. If a company is paying out dividends to its shareholders, it stands to reason that they are making money.
The most important thing to remember is that your own individual discretion is required to select the best dividend stocks.
As always, use these points in conjunction with others. You decide.
Thanks for your visit, You may find some of my other posts below of interest.
Thanks again. Michael
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