The Dividend Method
Show notes:
This is the Help Me Retire Podcast… with your host… Mike Brown… Senior Wealth Advisor with Raymond James Financial Services… and head of Brown Family Wealth Advisors…
Mike is the best-selling author of Your Way to True Wealth: How to Make It Happen, Make It Last, and Make It Matter…
He and his team have been helping clients pursue their dreams of financial independence for the past 30 years… and in the Help Me Retire Podcast… he’ll share his best ideas with you…
And now… here’s Mike…
In Episode 8 of this podcast… I talked about how important income is in retirement… for some pretty obvious reasons…
Retirees need income to pay the bills… and because those bills have a way of going up over time… you also need a source of income that can increase over time as well…
And if at all possible… we’d like to have our cake and eat it too…
In addition to a rising stream of income… most retirees say they want to keep their principal intact over time…
They want to preserve their purchasing power… for themselves and future generations if possible…
We agreed that equities are really the only investment that fit the bill for us… at least based on how they’ve performed over the long run…
And today… in this episode of the Help Me Retire Podcast… I’m going to drill down on that idea some more… and describe to you exactly how we decide which companies to buy for our clients’ portfolios…
Exactly how we pick stocks in other words…
Before we do that… I want to remind you that wherever you are in pursuit of what we call True Wealth…
Building wealth…
Seriously considering retirement… planning transition…
No longer working… trying to make money last… and make it matter…
The concepts you’ll hear me explain today can work for you…
Rising-dividend companies are not only good at generating income for retirees…
You can also reinvest that rising stream of income… buy more shares… and compound your way to True Wealth…
So wherever you are on your journey… we’ve got resources for you…
Weekly ideas in our free e-letter: Wealth and Wisdom
Web site: brownfamilywealthadvisors.com or brownfwa.com…
If you’re looking for specific advice on how to retire… you’ll find a wealth of material on our educational website… helpmeretirepod.com…
You can also get back issues of our weekly e-letter… Wealth and Wisdom… on the site…
As well as the quarterly webinars we put on for our clients… you’ll find those recordings there also…
Brown Family Wealth Advisors is also on Facebook and LinkedIn…
Again… lots of resources to help you retire… and we’re adding new resources every week…
So… what I’m about to describe to you… is an investment strategy we call… The Dividend Method…
It’s our investment philosophy… grounded in the idea that owing shares of businesses that pay dividends… and increase them consistently over time…
…have done at least four good things for us historically…
One… they give us cash flow… money we can spend in retirement… cash flow that we can reinvest to help us compound and build wealth in the years leading up to retirement…
Two… stock dividends have also increased… roughly three years out of every four since World War Two… and they’ve increased more than twice as much as the overall cost-of-living…
That rising income has helped investor protect their purchasing power…
The third reason we like rising-dividend companies… is that historically… their stock prices have been considerably less volatile than the overall market…
And four… again, historically… rising-dividend stocks have outperformed their peers in terms of total return…
Those four things are exactly what we’re looking for in the portfolios we manage for clients… and they have not disappointed…
But it’s one thing to say we want to own rising-dividend companies… it’s another to decide which stocks we want to buy… and when…
There are nearly 300-companies that qualify for the Nasdaq Dividend Achievers list… companies that have increased their dividends every year for at least the past 10 years…
And there are 67 companies that make up what’s called the S&P 500 Dividend Aristocrats list… companies that have raised their dividends for at least 25 straight years…
We typically own about 25 companies in client portfolios… and to find them… we follow six essential criteria…
And by the way… I describe all six standards in my book… Your Way to True Wealth…
Read Chapter 7… the Dividend Method… to learn more…
The first standard… the first thing we look for… is quality…
I’ve always felt that when you buy a company’s stock… even one share… you should plan on holding it for a long time…
You are… in a way… becoming a business partner with this company… and you don’t want to run the risk that they’re not going to be around for a long time…
We look for unique competitive advantages… maybe a product or service that this company can provide that their competitors can’t…
Products or services that customers keep coming back to… time and time again…
They make things that people want to buy… things people have to buy…
We like what are called… recurring-revenue businesses…
The example I used in my book is… would you rather own a business that makes giant air filtration machines… which might not need to be replaced for 20 or 30 years…
Or would you rather own a company that makes the filters that go into these machines… and get replaced every six months?
And we want to own businesses that are consistently profitable…
I mean… companies are in business to make profits… that’s a given…
But what is the company doing with those profits?
Are they able to use that money to pay down their debts… hire quality employees… come up with innovative products and services?
In other words… is this company able to reinvest its profits productively… and create value for its shareholders?
Now… the second standard of The Dividend Method flows right out of the first one…
We look for companies that are financially strong… with strong balance sheets… and reliable cash flow… not a lot of debt…
Why is that important?
It’s another competitive advantage…
The next recession we have… when it gets really tough to grow… or in come cases… even stay in business…
Companies with solid balance sheets and little debt are able to take advantage of tough business conditions…
They can price their products and services more competitively than other companies… capture market share…
In some cases… they might even be able to buy out a competitor who’s struggling…
Companies that are financially strong are also able to borrow money when they need to… at lower rates than the competition…
What all this means for shareholders… is not having to worry so much about whether this company is going to stay in business…
And research has shown that quality has been rewarded in the form of better stock performance over time…
There’s a market premium for high-quality… financially strong companies and their share prices…
Okay… quality… and financial strength… one and two…
The third criteria… the third standard for Dividend Method companies… is growth…
Why is growth important?
Well… remember our investment philosophy when it comes to equities… is rising income…
Not just to be able to spend or compound that income…
But for what it says about a company that’s able to keep sharing its success with owners year after year…
Think about it… I said it a second ago… dividends come from profits… or earnings…
And for a company to increase its dividends over time… those earnings have to continue growing…
There are some businesses that have paid dividends for years… but they never seem to increase them…
That’s not the kind of business we want to own…
We want companies that are consistently able to increase their profits… or earnings… AND their dividends…
Those earnings don’t have to increase every year… nobody’s perfect… and business conditions can get tough from time to time…
But we don’t like to see losses in the last 10 years or so…
And we certainly don’t want to see a company reduce or eliminate its dividend…
If we do… it’s time to sell that stock… take our lumps… and our clients’ money… and move on to a better idea…
Doesn’t happen often… and a lot of time companies that lose money or cut their dividend can recover…
We just don’t want to wait around for that to happen if we can find more attractive opportunities…
We’re talking in this episode… about the six things we look for when we buy stocks for our clients…
The six standards… that make up our equity investment philosophy… which we call… the Dividend Method…
Quality… financial strength… and growth… those are one… two and three…
Standard number four… is to make sure as best we can… that the dividends a company pays us… are sustainable in the future…
Understand that companies pay dividends at their own discretion…
There’s no law that mandates profits be shared with stockholders… dividends are never guaranteed to increase over time… in fact… they’re not guaranteed at all…
But companies that consistently pay dividends and increase them over time… typically do so…
A) because they can afford to… and…
B) because they think it’s a good business practice… a good way to attract and keep loyal shareholders…
By the way… loyal shareholders often become loyal customers for that company’s products and services… so there’s an incentive to maintain a consistent dividend policy…
So what makes those dividends sustainable? What are the signs that dividends might continue to be paid… and increased… in the future?
Well… we talked about the first sign… profits or earnings that increase over time…
Beyond that… we need to know what the company is doing with those profits…
Are they paying out most or all of it in dividends? If so… how can they continue growing the business?
What percentage of those earnings are paid out in dividends? We call that the payout ratio…
So what’s an acceptable payout ratio?
Certainly, anything close to 100-percent… or even over 100-percent would be considered a red flag… especially if that’s the norm…
But we take it a step further… and compare a company’s payout ratio to other companies in its own industry…
Some industries tend to have higher payout ratios than others… so we need to compare consumer staples companies with other consumer staples companies, for example… financial companies with other financial companies… and so on…
So, here’s what makes us think twice about investing in a particular company… several things…
Payout ratios that have trended sharply higher over the past 10 years… and are higher than other companies in the same industry…
One-year growth rates in earnings and dividends that are significantly lower than the company’s five-year growth rates… and five-year rates significantly lower than 10-year rates… could mean the company is slowing down…
Dividend growth rates that have been higher than the growth in earnings and cash flow for an extended period of time…
Declining profit margins… weakening balance sheets… or other signs that a company is becoming less profitable… such as a falling return on equity… or ROE…
It’s great to see nice… growing dividends… we just want to feel comfortable that those dividends will be able to continue increasing in the years ahead…
Standard number five… just how big is that dividend? What’s the current yield?
Yield is the number you get when you divide a company’s current dividend by today’s stock price…
So if a company is paying a dividend of two-dollars per share… and the price is 50-dollars per share… we say that stock is currently yielding… four-percent…
Keep in mind that the yield is constantly changing… it changes every time a company increases or decreases its dividend…
And it changes a little bit every time the stock price ticks up or down…
The dividend yield tells us in an instant… the income return we’ll get for every dollar we spend for a company’s stock…
Naturally… we prefer higher yield to lower yields… but only up to a point…
If dividend yields are really high… well above other companies in the industry, for example… it would be a red flag…
Other investors… the market… may be telling us that the dividend is unsustainable… or that there’s some other business risk we’re not aware of…
And if the dividend yield is really low… we have to wonder whether owning this particular stock is worth the trouble…
Yes… dividend growth is what we’re looking for in the end…
But if the starting point is too low, it might take years and years to look attractive from an income perspective…
When all is said and done… we prefer owning companies with dividend yields that are higher than average…
Higher than the S&P 500… and preferably a little higher than the industry average as well…
The sixth and final standard we look for with the Dividend Method… is one of the most important…
But also… sometimes… the hardest one to meet…
We like to buy things when they’re on sale… like straw hats in the winter… and snow shovels in the summer…
It’s not enough to know what something costs… we want to get the best deal possible…
Or as Warren Buffett famously put it… “Price is what you pay. Value is what you get.”
We’re looking for value… whether we’re buying tomatoes at the farmer’s market… a new car off the showroom floor… or shares of stock in a company that meet our other five standards…
But what signifies value? How do you know you’re getting a good deal?
There are lots of definitions of value… and the sad truth is… none of them works every time…
Instead of trying to guess which approach will work best to spot a bargain… it’s better to find a strategy that makes sense to you… a strategy you believe in…
Because if you do that… you’ll be less likely to second-guess yourself and wind up chasing your tail…
At Brown Family Wealth Advisors… we actually look at several metrics to spot value… knowing that the best any investor can do is to invest with the odds on their side…
You won’t know for months or years if you’re right… but the more you look beyond just the price of a stock that meets your criteria… and see what you’re actually getting for the investment you’re making… the more likely you’ll be successful in the long run…
One simple standard we use is something I just discussed a minute ago… the stock’s dividend yield…
Not just the current yield… we like to compare the current yield to what’s normal for a particular company over… say… the last 10 years…
Think about this… because of the way division works… lower-than-average dividend yields likely mean higher-than-average prices…
Conversely… higher-than-average dividend yields are likely associated with lower-than-average prices…
So if we’re looking for value… we would prefer to buy a stock when the price is low instead of high…
Which means we’d rather buy it when the dividend yield is high instead of low…
Let’s figure out… what’s been the average high yield and low yield over the last 10-years or so… based on the low price… the high price… and dividend paid each year…
If the current dividend yield is near or above the normal high yield… it might be worth considering…
And if today’s yield is close to or below the normal low yield over the last 10-years… maybe we take a pass…
Again… that’s just one simple method for spotting potential value… but it’s a good one to help us weed out over-priced stocks…
And those are the six standards… the six criteria of the Dividend Method…
Number one… we want to focus on high-quality businesses…
Two… businesses that are financially strong enough to weather the storm…
Three… we want to see both earnings and dividends increasing consistently…
Four… we want the dividends a company is paying to be sustainable for years to come…
Five… we’d like to see an above-average current dividend yield…
And finally… number six… we want value… we want the stock’s current price to be attractive…
If we’re right… it could possibly mean greater return potential… and lower risk in the meantime…
Again… it’s all in the book… Chapter 7 of Your Way to True Wealth… How to Make It Happen… Make It Last… and Make It Matter… available at Amazon… Barnes and Noble… and major booksellers nationwide…
Thanks for your time today… we’ll talk again soon…
Securities offered through Raymond James Financial Services, Inc., member FINRA/SIPC.
Investment advisory services are offered through Raymond James Financial Services Advisors, Inc. Brown Family Wealth Advisors is not a registered broker/dealer and is independent of Raymond James Financial Services.
Any opinions are those of Mike Brown and Brown Family Wealth Advisors and not necessarily those of Raymond James. This material is being provided for informational purposes only and is not a recommendation. There is no guarantee that these statements or opinions will prove to be correct. Investing involves risk, and you may incur a profit or a loss regardless of the strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation.
Holding stocks for the long-term does not insure a profitable outcome. Investing in stocks always involves risk, including the possibility of losing one’s entire investment. Dividends are not guaranteed and must be authorized by the company’s board of directors.
The NASDAQ composite is an unmanaged index of securities traded on the NASDAW system. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
