Last week I gave my initial thoughts on dividend investing. I thought it would be fun to follow that post with the story of someone actually doing it. This is a guest post from ESI reader (and a friend of mine) Mike Hunt. I asked Mike to share a bit of his personal financial situation and then share his strategy and results in dividend investing. Enjoy! ESI
Meet Mike Hunt
At age 42, I’m lucky enough to just meet the definition of being Financially Independent. Our family is at the point of covering our investments from passive income. However although we are at this point, I am continuing to work for a few reasons:
- We have a young daughter who is 2 ½ now and are trying to have another child.
- We live in Southeast Asia and schooling costs are very high for international programs (our daughter’s early years education is approximately $8K USD per year and that will go up substantially when she goes to primary and secondary school).
- I’ve recently started a new job about 1 ½ years ago that I find enjoyable, challenging and fulfilling. My health is as good as it’s been in my adult life and I’m a quite fit 160 lbs on a 6’2” frame. The job is located one mile from my house so the commute times are easy.
Our family financial objective is to grow our passive income to continue covering our expenses with a surplus while we undergo the expected lifestyle inflation associated with growing a family.
How Did We Get to This Point?
My wife and I have been married for 8+ years, and when we first got married both of us were working. After a few years my wife started trying her own small business ventures until she had our daughter and at that point she has been a full time Mom.
I was lucky enough to get out to Asia nearly 10 years ago in a very senior position at a relatively young age. Basically I’ve been running different companies for larger multi-national corporations. It was difficult at first but it has gotten easier with experience. Or maybe it still is just as hard but I’ve been able to get used to the work. Either way, it’s not terribly stressful anymore. My current job is as the head of Sales & Marketing and Business Development for a Health Care organization that does about $500M USD of revenue each year.
Through the last several years we have been saving well over 50% of our after tax income by living well below our means. For 7 years we were staying in a 900 sq. ft 2 bedroom condo but before the baby arrived we bought and moved into a much larger 2600 sq. ft 4 BD / 4 BA condo that is still located in the city center. That was helpful as we had extra space when family came over to visit and this is a place that we can stay for many years.
So we’ve greatly expanded our living costs but only after we saved a substantial sum. Since our expenses are essentially covered by passive income our after tax saving rate still remains more than 50% as I continue to keep working.
For years I didn’t have an investment plan and we kept nearly all of our savings in cash earning very little. I wasn’t worried about it since our savings rate was so high but I knew this strategy would be poor over the course of my life.
That’s when I started my dividend investing strategy.
Dividend Investing as Passive Income
My path to dividend investing was a long one, but here are the highlights:
My strategy was to:
- Create passive income that continues to grow faster than inflation each year
- Minimize fees associated with building, selling or maintaining the portfolio
- Invest in a basket of individual stocks based on buying into what I believed were reasonable valuations
- Look to hold stocks over a long period of time rather than buying to actively trade
- Identify strong sectors and specific brands and companies with a good track record for consistently making and growing earnings
- Continually continue to add to the portfolio over the next 10 years or more from cash flow generated by dividends plus savings from my normal day job
- Grow the annual dividend payments by at least 10% per year
- Maintain a mixture of higher dividend payers (>4% yield, normal dividend payers of 2-4%, and low dividend payers of <2% but with a good record of faster earnings growth
The Process
So I got to researching the different companies that I would use to create a dividend portfolio. A good place for me to start was with David Fish’s guide to dividend paying stocks, that list stocks that have raised their dividends consecutively over a period of many years. Dividend champions have raised their dividends for more than 25 years, contenders for more than 10 years, and challengers for more than 5. This list is free to access. This is a good starting point as a company that has been able to increase dividends consecutively for a long time certainly has a business model that is robust enough to grow earnings while paying a portion of it back to shareholders.
I then looked at the following criteria:
- The average P/E of the stock over the past 10 years
- The historical and current dividend coverage ratio of the stock (this is the percentage of earnings that goes to pay the dividend. If the number is low like less than 20% it means that this ratio can climb with the dividend growth exceeding that of the earnings growth, if it’s high then this would imply the opposite effect).
- Has the companies share count over the past 10 years been growing, declining or remaining static?
- How is the company spending its surplus cash? Acquisitions, stock buybacks, capital reinvestment, etc?
- Does the business have any risks of disruption by new technology or changes in the number of competitors or new government regulations?
- What are the key barriers to competition of the company (scale, first mover advantage, sticky customer relationships)?
- What is an attractive valuation of the company? Here is used a discounted cash flow analysis of future dividends. There are many types of free calculators available online.
- I also decided not to automatically reinvest dividends into the same company (DRIP’s) but to pool the cash from dividends and use it to fund new purchases, either into new companies or to add position to an existing company if the price is down and I still have the same conviction on the strength of the business model. I almost always have more ideas and opportunities than capital available.
I developed a portfolio containing about 30 stocks that were purchased over 2 years and are spread across consumer staples, industrial stocks, energy, financial / REIT’s, with a small weighting on technology stocks. Normally I tried to buy upon pullbacks based on market fluctuations or pullbacks based on stock specific news where I thought it wouldn’t impact the overall operations of the company, such as the data breach and weak Canadian store sales that impacted Target back in 2014 and knocked down the share price. But there have also been stocks like Visa that I bought near all-time highs because the business looks to still have good opportunities to grow into new markets. While the portfolio has a few winners (GE, MCD, V, KO, PM, UL, TGT) there are many stocks that have been crushed over the past year and have hurt the portfolio (CVX, DE, EMR, NOV, TD, KMI, IBM, KKR, BBL).
Last year the total dividend income was $57K USD and this year is gearing up to be about $61K USD on a portfolio value approximately $1.75M. There have been some bumps in the road though as some of the cyclical energy stocks have seen dividend freezes and a few dividend cuts.
My portfolio is down approximately 10% based on my cost basis, and my yield on cost is 3.5% while my portfolio yield is approximately 3.8%, reflecting the drop in the value of the portfolio.
General Thoughts
The beauty of well picked dividend stocks is that as the company grows the dividend each year grows as well while your ownership stake in the company remains. This is a key factor to compounding wealth as the share price normally grows as the earnings and dividend goes up so capital appreciation comes with increased cash flow.
Now is a particularly good time as the overall market is cooling off, but I’ve found that there is usually always something on sale as long as we keep looking. I have a watch list of a few dozen stocks that I’m interested in but haven’t found a good price to enter. These include: CL, DEO, SBUX, NKE, CLX, SJM but there are others on the list.
At the moment energy, retail and commodity stocks are really beaten down as cyclical plays. There is a strong chance that these will be very good investments when measured over several years. Normally during downturns the marginal players go bankrupt and production capacity drops dramatically until prices begin to stabilize (which haven’t happened yet). Demand is generally pretty sticky so eventually prices begin to climb again so the profits of the cyclical companies come back strongly and so does the share price. The key is to try and model the cash flows to determine a fair value price for the stock and look to buy at a margin of safety below the fair value.
It’s part art and part science as the equation for a dividend discount model for cash flows is fairly basic. The art is coming up with conservative estimates for the dividend (earnings) growth rate but looking at companies with a long history of growing dividends help with looking at general growth rates over a long range that covers a few market cycles.
I’m continuing to actively buy and am pretty sure that our household will be fine with this strategy through the rest of my career earning life and retired life. The key for me was to start with a few small purchases and get comfortable with the process. Now on days when the market is down I’m actually looking forward to making strategic purchases and to help lower my cost basis. I finally understood what Warren Buffett really meant when he said that he doesn’t care for things when the market is going up wildly. “It’s like celebrating the rising price of gasoline just because you happen to have a full tank.”
Now many may question the strength of the strategy when the portfolio losses are currently about 3 years of what the dividend income would generate. Actually I’ve learned a lot during this process and am not bothered by the current value of the portfolio being down. After reading many interviews with successful big long term investors, I’ve found that normally an investor does have to endure temporary losses when business cycles get soft and this is actually a great chance to add positions to the portfolio. If your character is to sell when the markets are deep in the red then you should likely not follow such a strategy as one would be inadvertently selling at the worst possible time and locking in the loss.
Starting small offers a good way to test your investing character. History shows that the stock market growth since the start of the market is approximately 8% or several hundred basis points over bonds and fixed investments. Investors really earn that extra percentage by having to live with the volatility of the market, which can be your friend of foe depending on your attitude and decisions.
Dividend paying stocks can be a good addition of any financial plan for passive income. We have seen that following a low cost index fund which is a buy and hold strategy is hard to beat by an active managed fund, dividend paying stocks can also do the same with its buy and hold. Most active managed funds have high turnover rates of there stock because they are betting on a sector to out perform and in some cases bet wrong.
Is there risk in dividend stocks? Yes but so is having bonds and stock funds and even real estate.
With research you can find good paying stable dividend stocks that also increase in value.
The key point for me is picking a strategy and trying to stay with it for 10 years or more. Giving up in the middle during a market downturn is the main point to avoid. Spending more time researching and less time buying is good too, especially in shaky markets. Another “full” position for a new stock in the portfolio is $50 – 100K USD so I take my time to wait until a good company has a compelling value before locking in my yield on cost with the purchase. Good companies that can grow earnings and dividends will keep growing the yield you are getting on the cost basis.
I’m guessing with the recent market downturn there are as many good companies with decent dividends as ever.
ESI- you are correct. There are better deals to be found compared to when the DOW was North of 18K points. When I see red, I’m feeling green 🙂
-Mike
Great post. I’m looking forward to researching some of the companies you mentioned for my own dividend portfolio.
Thanks- I’m glad the post could be of help. The more you practice, research and buy, the more you learn. I wish I started this at age 20 or 30 instead of 40 but then again I’m glad that I didn’t have to get to age 50 or 60 to have figured this out too.
-Mike
Mike,
Nice article. Do you have a goal in mind as to how much income you are ultimately looking to build up to? Will this be your sole strategy for retirement income or do you plan to have multiple streams of income?
Hi Jim,
Well, I’d like to have this income to be a good bit in excess (up to 2X) of my normal expenses so continuing to keep contributing for the next 10 years or more is the plan. It’s not like I can retire anyway since we have a toddler at home plus want to have another one so this feels fine.
It’s not my only source of income. I also have my 401k investments which bring in another 8K a year of dividend income plus a small amount of rental and other business related passive income streams. However it’s the primary leg of my passive income retirement strategy. That being said, my day job income totally overwhelms this passive income, even now so as long as I enjoy the work (as I do now) I will keep it up. It does proved a buffer in case something were to get derailed in my career, as I report to the Corporate CEO who will retire in 7 months and will have to develop good chemistry with his successor. Having enough income to survive and thrive coming in regardless of my job makes live that much more stress free.
-Mike
Mike,
Thanks for sharing, and I’m glad to see you’ve found a suitable investing strategy!
How much time do you think you’re spending on researching/choosing a typical stock and following it afterwards?
I try to read all the updates on the stock plus go through a few annual reports prior to buying. Most of the research is done before making the trade so in that sense it’s a sunk cost. Once I own the stock the level of research is much less- keeping up on any announcements or updates that are released and perhaps related articles. If there is a big swing in the stock price I will look into if there is any news that drove that and add this into the overall information for the stock. I only sold out one one position (ARCP) at the end of last year when they were faced with fraud charges and the executives left the company. At that point I wanted to deploy my capital elsewhere and fortunately it was only a small position. That’s also why you want diversification because things like this can happen and when it’s only 2-3% of your portfolio the sting is much less than if it were 25%. Oh I was pretty upset but I just moved on.
So at the outset I probably spent 200 – 300 hours researching this. And now I spend about 25 hours a quarter with managing the portfolio. Actually it’s not work at all to me but fun to learn more about the companies that I own. I’m also pretty psyched when I see people drink Coke products all around me, eating at McDonald’s and I am less irritated by all the smokers that I see since I own 1020 shares of Phillip Morris- the way I look at it now, I’m getting $11-12 a day of passive income indirectly from all these smokers so I’m a bit more tolerant of the situation.
-Mike
Mike,
Can you please outline, what means you use to research the company. Thanks for the thought process on what you look at while researching, but also, what means you use to get those questions answered will help the beginners a lot.
Another question: I perfectly follow the advantage of Dividend Stock from an income stream point. Do you think its still a good option for a young person (say 30 age, and 30 more years before taking money out of the pot). Or would it be better to use index to accumulate and deploy to dividend stocks when you near say 10 years before retirement. Do you associate your 1.75M growth to index or previous investment even though you said you were not invested as much as you are now, earlier. I assume you did have it invested for some part). Also the reason I am asking is even thought each position is 2-3%, 100K in one stock (say PM) is lots of bets against one companies management and at macro level lot of bets against govt sanctions and policies. Would one be better off spreading that risk across many companies.
Thanks for sharing your story.
Hi Richard,
My best advice is read as much as you can. Spend time with the company annual reports and try and understand their business model as best you can before you make any bet.
I tried to mention it in the article but by and large most of the portfolio I built up came from hyper saving for 10 years while making a strong income. I did have a small portion of this in a mutual fund for equities and a bond fund but most of it was just in the bank for a period of time. When you first start your savings rate far outweighs your rate of returns so focus much more on the former and don’t worry so much about the latter.
By having a portfolio of 30+ stocks then the weighting to each is a bit more than 3%. My cost basis for PM was around $80K so it’s a bigger portion of my portfolio- it did grow to $90K now so the portion grew and that is ok with me. I got into PM as I have seen a very long track record of tobacco companies returning the majority of their profits to shareholders. There are very low CAPEX costs and it’s an addictive product that prints money. Revenues and profits are currently depressed as it’s a business where the earnings and dividends pay out in USD but all the revenue comes from countries outside the USA. So it will benefit strongly once the dollar loses strength, something I believe will happen eventually. You are right, there is regulation, high taxes, more people are quitting, etc and that is why the valuation can be low at times (investor sentiment is normally poor) but the price increases each year more than make up for this. Last year was a disappointing 2% dividend raise primarily due to currency effects but this should improve over the coming years. I am ok making some relatively big bets even though there is risk attached to it. In the context of a $1.7M portfolio an individual stock of 80% is reasonable in my opinion. If you had a $100K portfolio you would be looking at a $5-6K position.
Like I said we all need to find out what is comfortable for each of us.
Good luck with your own strategy.
The other comment I have is it’s good to start as young as you can provided that you are still generating positive cash flow and don’t have a plan to sell the stock because you need more cash (you can sell the stock if you think something changed in the business and it doesn’t meet what you had in mind when you first bought in). As long as you continue to have positive cash flow coming in you keep building the portfolio, and you will be amazed at what one decade does to your positive cash flow position if you keep slugging away at it. You can use dividends to reinvest or spend but since your cash flow is positive then you are continuing to save money elsewhere so that doesn’t matter. Eventually when you are ready you can just live off the dividend stream, but this should be when it’s close or above your living expenses. It’s wonderful to be at that point already.
Thanks for your response, Mike.
Just an update to this thread, one year later the dividend portfolio is up to 2.2M with a little help from the Trump rally in the market. I did purchase DEO last year as well as DIS and initiated a medium position on NKE and CVS while selling out of DE when, what I thought was a high valuation compared to the earnings power of the business, which is very cyclical. I took the proceeds to reinvest in other stocks.
I ended up with about $60.6K of income in 2016 and am forecasting approximately $68K+ of income this year. The train keeps a rolling with dividend investing and with so many dividend raises and reinvestment of dividends, each year is sure to bring in a new record and that’s just fun to watch. My employer gave me a 3% raise this year but I received more than a 10% raise in my passive income by a combination of my own efforts (fresh capital), dividend reinvestment and dividend raises. Life is good. One day – years from now, the portfolio will be a monster. As I said earlier I focus more on the annual passive income and growth potential over the size of the portfolio.
-Mike
You are a BEAST!!!!
Congrats!!!!
Thanks ESI. But you are bringing in much higher cash flows with your excellent real estate purchases. That was a real home run and it’s one of the big keys to your retirement. Well done! I’ll get there soon enough too.
Mike,
Inspirational post! I’m am not as far along on creating my dividend portfolio, but share your views on the benefits. I have watched my in-laws retire in their 50’s with the dividend portfolio that has carried them safely into their late 80’s.
I am in the process of slowly converting a growth oriented ~$1.3M portfolio over to a more dividend weighted mix. It is currently generating about $29k of dividends per year. It is a great deal of fun to text Mrs. Wease with the income “raise” that I give us, each time I convert a chunk of an index ETF like VO over to something paying a bit more yield, like CCI or OAK.
Conceptually I like the portability of a stock/REIT/MLP when compared to direct real-estate holdings. I’ve moved enough, and will again at least one more time, to not want to build a rental portfolio, yet.
Thanks for the well written post!
Thanks for the comment. It sounds like you are progressing well. I will write an update post on how the strategy has been progressing in early 2018, as a two year update. 2017 was a very good year for dividend raises so the bar continues to get raised in spite of some turbulence in GE, where I expect there is a likelihood of the dividend to be cut in the coming weeks.
-Mike
I would be very interested to know your thoughts on Closed End Funds (CEF’s) that pay 6-9% dividends.
Sorry, I don’t have any experience with them.
Hi Ron,
I haven’t purchased closed end funds but have a friend that uses this as part of his strategy as he can pick up some deals with high yields at times. As I see it the key risk is the lowered liquidity if you need to sell as there may not be a pool of buyers. You also need to understand what is in the fund as if there is a distressed market situation the fund could be effected. Lastly it is important to validate that there is no leverage being used as that could blow up the fund in an extreme down market.
I hope that helps.
-Mike
Mike,
This is a great post and I’ve re-read it multiple times as I’m in a similar situation to you (ie saving phase) in Hong Kong.
One question, does your dividend portfolio include foreign stocks which have withholding tax on the dividends (eg 30% for US dividends)?
Or are they mostly focused on stocks incorporated in UK, HK, Singapore which do not have withholding tax on dividends.
Hi Jon,
Thanks for your comment. Since I am investing out of the USA I generally buy companies where there is a tax treaty agreement to not withhold income, like the UK. I do own Diageo (DEO), Unilever (UL not the UN that is domiciled in the Netherlands) and Royal Dutch Shell (RDS.B, again domiciled in the UK). There have been some other companies that have caught my eye (Nestle, LVMH) but the tax withholding on dividends made them less favorable and it lowered my level of interest.
I have a small 401K and Roth account and there I buy my Canadian Dividend stocks (banks, energy companies, etc) as they are not subject to tax withholding if in a tax advantaged account.
Some markets, like Thailand, have a small withholding and tax on dividends – it is 10% there. I wouldn’t be against buying these companies however the company performance is generally higher for the US and UK listed companies.
I hope that helps.
Best of luck on your journey out there in HK.
-Mike
Jon,
I should add that the US market has the best depth in terms of quality of companies and strong liquidity so you should get exposure there. Since the US / UK has a tax treaty one would think you could get a depository receipt on a US listing in London with no withholding taxes. It’s worth looking into for sure.
-Mike
As another update to this post, I can fill in the remaining years of performance:
2015: $57K in Dividends
2016: $60K
2017: $74K
2018: $91K
2019: $108.7K forecasted in dividends!
Yes, this year I will break receiving 6 figures in dividends! I was pretty enamored with this achievement at first but shortly after realize it was inevitable. Now I’m just plodding ahead. The value of the portfolio is now worth $3M and mentally I’m still ready to ride it down 50% from peak to trough when tough market conditions come to us (that is a when not an if…). I will keep my cash flow above expenses and continue to buy more quality stocks during this period. Like I said, it’s a lifelong journey.
It’s fortunate for me as I am going through a period of underemployment. We had a second child, he is 2 months old and I”m working part time so I can help out at the house. Without this dividend portfolio providing an invisible hand to the household finances it would be much more stressful. That gift of flexibility is enormous and one that cannot be understated.
Secondly to see the growth from $60K to $108K in just 3 years is just astounding. I don’t expect that to be repeated any time soon, as much of it came from the corporate tax cut but it is nevertheless quite amazing. Remember $48K in passive income at 3.8% (the currently yield on the portfolio) equals $1.26M extra dollars… and I only put in less than 30% of that with fresh cash – the rest came from dividend reinvestment and growth in dividends by the company.
I am pretty sure that anyone who sees this results over a few years will be convinced to stick with it as a strategy.
Best wishes,
Mike
Can you explain in some detail how you do the below? I understand the calculators but actually using an example of how you did it?
“What is an attractive valuation of the company? Here is used a discounted cash flow analysis of future dividends. There are many types of free calculators available online”
Hello Mike, a few questions below from what you wrote.
I then looked at the following criteria:
The average P/E of the stock over the past 10 years (Where and how do you find the 10 year PE?)
Has the companies share count over the past 10 years been growing, declining or remaining static? (How do you check share count increase, where would this be found on the balance sheet and you look at the total number of shares for each year?)
How is the company spending its surplus cash? Acquisitions, stock buybacks, capital reinvestment, etc? (How is this determined as well?)
(Are the following questions below more philosophical questions you have to answer yourself?)
Does the business have any risks of disruption by new technology or changes in the number of competitors or new government regulations?
What are the key barriers to competition of the company (scale, first mover advantage, sticky customer relationships)?
What is an attractive valuation of the company? Here is used a discounted cash flow analysis of future dividends. There are many types of free calculators available online.
(which calculator do you use?)
Thanks i still hope u check this post
I don’t know if Mike will check this and I don’t know if this is the right answer to any (all) of your questions or not, but I do know from talking to Mike that he looks at annual reports from companies as part of his overall research, so perhaps this is where he finds this information…