How I Added Dividend Stocks to My Portfolio, Part 1

Warning: I need to put this upfront just to be 100% clear to all readers.

This post is about what I’ve done investing-wise.

It’s not about what you should do investing-wise.

I do not know your goals, financial situation, or any one of a hundred other details that would even slightly qualify me to offer any investing advice to you.

As such, this post is not meant as stock advice. I am not recommending you do what I do, I’m simply telling what I did.

You need to make your own decisions based on your own goals and situation in life.

I could lose every penny of the money I’ve invested. It’s a very risky time with the market in all sorts of flux.

Every premise I’ve used to try and make a smart decision could be wrong.

If I do lose it all, I’ll be fine. I’ve already won the game, so now I’m just making adjustments based on the cards we’ve all been dealt.

You do your own investing at your own risk.

Ok, now that you’ve been warned, let’s get to the post…

Thinking About Dividend Investing

As I noted in Seven Steps to Creating Passive Income through Dividend Investing, I had been thinking about investing in dividend stocks for some time.

If you’ve been connecting the dots, you probably saw this coming.

By “dots” I mean that I’ve been writing about dividend investing for a while now. Here are some of the posts where I’ve covered it:

• Dividend Investing Basics — Written over four years ago…
• Dividend Stock Investing as a Source of Passive Income — Solid advice from a dividend investing expert.
• Dividend Investing Will Always Beat a Side Hustle — An interesting perspective from a guest poster. I actually prefer both options.
• Nine Investing Strategies Millionaires Use to Accumulate Wealth — “Of the 63 millionaires answering the investing questions, 10 mentioned dividend investing specifically while many more highlighted dividends churned off from equity investments.”

I was interested in dividend investing as yet another income source to add to my multiple streams of income. After all, additional income is a good thing, right? 😉

But I had a problem with dividend investing. The issue was that almost every stock I was interested in seemed highly over-valued. And as you know, I’m not a big premium-price buyer. I’m more of a value-oriented guy. 😉

In fact, it seemed like almost everything was over-priced. Real estate, my other main interest, certainly was (IMO) in the two markets I’m willing to buy in (Grand Rapids where my other properties are and Colorado Springs where I live).

Given that I couldn’t find what I considered to be reasonably priced investments, I ended up accumulating a ton of cash on the sidelines — around $500k at one point. (Some I started with, some I accumulated because we spend less than we earn, and some came from the sale of Rockstar Finance.)

I did deploy $125k of that in private loans, moving it from earning less than 2% to throwing off 10%.

But I still had a lot of cash, even if you count some of that as an emergency fund plus some cash I have set aside to help my daughter and son-in-law buy a home when they move to Colorado later this year.

Then, as everyone in the world knows, we got hit big-time. The markets tumbled, making those once lofty-priced dividend stocks much more affordable. In fact, they fell past “affordability” into downright “cheap” territory. This was my kind of stock sale!

Warren Buffett has said it is wise for an investor to be “fearful when others are greedy and greedy when others are fearful.”

People certainly were fearful about the market, and thus I thought it was the right time to consider dividend investing as a real possibility.

Digging into Dividend Stocks

So the declining market peaked my interest in dividend stocks again and I started making some moves to consider how I should proceed.

The first thing I did was contact Mike, the author of Seven Steps to Creating Passive Income through Dividend Investing, to get his thoughts on investing in general as well as some specific stocks I should consider.

Our back-and-forth conversation along with a reader request is what prompted his informative post.

He gave me some thoughtful, detailed advice (a shorter version of that article) and I began to seriously consider buying stocks for the first time in over 20 years.

The second thing I did was move my money around, out of my “high interest” savings accounts into my Vanguard brokerage account.

Good thing I started this early because Synchrony Bank took forever to transfer the money. In fact, I may close my account there since they were so slow.

Anyway, $200k was eventually transferred to Vanguard.

At this point, I had to change my account status there so I could buy stocks in it (I had to make it a brokerage account). I made the request and they facilitated the change very quickly, though I did lose another day getting my cash put in the right fund (so I could actually trade it).

While all this was happening, I was educating myself on dividend investing.

Learning about Dividend Investing

I had a general feel for what dividend investing was about, but that was it. I needed a lot more education before I was going to invest any money.

Mike was a big help, of course. I added to this by doing my own searches and reading a ton of articles.

I must say that Google’s rankings for “how to get started in dividend investing” and related terms were pretty weak. I had to sift through a ton of worthless posts to find ones that offered enough meat to educate me.

But I did find some and wanted to share the highlights with you.

Let’s start with the Motley Fool which posted the following on what metrics to use when considering dividend stocks:

Before you buy any dividend stock, it’s important to know how to evaluate them. The following metrics can help you understand how much in dividends to expect, how safe a dividend might be, and whether you should avoid a particular dividend stock.

Dividend yield — The annualized dividend, represented as a percentage of the stock price. For instance, if a company pays $1 in annualized dividends and the stock is $20 per share, the dividend yield would be 5%. Yield is also useful as a valuation metric (for instance, by comparing a stock’s current yield to historical levels) and can be helpful to identify red flags. The key thing to know is that, while a higher yield is better, a company’s ability to maintain the dividend payout — and, ideally, grow it — matters even more.

Payout ratio — The dividend as a percentage of a company’s net income. If a company earns $1 per share in net income, and pays a $0.50-per-share dividend, its payout ratio is 50%. In general terms the lower the payout ratio, the more sustainable a dividend should be.

Cash payout ratio — The cash dividend payout ratio can be a handy metric to use alongside the earnings payout ratio, since earnings can vary significantly from cash flows, particularly from one quarter to the next.

Total return — The overall performance of a stock, the combination of dividends and gains or losses from share price change. For example, if a stock rises by 6% this year and pays a 3% dividend yield, its total return is 9%.

EPS — Earnings per share. In general, a company must earn more than its dividend in order to sustain it, and this metric normalizes its results to the per-share value. The best dividend stocks are companies that have shown the ability to regularly grow earnings per share over time. Companies that consistently grow earnings per share often have strong competitive advantages. The result is a company that can keep paying its dividend and potentially increase it.

P/E ratio — The price-to-earnings ratio divides a company’s share price into earnings per share. P/E ratio is a valuation metric that can be used along with dividend yield to determine if a dividend stock is fairly valued.

Retire by 40 offered its own criteria for picking dividend stocks as follows:

• Start with Dividend Aristocrats
• PE ratio is less than 20
• Dividend yield is more than 2.5%
• Payout ratio is less than 70%
• EPS for the next and past 5 years should be positive

The Financial Mentor weighed in with their recommended factors to consider:

• Dividend yield: over 3%
• P/E Ratio: under 20
• Forward P/E Ratio: under 20
• EPS Growth next 5 years: positive
• Return on Equity: over 10%
• Sales Growth past 5 years: positive
• EPS Growth past 5 years: positive
• Payout ratio: under 70%

Obviously everyone has their own recommended list of what’s important to look at before you purchase a stock.

I took it all in, knowing that I’d likely settle on a blend of data that I felt the most comfortable with.

Let’s review a few more ideas. Here’s what Investopedia suggests:

Dividend stock ratios are an indicator of a company’s ability to pay dividends to its shareholders in the future.

The four most popular ratios are the dividend payout ratio, dividend coverage ratio, free cash flow to equity, and Net Debt to EBITDA.

A low dividend payout ratio is considered preferable to a high dividend ratio because the latter may indicate that a company could struggle to maintain dividend payouts over the long term.

Investors should use a combination of ratios to evaluate dividend stocks.

Not to be outdone, the Motley Fool got it down to three key pieces of information:

When evaluating a dividend stock, its yield is only one piece of the puzzle — there are two other important metrics that help put the dividend yield into context:

Dividend yield — This is the most obvious and lets you know how much you can expect to get paid per year as a percentage of your original investment. For example, if you buy $1,000 worth of a stock with a 3% dividend yield, you can expect dividend payments of $30 over the next year. Contrary to popular belief, this is probably the least important of the three metrics to long-term investors.

Dividend growth — A stock’s current yield is important, but if it stays constant over the years, inflation will eat away at your income stream. For this reason, it’s important to look at a stock’s history of increasing its dividend, and this means looking at two pieces of information. First, does the company consistently increase its dividend? And how rapidly does the dividend grow over time? With dividend growth, it’s important to keep in mind that a company’s past behavior doesn’t guarantee the pattern will continue, though it does make it more likely.

Payout ratio — This lets investors know how much of a company’s profits get paid to shareholders as dividends and is usually expressed as a percentage. For example, if a company earns $1.00 per share and pays a $0.60 annual dividend, its payout ratio is 60%. A lower payout ratio indicates that the dividend is safe, even if the company’s revenue drops. It may also indicate that the company reinvests more of its profits in order to grow its business.

And to wrap up, Wallet Hacks listed these as the most important metrics:

• Number 1: Dividend History
• Number 2: Price-to-Earnings Ratio
• Number 3: Dividend Yield
• Number 4: Payout Ratio

Lots to choose from, huh?

Ok, so now I had a lot of information. How was I going to synthesize it into my own personal strategy?

Beginning with the End in Mind

I have always loved the book The 7 Habits of Highly Effective People. One of the habits I have used regularly is “begin with the end in mind.”

Here’s how FranklinCovey defines this habit:

Begin with the End in Mind means to begin each day, task, or project with a clear vision of your desired direction and destination, and then continue by flexing your proactive muscles to make things happen.

So that’s where I started — by thinking about what I hoped to accomplish with dividend investing.

Obviously I wanted to create an additional source of income. But it was more than that.

I also wanted an investment with some upside growth opportunity.

My target was 3.5% to 4% income plus another 4% or more for growth (targeting 8% overall).

In a worst case scenario, I was ok with the stock staying relatively flat and paying out the dividend. After all, I was moving 2% money to 4% money, so I was good even if that’s all I got.

Fine-Tuning My Process

Ok, so I wanted income with some growth. That’s good for an objective, but what qualities would my stocks have that would allow me to meet my goal?

As I thought of it, I wanted stocks that would provide income and growth while making sure the following were delivered (to the best you can “make sure” of anything in investing):

• The dividends I expected were solid (not likely to decline, but likely to increase).
• Dividends were significant (yields of at least 3.5% but preferably 4%+).
• The company was a good value with long-term growth potential.
• In a worst-case scenario, the company had enough assets to pay at least something back. In other words it had a built-in floor that protects it somewhat in case of disaster.
• I had to be interested in their business at least somewhat. Sure, I’m interested in almost anything that makes good money and grows like crazy, but I still need to like the stock for some other reason as well.

From all these, I now knew what I was looking for.

It was time to assemble potential stocks and set some guidelines for evaluating them.

To see which stocks I selected, please read part 2.