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August 8, 2017

How to Build Your Dividend Income Portfolio (Part 1)



There are so many different strategies to follow to make money on the stock market.  There really is no one way to do it.  Some investors focus on stocks that appear under valued. Others focus on just investing in the indexes and they buy a basket of the top companies traded on the stock exchange.  These are just two strategies among many.  Some investing strategy takes on more risk while some focuses more on safety by investing in more stable companies.  It really comes down to your risk tolerance and your investment goals.  
 
With investing, it is important to have an investment objective in mind, because this determines the type of stocks you are looking for and what stocks to avoid.
 
Mutual funds and investment managers always invest with an investment objective.  It is always shown in the prospectus.  It states what they plan to do with the investment capital and it also restricts them from something that is outside of the investment objective.  This here is an example of an investment objective from CIBC Balance Fund. 
 
For individual investors such as you and I, not knowing what the investment objective is can cause us to buy stocks that are not suitable to our risk tolerance.  Have you seen investors who would buy shares on a rumour, or follow the herd, and sell when everyone else is selling? 
 
Part of the reason is because there is no investment objective.  The investment objective helps us decide whether an investment is worth adding into our investment portfolio or not.  It will also help us filter out the noise and focus on what’s important to us.

With my income portfolio, my investment objective is this: 

“To have frequent reliable dividends while preserving my investment capital.”

What this objective means is I want to focus on only companies that pay out either monthly, quarterly, or annual dividends without too much risk to my money I’m investing with.  My risk tolerance with this type of strategy is low.  I want to be able to invest in reliable companies that can pay dividends forever.

With the above objective, the following 3 criterias are important to me when I am sifting through companies to invest in:

  1. Can the company pay its dividend while it is growing its operations?

  2. Can the company continue paying its dividends for a long, long time

  3. Can the company retain its market value regardless of how the market moves?

Can the company pay its dividends while it growth its operations?

A company that pays out more than it takes in is in serious trouble.  Eventually the firm will run out of cash – if not now then later.  There have been companies I invested in that burned me for doing this.  A lot of times the dividends the company pays out is great but after a few quarters, the company fizzles out because the company is losing more money than it is bringing in.  Once a company cancel its dividends, the market always reacts negatively to it.  

To avoid these headaches, it is important that the company pays its dividends but also have a strategy for its future. Look into evidence where the company is investing in itself for future growth.  One company that does a great job in safeguarding its current cash flow while possessing strong growth prospects is CT Reit.

Can the company continue paying its dividends for a long, long time?

Once I invest in a company I don’t want to check frequently on whether it is doing well or not.  I like to (what I call) invest and forget, meaning I buy the stock and I don’t think too much about it.   For this category, a company’s ability to support those payments over a long period of time or possibly forever is very important to me.

It is impossible to see how a company performs in 5 years or 10 years.  Generally, companies that can sustain a dividend over long periods of time are firms that are in industries that are boring, or in a line of business where there are few external threats to its profit. Companies such as Richard’s Packaging and  Riocan are companies that I consider as having dividend paying longevity.

Can the company retain its market value regardless of how the market moves?

What I am referring to here is market risk.  The company you invest in can be financially sound and its business is profitable, but if everyone is in a state of panic and is selling stocks left, right, and center (read Black Monday, 1987) then almost likely the stock you hold will take a hit as well.  When people panic sell, investors lose all sense of logic and will generally follow the herd.  This is an example of market risk.

It is difficult to completely eliminate market risk but there are some companies that are more cyclical and more influenced by how the overall market move.  My criteria here is if the market should sneeze or cough, would the company I invested in be immune anything the markets throw at it.  A company that I consider to have lower market risk than others is Pizza Pizza

Finally, it is very important that you understand this: there is no guarantee that even following the above 3 criterias that the selected companies will not go bankrupt.  If an advisor is guaranteeing you stocks can earn you a certain percentage of return of return then they are lying.  Since there are no guarantees, we can at least increase our chances of finding and investing in successfully managed companies with great dividend payouts. That really is the stock analysis game.


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