Wednesday, December 16, 2015

A Guide To Dividend Investing

When it comes to investing in stocks, there are all sorts of different strategies people use. Growth investing is the strategy of buying the stock of small companies that you think will get bigger. A growth investor might have bought stock in Microsoft in the 1990s, believing it would grow into the huge company it now is. Value investing is buying stock of established companies when their stock price is less than what the company is actually worth. For example, if a value investor thinks a company is worth $10 a share and the stock is currently trading at $8 a share, this would be a buying opportunity. Warren Buffet is the most famous value investor. Dividend investing is the strategy of buying stocks that pay dividends. And, of course, investors can use a mix of strategies.

There are a couple hurdles with the first two types of investing. Growth investing requires you to be able to predict which companies will succeed and which will fail. Value investing requires you to be able to read financial statements and determine what a company is truly worth. This is not to say it is impossible to be successful with these strategies. It just takes a good amount of specialized knowledge (or good luck).

They also depend on one other thing - the rest of the market eventually coming around to your point of view. These strategies depend on stock price increases in order to generate a profit. If the stock price increases, that means the general public has finally acknowledged what you discovered earlier and those companies' stocks will be in demand. To put it in real estate terms, this is like buying a house as an investment and waiting for it to appreciate in price.

Why I Like Dividend Investing

Dividend investing, on the other hand, doesn't rely on share price increases to generate a profit. Instead, dividend investors are looking for the income stream the stocks provide. So obviously, a long term dividend investor should be worried about two things: how reliable is that dividend and how stable is the company?

A good dividend investment would be the stock of a company that has a long history of paying (and preferably, raising) dividends. They should also be a stable company with a reliable income,which will enable the company to continue paying dividends in the future.

Choose Your Own Adventure

A cool fact about dividend investing comes from the definition of a stock's dividend yield. As I mentioned last time, this is calculated with this formula:

Using this, if we know the stock's dividend, we can choose our purchase price to get the return we want. It's just like those Choose Your Own Adventure books, but you get to choose what return you want. Well, within reason.

Let's look at this using my favorite stock, Realty Income (O). At the time I am writing this, the company is paying a monthly dividend of $0.1905 per share. That works out to $2.286 per year. The stock is currently trading at $50.11, giving a yield of 4.56%. But suppose I want to earn 4.75% instead. Using the above formula and solving for Current Share Price, we can see a stock price of $48.13 will result in a yield of 4.75%. I just have to wait until the stock price drops to that point and buy it to get that return rate.

Now whether or not this is achievable, is another matter. You'd have to wait until the stock price drops to that level and it may not. But if you just have to have that 4.75% instead of the 4.56% and you have patience, you could reach your goal.

The nice thing about this is that, as long as those two requirements are met - the company continues to pay the dividend (or increases it) and the company stays in business - the dividend investor really doesn't care about the share price after the stock has been purchased. As long as the dividend doesn't fall, the money spent on that stock will always be earning the same percentage rate.

Suppose I buy $10,000 worth of Realty Income stock today at $50.11 per share. As long as the dividend remains at $2.286 per share per year, that money is always earning me a 4.56% return, no matter what the stock price does in the future. I've already bought that stock at that price, so that rate is locked in, even if the stock price falls to $30 or rises to $60.  As long as I don't sell the stock, I'll be earning 4.56% on my $10,000 investment.

Why I Like Realty Income

My previous experience as a real estate investor has taught me that cash is king. It's all about the cash flow. I want passive income and that is the ultimate goal that this blog is documenting - my quest to buy a Tesla with passive income. Hence my preference for dividend investing.

As mentioned earlier, the two most important things a long term dividend investor cares about are the stability of the dividend and the stability of the company. This is why I like Realty Income. The company is a real estate investment trust (REIT), which means they own property and rent it out to others and collect rent. They market themselves to investors as "The Monthly Dividend Company," in part because they pay dividends monthly while most stocks pay them quarterly and also because their dividend is what they are known for.

The company has been paying monthly dividends for 543 consecutive months. That's over 45 years! I'd say that's a pretty darn consistent dividend history.

They have increased their dividend 82 times since they were first listed on the NYSE in 1994 and they have increased it for 72 consecutive quarters. Look at this chart of their dividend history:

Constantly increasing. Very nice. And it's even more impressive when you realize that they were able to continue increasing their dividends even when the real estate bubble collapsed a couple years ago. They have never, in their entire 45+ year history, decreased their dividend.

This company has everything a dividend investor looks for in a company. That's why I love them.

Next Steps

As I have mentioned a couple times here, I'm not going to stay in dividend stocks forever. I plan to move into the hard money lending area once I have $20,000 saved up. Tune in next week to find out why.

Note that I am not an investment advisor and I am not recommending any specific investment. Consult your own advisor for advice specific to your situation.


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