This is a guest post by Financially Integrated who writes about dividend investing, wealth creation and escaping the rat race.
I have been attracted to dividend stocks for the better part of a decade. Over that time, my approach to investing in dividend stocks has changed somewhat, but the central theme remains high quality wide moat businesses that return a regular, growing stream of income.
I stumbled onto dividend stocks as a result of personal investment failures. My initial investing experiments in my early 20’s were focused on chasing internet stocks with unsustainable business models. I had wrongly reasoned that they were a solid way to build quick wealth.
Unfortunately, what soon became apparent to me was that these were often businesses with poor economics and no sustainable competitive advantages. It cost me valuable time and money to ultimately figure this out, as my losses in these positions mounted.
I soon embraced Warren Buffet’s Rule No 1, which is to never lose money. I realized that the best way to do this was to invest in businesses that have sound defensive positions and which generate significant cash flow. I also noticed that many of these high quality businesses happen to return significant cash flow back to shareholders in the form of dividends.
With that, I embarked on my journey of accumulating dividend income. I started accumulating many of Australia's best dividend payers (I am originally from Australia). The list included the highest quality Australian banks, telecommunication firms and retailers to diversify my income base
The dividend income soon started pouring in. What began as an initial set of small cash returns soon turned into an income stream of over AUD$20,000 in annual dividend payments. My strategy was a simple one. I identified businesses that had solid competitive advantages and strong returns on equity and essentially employed a 'set and forget' approach.
When I eventually approached the US market, I followed precisely the same strategy. I looked at large cap dividend businesses that had inherent competitive advantages and solid ROE and proceeded to steadily accumulate the business. Pretty soon I had added companies like Johnson & Johnson (JNJ), General Electric (GE), Wells Fargo (WFC) and others to my list of dividend payers.
Somewhere along the way, I happened to notice that companies that were slightly earlier in their growth cycles happened to be more generous with their dividend increases, largely as a result of their better earnings profile. While their dividend yields may be slightly lower, the rise in their dividend income combined with superior capital growth started to become a little more appealing.
As a younger investor in his late 30's, I also have a long way to go to retirement. I may potentially need my retirement income to last me the better part of 50 years. I thus resolved to modify my dividend income approach to have a portfolio approach to dividend income, rather than necessarily push towards only mature, established companies with higher yields.
Companies all have their own defined lifecycles. with discrete growth phases. Companies start out in a hyper growth stage where revenues typically go through the roof but profits can be subdued and cash flow seems hard to come by. They then go into a more steady, consistent profitable phase that produces consistent cash.
Finally companies typically go through a process where growth slows down to a level that is slightly above inflation. It is at this phase where companies are most vulnerable to disruption.
My desire is to have a collection of dividend companies at a variety of different stages, to ensure my dividend income never has a chance to become “stale” or have too high a risk of disruption because my portfolio is made up of only very mature businesses.
What this practically meant was to have a blend of regular, established dividend paying stocks with relatively higher yields, complemented by more modest dividend paying stocks with lower yields but a better growth profile.
My hope with this revised approach is that I will have a steadily growing stream of dividend income that will have a growth profile of at least 30 years or more. I will add emerging dividend payers as needed, and sunset those businesses whose business models and income are at risk of disruption.
The result of this is that my portfolio now has a blend of classic dividend stocks such as Johnson & Johnson, General Electric and Wells Fargo, complemented with some "less traditional, lower yielding dividend stocks" such as Fastenal, Starbucks, Nike, Yum Brands and Visa that are exhibiting more rapid growth and more quickly growing dividends.
I now have a core group of 30 US dividend paying stocks, that I have just been steadily accumulating, and intend to accumulate for years to come. The characteristics of the businesses that I am accumulating are all the same, irrespective of their yield.
That is, they are solidly competitive businesses that generate significant cash flow, strong returns on equity and that I believe can serve me well for years.
While my blended portfolio yield is probably lower than someone who has a portfolio full of high yielding stocks, I still feel that my dividend income and capital growth will have grown substantially by the time I need it for retirement.
Dividend stocks have had a significant positive impact on my approach to personal finance. I love that these businesses allow me to sleep contentedly, and accumulate steadily without fear, irrespective of market conditions.
I also like that I see the fruits of my investment strategy daily, irrespective of what markets do, through the income that I have to meet my general expenses.
Overall I remain convinced that dividend stocks provide an important plank in a secure retirement strategy.