Intro To Dividend Investing
Dividend investing is my preferred method of building a solid portfolio. As mentioned in my previous post Finding My Investment Style, dividend investing is purchasing stocks that pay dividends on a monthly or quarterly basis. These dividends are then re-invested to purchase additional shares. This process is called a Dividend Reinvestment Plan (DRIP). The compounding effect of a DRIP grows your portfolio at a much faster rate. The additional shares from the DRIP will then allow you to purchase more shares in the future. Your money is now working for you, instead of you working for your money.
What is a Dividend?
A dividend is a payment, usually in cash, that is paid by a company to its shareholders. As mentioned, companies pay out this distribution either on a monthly or quarterly basis. The most common dividend frequency is quarterly.
Here is an example of a dividend announcement. Enbridge is a major Canadian fuel transportation company.
Enbridge (ENB) declared a quarterly dividend of $0.671 per share, or $2.684 annualized.
The dividend will be payable on June 1, 2018, to stockholders of record on May 15, 2018, with an ex-dividend date of May 14, 2018.
Key Points or Terms
The dividend amount that will be paid to shareholders is $0.671 per share quarterly and $2.684 per share annually.
This is the date that the company will distribute the dividend through its transfer agent. The transfer agent will then process the distribution according to their records of registered shareholders. If you own the shares directly through the company (Enbridge), the payout will be reflected on payout date. If you own it through a brokerage account there could be a day or two delay due to the processing time.
You must be a registered owner of the company on this date after settlement.
If you purchase this security on the ex-dividend date, you will not be entitled to this particular payout. Because settlement is 2 business days you will need to purchase the security on or before May 13 to be entitled to this distribution.
Dividend Reinvestment Plan (DRIP)
When you first start off dividend investing, I recommend
- Enrol through a brokerage account – When you enrol in a DRIP through a brokerage account they will usually enrol you through a market DRIP. This means that your brokerage will buy shares of Enbridge in the market (for all its clients – bulk order) and distribute it accordingly. Fractional shares are usually paid out in cash.
- Enrol directly through Enbridge (via their transfer agent). When you enrol directly through Enbridge you will receive fractional shares in your account. The advantage of this method is that the fractional shares can add up quickly over several years. The disadvantage is that it is much more difficult to manage and selling the security requires you to deposit the physical certificates into a brokerage account. This process can take up to a week, sometimes even longer.
As your portfolio grows in size you may find that you are overweight in a particular dividend stock or sector. In this case, you may want to stop the DRIP on a particular stock and allocate the funds to other stocks. This allows you to manage asset allocation without selling securities.
Dollar Cost Averaging (DCA)
Dollar cost average is the process of purchasing a set dollar amount of securities over a specific time period. For example, you could save $1000 per month and allocate that towards purchasing a stock every month or quarter (or whatever time frame you decide on). With DCA you don’t need to time the markets. Your portfolio benefits when the stock is low by purchasing more shares. Your portfolio also benefits when the stock goes up. It’s a win-win. Here is more information on DCAs at Investopedia DCA.
The Power of Compounding DRIPS and DCA
Here is an example of the power of DRIPs and DCA. I found this DRIP calculator on DQYDJ that provides DRIP calculations for US securities.
An investor who purchase $10,000 of Johnson & Johnson (JNJ) on Jan 1,
An investor who purchased $10,000 of JNJ on Jan 1,
At today’s dividend yield the investor would receive almost $15,000 per year in dividends. That’s just over $1200 per month, every single month (excl’d taxes).
Where To Start
When I’m looking to purchase a stock as a core holding, a stock not for trading purposes, I start with the Dividend Aristocrats or Canadian Aristocrats.
Dividend Aristocrats are companies listed on the S&P 500 that have increased their dividend every year for more than 25 consecutive years with a market capitalization of over $3 billion. These are well known companies like Coke, Procter and Gamble and Johnson and Johnson.
Canadian Dividend Aristocrats are Canadian companies that have increased their dividend every year for 5 consecutive years. There are about 80 companies on this list and includes all of the big five banks, as well as Enbridge and BCE.
From this list, I follow Peter Lynch’s advice to purchase stocks of companies that I know and understand. This eliminates a lot of companies on the list. I then use technical analysis to help me determine when to buy for my core holdings. I’ve found that these indicators have a close correlation to actual valuations. I review dozens of stocks utilizing technical analysis. Then I’ll do a deeper analysis of the stock.
There are various valuation methods that may be of interest for those who are more mathematically inclined and enjoy the deeper analysis of stocks. Warren Buffet talks a lot about buying stocks at a discount, or stocks with a margin of safety. To do this he calculates the intrinsic value of a stock, if the stock is trading above this price then its currently on ‘sale’. The size of the discount is the margin of safety an investor is willing to accept.
There are many stock valuation metrics; each with its own benefits and drawbacks. Here are some of the most common methods. Price to Earnings (P/E), Discounted CashFlow (DCF), Earnings Per Share (EPS), EPS growth rate etc… Here’s some more information on valuation: Investopedia Valuation, Wiki Stock Valuation
For Canadian Investors
If you invest in a US dividend stock in a taxable brokerage account, you will incur a foreign withholding tax of 15% on the dividend distribution. For example, if a stock pays $100 in dividends, the withholding tax of $15 will be deducted from the payout and your taxable brokerage account will be credited $85.
One way to avoid paying this withholding tax is to hold US dividend stocks in a Registered Savings Plan (RSP). RSP accounts are exempt from the withholding tax. Please don’t confuse this with the Tax Free Savings Account (TFSA); as TFSA’s will still incur the foreign tax.
Dividend growth investing is a great investment process for anyone looking to achieve financial independence. Dividend distributions provide an investor with an accurate monthly cash flow amount. Theoretically, when cash flow exceeds your monthly costs you’ve reached financial independence. In practice, you should build in a buffer for unexpected events or higher than expected future expenses (eg health issues, extended travel, etc).
Dividend investing is the investment method that has allowed my wife and I to retire early and to explore the world. Read about our travel adventures at The Wandering Asian Couple.