Dividends: The Ultimate Passive Income

Dividends are payouts from companies that are rewarded for being shareholders and stock owners of that specific company. 

A quality dividend portfolio can help you generate safe, steadily growing income each year whether stock prices move up or down. With a portfolio of 15 or more diversified stock, you can ensure a monthly income.

The goal is to build a dividend portfolio that delivers a safe dividend yield of 4-5% and grows your income ahead of inflation while preserving capital during a downturn. Based on the Principal amount invested, it is possible to live indefinitely off of dividend income.

Disclaimer; I know I mentioned in other articles that the safest method of investment is S&P Index funds and sleep on it but this method is for those like me who enjoy picking stocks and learning the process of investing.

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Why Dividends?

Investing in dividend stocks means you are taking an ownership stake in a company whose goal is to grow its income-producing assets and thus cash flow over time. Along the way, dividend stocks usually grow their payouts to investors, resulting in rising income and usually higher share prices over the long term to generate healthy total returns.

Dividend-paying stocks have an impressive long-term track record, with S&P 500 companies paying dividends delivering a 9.25% annualized return from 1972 through 2017. Some Dividends have consistently paid and increased for 25 and sometimes 50 years!

A portfolio that holds more in stocks has historically delivered far superior annual returns, but it is also more likely to incur short-term losses. If you are comfortable with price volatility, then you can potentially maintain a pure high-yield dividend growth portfolio, made up almost exclusively of blue chip dividend stocks. 

High-yielding dividend growth stocks have historically proven to be one of the best performing asset classes. For example, between 1928 and 2017, a time period that includes the Great Depression and two other 50+% market crashes, the 40% highest yielding stocks in the S&P 500 generated total returns of approximately 11.2% annually. 

If you can tolerate higher price volatility, then use an Emergency fund extra to maintain several year’s worths of living expenses in an Emergency Fund.

That’s because the 4% rule will be sufficient to cover expenses throughout a 30-year retirement. Thus you merely need to maintain your Principal (offset inflation) in order to likely avoid running out of money.

General Consideration when building a portfolio

• Hold between 20 and 60 stocks to reduce company-specific risk
• Equal investment amount in each holding since it’s hard to predict winners and losers
• Invest no more than 25% in any one sector 
• Target financially healthy companies 
• Invest immediately among your chosen stocks and plan to hold 
• consumer staples, healthcare, utilities, and telecoms have been the most recession proof sectors, they provide essential goods and services that consumers continue to buy even during a downturn

Best Example of Successful Dividend Investor: Warren Buffet

Probably the most successful investor of our time with plenty of lessons to learn from his letters to shareholders. 

Buffett’s strategy has evolved to concentrate more on buying up wonderful businesses at reasonable prices rather than buying the dip for “cheap” stocks. He looks for companies that have strong economic fundamentals and numerous opportunities for growth.

He invests in the long term, even if some of his choices have not paid well. A strong example is IBM and Kraft-Heinz even though he stood by his decision and described it as overpaying.

When Warren Buffett makes an investment, he has said that his favorite holding period is “forever.” The idea is to buy excellent companies with solid long-term growth prospects and let them compound over the long run.

What are the metrics to look for 

1. Dividend Payout Ratio

The dividend payout ratio measures how much of a company’s earnings are paid out as a dividend.

A high payout ratio (e.g. above 70%) could mean that the dividend payment is riskier because it consumes the majority of a company’s earnings.

Generally speaking, I prefer to invest in companies with payout ratios below 40%. 

2. Free Cash Flow

Just like our Emergency funds, Without free cash flow, a company is unlikely to survive in the long run. This means it does not have funds to return to shareholders via dividends and buybacks or to use for acquisitions and debt repayments. 

3. Return on Invested Capital

Businesses take in funds (debt and/or equity) and invest to generate a return for shareholders. 

Companies that earn higher returns can compound our investment and are generally more desirable. Companies that earn returns below what investors demand disappear.

4. Operating Profit Margin

A company’s operating profit margin divides its operating profits by its total sales. Operating profits generally represent the company’s earnings before interest and taxes.

Higher operating profit margins can be a sign that a company has a strong economic foundation.

5. Sales Growth

Sales growth is a basic financial metric that simply subtracts one period’s revenue from another period’s revenue and expresses the difference as a percentage of the former. For example, if sales increased from $100 last year to $120 this year, sales growth would be 20% ([$120 – $100] / $100).

Trends in sales growth can inform us about the volatility of a company’s business model and its ability to continue expanding. This is the main reason why Earnings reports grow or drop a stock on the day of reporting. 

6. Net Debt-to-Capital

The net debt-to-capital ratio tells you what proportion of a company’s financing is from debt.

The company’s debt-to-capital ratio would be calculated as follows: total book debt ($20) divided by total book debt ($20) plus equity ($80). The result is a debt-to-capital ratio of 20% ($20 / $100). In other words, debt accounts for 20% of the company’s capital structure in this case.

I prefer to invest in companies with a net debt-to-capital ratio no higher than 30%, although some businesses such as utilities can reasonably take on higher debt levels due to the reliability of their earnings.

7. Net Debt / EBITDA

While the debt-to-capital ratio was focused on the company’s capital structure, the net debt / EBITDA ratio compares a company’s debt to its earnings.

EBITDA stands for “earnings before interest, taxes, depreciation, and amortization” and is meant to be a proxy for cash flow, although it does not account for a company’s capital expenditures to maintain and expand its business. 

8. Price-to-Earnings Ratio

The price-to-earnings (P/E) ratio is arguably the most popular valuation metric used by investors.

I generally prefer to buy companies that trade at P/E ratios less than 20 and intend to hold our stocks as long as possible once we buy them.

My Personal Philosophy in investing 

Some investors only look at the fundamentals and balance sheets when looking at investing and nothing else. Regardless of what a company does or how it does is irrelevant.   

That is absolutely not my style. 

I am a very socially conscious investor and do not like to invest in industries that actively harm other Humans. Money is power in this day and age and where you deploy your money speaks volumes of a person’s character. I refuse to prop up unethical actions in the name of pure profit.

I am of the opinion that there literally thousands of companies to choose from, so my profits can be made elsewhere. Hence, I do not Invest in Tobacco, Arms, and weapons, Gambling or predatory lending. 

These types of choices are my own personal choices and I Encourage you -The reader – To be conscientious too but it ultimately is your own choice.  

To me, this Principle is more important and worth losing a chance or two at these investments. In return, This is how as an investor I sleep well at night, even if I do not become the next Warren Buffet.

My Dividend Stock Picks 

These are some of my dividends picks for the month of October 2019. Keep in mind some of these numbers could be different if you’re reading this in the future and I want to give a disclaimer that I am giving my own opinion as I am not a financial advisor, just some guy on the internet sharing my own experiences.

This is only a part of my total investment as I do not put all investments in one basket, but it’s a part that if it is gone – by some freakish bad luck – I won’t miss it.

Ticker	Sector	Div. Yield %	P/E Ratio	Valuation
AMGN	Healthcare	2.85	13.7	Reasonable
BHP	Material	5.52	12.0	Undervalued
CLX	Consumer Staples	2.86	24	Undervalued
KO	Consumer Staples	2.99	24.5	Reasonable
LOW	Consumer Discretionary	1.96	18	Undervalued
MMM	Industrial	3.55	16.7	Undervalued
NTAP	Technology	3.61	12.4	Undervalued
O	Real Estate	3.47	23	Overvalued
PPG	Industrial	1.71	18	Undervalued
SWKS	Technology	2.05	14.3	Undervalued
WEYS	Consumer Discretionary	3.92	14.74	Undervalued
XOM	Energy	5.10	20.9	Undervalued

Most of the stocks I picked are undervalued at this specific time, This allows for an opportunity for growth of %9.7 increasing my direct capital gains on my principal.

My Personal Dividend yield is 3.38 which is decent and can be increased with time as I invest more into higher yield stocks. I have also distributed my income so that no one stock holds more than 10% of my total investment and no sector is larger than %14. 

I also diversified into 8 different sectors, but I intend to invest more in utilities and communications as soon as I see a better valuation on some of my stock picks. My monthly income from each company ranges from 5% to %15 as I do not want any one big source of income, so if a company disappears it won’t hurt as much.

I would receive monthly dividends for the whole year, with fair stability based on the metrics I described earlier. The stocks I chose to have a safe dividend payout rating with some paying dividends for over 60 years and have survived the previous recession, low debt, and historical great sales growth. I do expect them to be able to handle tough times

My strategy is to invest a certain amount every month, For 10 years at a minimum but most likely forever. Usually, my calculations are correct.

Thanks for reading up to this point!