Why 'Dividend Growth' Stocks?

The purpose of this blog is to illustrate the benefits of selecting stocks for their dividend growth characteristics, and a way to track my performance over time.

What is 'dividend growth' exactly? It is quite simply selecting investment candidates based on the rate at which a company increases its dividends over time. It is easy to oversimplify by considering 'dividend growth' to be the only criteria, but as with all things Wall St., nothing is ever quite that simple.

I am a strong advocate of using the quality ratings of Schwab and especially S&P as a gauge of stock quality.

Rules – running the portfolio has some rules. The good news is they are easy to follow.

1) Stick with what you know. If you understand what the business does, particularly if it sells a tangible product (diapers) or understandable service (payroll processing) you meet this simple rule.

2) Quality – two measures. One is the S&P rating, and the other is the Schwab rating. Both are found on Schwab.com. The more important rating is S&P. S&P rates stocks from 1 star to 5 stars. You want 4 or 5 star companies. Sometimes an exception can be made to buy a 3 star, for example when Schwab rates the same stock as an “A” or “B”. Ideally the stock has 4 or 5 stars from S&P AND it is rated “A” or “B” by Schwab. These are guides. Use judgment in applying them. After all, the ratings themselves constitute a subjective judgment. S&P does a very good job though, and I can trust how they arrive at their ratings. Just read one of their reports and you will see.

3) Diversification – ensure you have at least 25 holdings that are diversified across all major economic sectors. Those are industrial, consumer, banking/finance, insurance, utility, foreign, telecom, materials, energy, and technology. The goal is to consistently outperform the broad market, as measured by the Wilshire 5000 index.

The most important rule is to select only companies that have good dividend growth. It is not just about selecting a company that pays a good dividend yield. In fact, low or high yield doesn’t matter very much (although 1.5% is a good minimum goal for initial yield). The idea is to earn higher and higher yields on your original investment over time. You may start out with a yield of around 3%, but five years from now the yield should be 5-6%, and in ten years 11-12%, and that is not counting unrealized capital gains. Collect dividends in cash - do not reinvest. Then, once you have collected $4-6,000, buy another stock or more of what you already have, using these criteria (revisit your diversification). Tax law favors dividend stocks. Dividends are taxed as regular income (not at a higher capital gains rate). You should not have to ever sell, but consider selling if the dividend growth rates slows a lot, or stops, the payout is more than the company’s income for three years in a row, or the company's long term prospects are diminished.

This is a real portfolio. Most of the positions were taken at the beginning of Oct 2006, and as you can see below, we have an unrealized gain of over 6% (as of 15 Dec 06). I'd like to take all the credit for that gain, but as you probably realize, it is largely a function of the stellar market performance we've had since October. The blog will track its performance, and any changes/additions made.

Here's the portfolio (prices and other calculations update every 5 mins during market hours, just refresh your browser):



And, here are the names and details for those companies (thanks to Yahoo!).

I hope you follow me on this journey. It may even be fun!