With any investment approach, there needs to be some rules. This helps to temper the emotions. We stated our rules at the
outset. Since we have made it through the first year, let's revisit those rules and try to expand on them a bit more.
1. Stick with what you know. Basically we should know what the business does. This is known as the "Warren Buffet" rule. His basic philosophy was that "if you don't understand what the business does, why would you invest in it?"
2. Quality - Good measures of quality are hard to find. Wall St. research is extremely biased since their motives are impure. The purpose of those firms is to promote the purchase of stocks since these same firms underwrite what is sold. Most short side research is done by smaller independent firms. A few well-known firms are generally considered more reliable, such as S&P and
Schwab. I trust them more, but still you have to be careful how you treat the information. And unfortunately, not all firms we are interested in are covered. Most common of these are smaller companies. We are finding some of the high
QDV stocks lack coverage. This means we have to be more selective, and it means we take smaller positions and build them slowly over time if/when they prove worthy, as evidenced by price and dividend appreciation. For
Schwab, "A" and "B" ratings are preferred, and for S&P, 4 or 5 "Stars" is preferred. Ideally, you like to see both, but outside of the large caps, you are lucky to get one or the other.
3. As we stated at the beginning, 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. We are having some difficulty following this rule of late. Some sectors do not have a history of growing dividends, at least not at the rate we are looking for.
Telecom performed very well over the last 12 months, and we made a lot, but the companies comprising the
Telecom HLDRs (
TTH) just don't grow their dividends. This is a real
Hobson's choice, since if we hadn't broke our rule on dividend growth, we would not have captured the appreciation and yield over the last 12 months. We are currently looking at a couple of small and new issue telecoms, which will be a better trade-off. We would rather have firms that are growing dividends and sacrifice not having more dividend history, then to stay with those that have demonstrated they will not increase dividends at an adequate rate. Utilities pay higher yields, but they tend to grow at a lower rate. Right now two utilities we own are
ONEOK (
OKE,
QDV 14.5%) and
Entergy (
ETR,
QDV 9.7%). This looks a bit light since many other sectors have companies with 20+%
QDVs, but this is a trade-off to have adequate diversification across sectors. This is the most difficult rule to follow, since there are trade-offs.
4. This brings us to rule four, which is the most important rule - own only companies that have good dividend growth. We have invented the term "
QDV," or Quarterly Dividend Velocity to better measure the rate at which companies increase their dividends over time. Our
portfolio now lists
QDV for every holding, and now lists
QDV at the portfolio level. The benefit of doing this is that it allows you to better estimate dividend cash flows in the future, and it focuses your attention on what is most important. If a company's
QDV drops too much, you investigate why and if necessary, sell the stock, particularly if you can find a similar one with a higher
QDV.
Certainly
QDV alone is not going to do it. Two important indicators to weigh are payout ratios and cash flow. Why? Because they are essential in measuring the likelihood of continued dividend increases. For example, is cash flow and profits keeping up with the rate of dividend increases?
5. I am adding a fifth rule, which is long term growth. Does the stock price have a strong long term growth trend? Particularly if it has a long trading history. The idea is that if the company is doing such a great job growing earnings, cash flow, and dividends, then the stock market should be increasing the value of those cash flows over time. Ideally you want the market trend to confirm the company's prospects. A dividend investing approach is usually considered to be a "value approach," but in practice it is really just about growth. We just think that a good portion of that growth should be passed on as shareholder cash flow.
I hope this helps you with your strategy. The point is to have a plan and to follow it as closely as possible.
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