With dividend growth investing being a very popular method for creating a growing passive income stream for the long haul, many first time investors might feel intimidated by the process of actually building up and creating their own dividend investment portfolio. While I can understand the hesitation and resistance some might feel to wanting to undertake such an endeavor, I can say first hand that the task is not as difficult as some might want you to believe. Creating your own investment portfolio that can provide you an ever increasing dividend income stream need not be difficult if you stick to some basic guidelines and investing principals during all market conditions. These investing traits have carried me through some of the toughest times to hold equities and today I am glad I followed my own set of rules as it has served me well for many, many years. With that being said, let’s dive into my personal method for selecting dividend paying stocks.
Back in 2007, when I decided to become a dedicated dividend growth investor, I chose to build the foundation of my portfolio upon the Dividend Aristocrats list. To me, this list entails the ‘best of the best’ in terms of finding excellent long term dividend growth stocks. To make the elite Dividend Aristocrats list, a stock must raise its dividend every year for at least twenty five years. If a company can achieve this feat its a clear sign that management has a shareholder friendly dividend distribution policy as well as the ability to manage cash flow in order to continually raise its dividend year after year. Names that I have considered from this list and are included in my current portfolio are, Archer-Daniels-Midland Company (ADM) with 40 years of dividend raises under its belt, Emerson Electric Co. (EMR) with an impressive 59 year history of raises and 3M Company (MMM) with 57 years of consecutive growth to name a few. Of course, this is not an endorsement of blindingly building a portfolio solely from stocks on this list, rather, it’s a solid starting point for further research to pick stocks and choose from some of the most solid and reliable names in their respective industries.
Next, I like to look at the payout ratio of a stock that I am considering. The payout ratio is simply a proportion of earnings that is paid out as dividends to shareholders. Typically, I like this ratio to be well below 80% as it would indicate a sustainable dividend yield with room for future growth based on current earnings. When payout ratios exceed 80%, it typically signifies a dividend that may not grow in a particular year or worse, may be cut. After all, the purpose of being a dividend growth investor is to build a portfolio of annual dividend growers and not cutters so paying attention to earnings/cash flow and the payout ratios becomes crucial. Some names with low payout ratios in my portfolio include Illinois Tool Works Inc. (ITW) at 39.8%, Becton, Dickinson and Company (BDX) at 30.8% and CR Bard Inc. (BCR) with a low 9.5% payout ratio indicating a very safe dividend with room for future growth based on current cash flow.
Many first time investors sometimes do not pay attention to payout ratios and instead focus on yield alone. This can be a mistake as high yields often indicate something inherently wrong with the company in general, as well as a potentially unsustainable dividend. For regular dividend paying stocks I like to see yields well below 5%. Anything higher, raises flags.
Continuing on my search for potential dividend stocks to add to my portfolio I look for stocks trading at decent to good values. Using the most simplistic measure, I pay attention to current, forward and historical P/E ratios. From Investopedia, “The price-earnings ratio (P/E Ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.” With this basic metric for judging value, I am able to see if a stock is trading at a good value or not. While not directly correlated to dividend health, the P/E ratio can help determine if the stock is offering a good current yield or not. Some current stocks from my portfolio that are trading at current low and historical PEs include, W.W. Grainger, Inc. (GWW) and The Bank of Nova Scotia (BNS) to name a couple.
Diversity among my dividend payers is crucial too. While scouring the Dividend Aristocrats list, it’s important to find stocks that hail from various sectors and industries. Personally, I favor the consumer staples the most for my long term portfolio as it offers many very defensive and stable long time dividend payers. I own stocks from other sectors as well, including industrial, finance, health, conglomerates and more. For personal reasons, I never owned any energy nor tech stocks in my long term dividend growth portfolio for the anxiety these volatile sectors potentially provide. The way I see it, asset allocation is merely a reflection of your own investment tastes and tolerance for risk. By most measures, my portfolio would be considered a lower risk and conservative collection of stocks.
There you have it. My basic methodology for choosing dividend paying stocks. It’s definitely part art and part science as sometimes certain investments just have a “right feel” to them even though the current numbers might not make perfect sense. If you have a long term horizon and can find a growing and sustainable business, it might make sense investing in that company for the long haul. After all, a dollar or two difference here and there in share price, usually does not make much difference in your long term returns especially if your focus is primarily passive income growth. We all know that time in the market is much better than timing the market when it comes to compounding dividend returns.
Disclosure: Long ADM, GWW, BNS, ITW, BDX, BCR, MMM, EMR
36 thoughts on “How I Choose My Dividend Stocks”
Thanks for sharing how you pick dividend stocks for your portfolio. It really is simple to do and one of my first screens is just a lengthy history of growing Dividends. If you could look at just one metric to identify quality companies that would likely be up there with a few others. Finding the ones trading at a discount is a bit trickier but identifying the quality companies is at least half the work.
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Without delving into quarterly reports and other figures that might otherwise overwhelm a new dividend investor I have found that sticking to some basic ideas for choosing stocks can be as effective as the mountains of research others tend to do. I always came from the belief that finding dividend stocks need not be difficult. Of course, it’s not just about buying blindly from a published list either which is why I look at values as well. Finding the discounted names might be a little more difficult as you mentioned but there are other interesting ways to find value such as Percent Above Average Yield (PAAY). Thank you for stopping by and commenting.
This is the comment where I agree a lot with. A diversified portfolio purchased at good valuations, with companies where earnings are growing, dividends are growing, and the payout ratio is not going up, is probably the thing that would be very helpful. If a business is a quality one, and has some advantages in the industry with slow change, you will likely do pretty well.
Reading footnotes may not really add in incremental benefits for most investors. Of course, if you are weird like me, you may sometimes find pleasure in reading some of them…
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Well said. There’s nothing wrong with delving into the footnotes and other detailed sources of information regarding a company, however that being said, people tend to fall into the analysis paralysis trap and never make a purchase because every condition of their screen is not perfectly met. As you mentioned, simply looking for a company with growing earnings, growing dividends and a sustainable payout ratio selling at good value should be enough for most. After all, understanding the business of KO, PEP, CLX, PG and the like is not that difficult. Thank you for the reply.
I have a very similar investment philosophy to you, except I think I might place more emphasis on valuation than you do. It’s interesting that your initial screen is the Dividend Aristocrats list – while certainly a good place to start, none of my holdings are actually on the list.
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Looking at the dividend aristocrats was how I first built my long term portfolio. Of course, I own names that are not included on the list but I still think it’s a good place to start. Valuation, in my opinion, is always part art and part science as there are several ways to “value” a stock. I stick to the basic value metrics as I mentioned in the post and so far I cannot complain about my results. Thank you for sharing your thoughts.
Agreed. Our stock screener has the same metrics, although the values we use are slightly different. Price lower than the market, payout ratio less than 60%, and history of dividend growth. Glad to see we are on the same page here with our research and it should serve us well for many, many years to come!
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In general, I think most long term dividend growth investors follow a very similar methodology, though I suspect some first timers get lured by the high yield stocks initially only to get burned down the road with dividend cuts or eliminations. Payout ratios of less than 60% is certainly more stringent, and for the most part, most of my holdings are in that range but every now and then you screen out some great utilities like SO, ED or D for example. As always, I appreciate your comment.
very solid advice. I wish I would have found this article when I first started investing. Although I agree with your thoughts about the tech and energy sector, I still feel their are some great investments to be had. Apple is shaping up to be a great dividend paying stock given it’s current success and growth especially with Apple pay. It is always good to play on the safe side nonetheless and I’m really not to sure how long I will be holding.
I wish I fully understood the concept of dividend growth investing when I bought my first stock. Of course, it was a different time back then and a CD was paying over 8% and all bank accounts paid interest as well, instead of a token amount today. In those days risking your money to earn a dividend of 2% or 3% was not as attractive as a guaranteed 8% or 9% with a CD. I’m not against tech or energy per se, it’s just that I’m averse to sectors with high volatility. I have owned quite a few energy companies in the past, CVX, BP, TOT, EPD, ETP, KMP (now KMI) and APU. I even owned a tech stock believe it or not way back, RHT. For now, my focus will continue to be with the consumer staples, industrial, health and finance sectors. Thank you for commenting.
Thanks for sharing your methodology Divhut. Curious – do you use any 3rd party analysis sources for your research? Or are these the key metrics? Cheers
Dividend Ten recently posted…Dividend Income Roundup – September 2016 – $14,888.17
I do not use any 3rd party analysis per se for my research rather source all my information from various online resources, including many of our fellow dividend blogs, Yahoo! Finance, Google Finance, Morningstar, GuruFocus and more. Thank you for stopping by and commenting.
One thing I want to add – I would encourage you to look at the list of dividend champions, as opposed to the aristocrats. This is because the list of champions is more complete, and the aristocrats doesn’t include or takes out companies for no apparent reason. When I started out in 8 – 9 years ago, I started with the aristocrats as well. But quickly moved to the list of dividend champions..
On another note – I started out around the same time as you, and my site in 2008. I am curious, did you ever read the DGI site before starting yours?
Dividend Growth Investor recently posted…Two Dividend Growth Stocks Showering Investors With More Cash
Thanks for the tip of using the ‘champions’ list instead. When I first started I only saw an ‘aristocrats’ list that caught my eye and over the years I noticed, the ‘champions’, ‘kings’ and ‘challengers’ crop up. To me, it seemed to complicate an easy concept of finding long term dividend raisers by breaking down these lists into subcategories but I see your point of using a more complete list to potentially find a new investment.
When I first started exclusively investing in dividend stocks I had no idea that there were any blogs dedicated to this topic. I simply started buying stocks based on my methodology mentioned in this post and it wasn’t till about late 2013 that I discovered this whole blogging world. Seeing all these great dividend blogs out there inspired me to start DivHut in early 2014. As always, I appreciate your comment.
The only reason I asked is because I would have loved to interact had we “met” earlier than say 2014.
Dividend Growth Investor recently posted…Can Apple become a dividend growth stock?
Absolutely. Looking back, I wish I would have been tuned in to the various DGI blogs out there prior to 2014. I find them all very useful and interesting as each has its own characteristics.
The trickiest thing for me, by far, is finding “stocks trading at decent to good values” as you say. It’s always the part that trips me up, which is made worse since everyone seems to have a different method of doing this. I’d be genuinely interested if you could go into greater detail about this part of your method. Maybe in a future post?
Great as always; thanks for posting this 🙂
Valuation is always part art and part science. There truly is no one way to accurately value a stock as there are so many different ways to do so, each with its own merits. Sometimes, it’s important to just stick to a basic valuation method like PE so as to not fall into the analysis paralysis trap and wait indefinitely for that perfect entry point for a particular stock. For my buys, there really isn’t much greater detail to get into regarding valuation as I simply pay attention to current, forward and historical P/E ratios. That’s really about it. Glad you enjoyed this post and I appreciate your comment.
Read this over on SA first!
I pretty much follow the same strategy, except I switch up the order and use the CCC list from David Fish (never really looked at the Aristocrats since I found the CCC). I did not fully follow the process recently when I got JNJ, MMM, and OHI in my new IRA, but the road ahead should be straightforward for those picks.
Here’s many more years of dividend growth!
Dividend Gremlin recently posted…Loyal3 Buys, Oct. 2016
That CCC list from David Fish seems to be the list many dividend investors go to when looking for potential stock picks. I still have not used that list for any of my buys but I guess I should start taking a peek. The general point of this post was that finding solid dividend growth stocks need not be difficult at all. As you mentioned with your recent buys for your IRA you did not fully follow the methodology but those businesses are pretty straightforward for the foreseeable future and should probably pan out long term. In other words, sometimes it’s OK to just ‘go for it’ especially when it comes to certain solid stocks/companies out there. As always, I appreciate your comment.
These investments are paying off for you big time. That’s why as a longterm reader to your blog, I often come here to inspiration. haha! You’re on point with your analysis. And thank you for sharing your investment experience. Keep it up, bro!
Thank you for those kind words. I really appreciate the feedback. I hope I was able to convey, especially to new stock investors, that finding solid dividend paying stocks is relatively easy and does not have to be overly complicated. I really believe that anyone can build an ever growing passive income stream if they just stick to a few very basic rules. I appreciate your continued encouragement and support.
it’s always good to read other people’s investing strategy and I’ve ended up using very a similar approach as you.
I use payout ratios and also judge value by comparing current PE vs historical averages and S&P average, although I’m not as stringent on a stock being an 25 year aristocrat. I don’t really worry about stocks being “overvalued” other than the reviewing P/E; I think price is reflected in the dividend yield and I’m investing more for income than capital gains. So if the yield is good (> 2 and < 6%) and the payout ratio is good then it's a candidate. I use the P/E comparison as a final selection criteria between similar stocks, usually picking the lower P/E.
The art part of it for me is sticking with companies / brands that I know or use regularly, and relying on dividend index funds for the majority of my investments in case my individual stock picks go badly.
Finally I weight by dividend income; I don't want any individual stock paying more than 5% of my dividend income. I don't worry about market cap weighting.
Dividend Life recently posted…September 2016 – Income Fund update
Thanks for sharing your methodology for picking dividend paying stocks. It looks like we are doing pretty much the same thing when it comes to evaluating potential buys. As you already know, the whole concept of stock picking is both part art and science for various reasons. The bottom line is that most of our fellow dividend growth investors use these same tactics to pick out dividend winners and hopefully screen out the dividend dogs.
When I first started I wasn’t so strict about a current yield as long as there was good dividend growth which put several low yielding positions in my current portfolio. I know many in the DGI space like yields well over 2% just to be a consideration. Thank you for sharing your thoughts.
Thanks for the insights Keith. I think you and I are the same in terms of looking at the Dividend Aristocrats list in order to search for stocks. Its great that you used it to build the foundation of your portfolio as businesses do not come much better than those on the list!
Money Grower UK recently posted…October monthly stock purchase – Pennon (PNN) Whitbread (WTB) Centrica (CNA) Barr (BAG) plus more
Those are my thoughts exactly. If you are worthy enough to make it on to the aristocrats list then you must be doing something right in terms of a dividend distribution policy. Thank you for stopping by and commenting.
Why make things more complicated then the need to be, eh? I like your basic strategy, which seems to be paying off handsomely. Is it Perfect, no, but is it working, absolutely!
Well done DH, keep doing what your doing.
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I totally agree. Sometimes, we like to complicate things for no apparent reason. I like to keep things simple in life and with investing. As you said, it may not be perfect and more detail in my analysis could be useful, but the current methodology does work for me and has worked since 2007. As always, I appreciate your comment.
Solid advice, and I mostly use the same signals to guide my purchases although I concentrate a lot more on Canadian stocks and leave US/International in the hands of ETFs. It’s interesting that you avoid tech stocks, I do as well even though the sector is one of the most profitable ones. My feeling is that the field moves way too fast, and nobody has a “moat” in the area that can’t be disrupted in an extremely short timeframe. Myspace was all the rage until Facebook appeared, anyone who was anyone had a Blackberry until iPhone stole their thunder.
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My only exposure to Canadian stocks are the large banks but I am aware of many other Canadian stocks that are worthy of a spot in any American portfolio. Before I became a dedicated dividend growth investor I did own one tech name, RHT. In fact, I held it for several years and it turned out to be one of my best trades ever. But, as you mentioned, I do not like the speed at which the sector changes. Titans of today can quickly become ghosts of the future. Forget all the dot coms that went bust, who even thinks of AOL these days? AOL was the Internet for most of the online population in the U.S. Today… like Compuserve, Earthlink and Prodigy they are memories. Networking? Look at the max chart of MRV Communications, Inc. (MRVC) a one time darling. Long term tech investing can be very difficult. In fact, AAPL was, at one time, on life support prior to the release of the iPod. Think PowerPC days, etc. You mention Myspace, how about Friendster, TheGlobe or even Geocities and more. Blackberry… Remember the must have slimmest phone you had to get… the Motorola Razr. The whaaaaat??? It’s nice to see eye to eye with someone regarding the tech space. Maybe it’s because I’m in it and see the changes occur on an almost month to month basis. Thank you for sharing your thoughts.
Very good post!
My most important metric is the payout ratio too. It doestn matter if a stock yields 12 percent when the payout ratio is above the 100 percent. I think this metric is something every dividend growth investor have to look at.
thanks for sharing!
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Being a dividend growth investor I would think that most would consider the payout ratio as one of the top metrics to consider. After all, we are most interested in making sure we continue to receive dividends and that they are raised on an annual basis. Of course, this doesn’t mean to ignore valuation as it can become easy to overpay for a stock if just focusing too much on the dividend statistics. Thank you for stopping by and commenting.
Sigh, I get so jealous when I see the number of dividend champions and aristocrats that exist in the US! Such high quality companies.
I’ve made that payout ratio mistake in my early days too. Glad to learn the lesson when my portfolio was still small.
Canada is another country with many solid long term dividend payers and raisers. I always wondered about ‘aristocrat’ type companies in other countries. Is there a similar list for Australia? Keep looking for those solid dividend stocks wherever they may trade or be domiciled. Of course, now that you know the value of watching payout ratios you can hopefully avoid dividend cuts in the future. There’s never a guarantee that a dividend will be paid but there are steps that can be taken to mitiagte that potential. Thank you for commenting.
Thanks for sharing your method. Not many people are frank when it comes to sharing their strategy. There are many “fluff” articles on investments that are full of clichés. I’m really glad to see that you followed your own set of rules and it paid off. Trusting your gut is one of the most important features of an investor.
These sets of rules I set up for myself are more guidelines than anything. But still, they’re guidelines that I continue to follow and they have served me well. My main goal is to generate an ever increasing passive income stream and since I became a dedicated dividend growth investor that is what I have accomplished. Thank you for sharing your thoughts.