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Knowing When to Buy Dividend Stocks

With my debt and savings habits under control, lately my thoughts have been more so on investing strategies. One investment strategy that I believe in, as you may know, is dividend investing.

Dividend investing can mean a couple things. It could include investing for yield or dividend growth. Investing for yield is simply basing purchase decisions on the dividend yield of the stock. The higher the percentage yield, the better. The Dogs of the Dow strategy comes to mind for this one. In my opinion, basing investment decisions on yield alone is a dangerous game. More times than not, an abnormally high yield simply means an unsustainable dividend. When the dividend payouts become too much for the company to carry, dividends are typically cut dragging the stock price with it.

Investing for dividend growth is making purchase decisions based on the history of growing dividend payments over the years.  Although the initial purchase yield may be lower, it’s a great strategy for buy and hold investors as it gives raises to loyal shareholders over time.  Buying and holding dividend growth stocks is more in alignment with my beliefs and is one of the key components in my dividend investing strategy.

Having explained the two strategies, I use a combination of the two when making purchase decisions.  I narrow down the list of strong dividend companies based on a history of dividend growth, but only make my purchase when that particular stock reaches a yield threshold.

How do I determine the yield threshold?  By going back through the history of dividend payments and figuring out the average yield over the years.  Once that is determined, I usually pick a yield that is above average which then can be converted into a target stock price.  From there, I can watch the market (or use alerts) to indicate that it’s time to pick up a new position.

The Process of Finding Dividend Stocks to Buy

  1. Pick your stocks. Find strong dividend stocks with a history of increasing their dividends over the long term.  A great place to start is the dividend achievers list.
  2. Calculate the average yield. Do your research and figure out the average stock yield over the past 5 or more years.  One tool for this is Yahoo Finance historic prices tool.  You can select “dividends only” which will list dividend distributions over the past several years (depending on the stock).  Another way, which may be easier, is to use BigCharts.com and select “Lower Indicator” to be “Yield”.  It will graphically show you what the yield has been in recent history.
  3. Pick your buy point. Select the yield at which you would be comfortable purchasing and convert that into a stock price.  For example, if Royal Bank’s average yield over the past several years has been around 3.5%, I may pick a buy point of 5% yield.  The current dividend is around $2/share which would equate to a target buy price of $40 ($2/0.05).
  4. Use stock alerts. As we are all busy people, it’s a challenging task to keep your eye on the market which is why I use stock alerts.  There are various ways you can do this such as MSN money alerts, an Excel spreadsheet (with stock addin), or even a Google Spreadsheets (built in stock price functionality).  MSN Alerts are prehaps the most convenient if you are a MSN messenger user.  The spreadsheet option can provide more details, but requires that you check the spreadsheet periodically for buy signals which may or may not be convenient.

Although not overly detailed, that’s a fairly comprehensive overview on my dividend picking process.  For those of you who are fairly new to the blog, here my most recent dividend portfolio update.

I know there are a good few hardcore dividend investors reading this, do you have anything to add?

In a future post, I will put more details into how I use spreadsheets for stock alerts.

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

FrugalTrader About the author: FrugalTrader is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 22 comments… add one }
  • saveING.ca This is why I signed up with ING Direct November 18, 2009, 10:55 am

    my favourite dividend stocks: Procter & Gamble (PG), Clorox (CLX), Emerson Electric (EMR), Wal-Mart (WMT) and Pepsi Co (PEP)

    thanks FT!

  • Nurseb911 November 18, 2009, 11:49 am

    Once your portfolio is constructed I’ve found that one of the easiest ways to decide is to simply put on your portfolio manager’s hat and buy the stock that has the lowest weighting. I’ve found this to be a very easy strategy for taking out the emotions when investing because instead of deciding what stock to buy it’s simply a decision of which stock is lagging that needs to be added to.

    I like your criteria for selecting through from a new investor perspective.

  • Finance_Addict November 18, 2009, 12:34 pm

    Good Post. I agree with your approach. I would add that there are other sectors besides financials and energy that have strong yield and dividend growth profiles. Namely Telco.

  • Elbyron November 18, 2009, 2:05 pm

    I don’t have much investing experience, but it seems to me that most brokerage services offer the ability to set up email stock alerts. Or there are free websites like zignals.com where you can set up a stocklist and alert conditions, and have the alerts sent to your email, phone (SMS), or displayed on an iGoogle widget.

  • kenyantykoon November 18, 2009, 3:06 pm

    i recently read a financial book called the conspiracy of the rich and the author was suggesting this type of investing during lean economic times such as this seeing as how it increases periodic cash flow and reduces to some extent the effect of inflation. I agree with this method

  • Brendan November 18, 2009, 3:31 pm

    My method is much the same. I will not buy a stock trading below it’s 5 year yield. I also place priority with a recent dividend increase. I consider it a safer purchase.
    I only watch a dozen or so. My criteria:

    1. Non cyclical with history of dividend growth.

    2. Higher than average yield.

    3. Recent dividend increase.

    4. Low payout and PE.

    5. “Reasonable” Graham price. I calculate and keep track of the graham price of a stock and rate them as a % of price difference

    I.E. 10 dollar graham price trading at 11 would be -10G/D% and if it were trading at 9 then it would be +10G/D%. Trading at 10 would be zero.

    If I have 2 stocks with all else being equal then I will buy the stock trading closer to its graham number.

  • sco November 18, 2009, 7:13 pm

    How did you chose your strategy? How do you know that historic dividend growth translates into future dividend growth? How do you know that your picking strategy is better than randomly picking stocks?
    The easiest way to test your strategy would be:
    – consider a historical period, let’s say 1995-2005. Pick the stocks at the end of 2005 according to your strategy
    – calculate the total returns of your stocks for 2006-2009 and compare with the returns of S&P TSX for the same period. You can also compare the standard deviations to get an idea about the risks.
    – if the return of your strategy is less than 5% more than the return of the S&P TSX, then the strategy has the same returns as a random strategy (gamble).
    The same testing should be applied to any investing strategy.

  • Brendan November 18, 2009, 7:26 pm

    Sco while there are no guarantees when investing there certainly are reasonable assurances.

    Past dividend growth does not mean future growth BUT I am reasonably assured that if a company can raise dividends for 40+ years they will continue to do so in the future.

    So long as the payout ratio is in check.

    Enjoy picking your stocs via dart board. I will stick to my dividends.

  • sco November 18, 2009, 8:08 pm

    Brendan,
    if you didn’t properly test your strategy, you are actually picking your stocks via dart boards.
    I am not. I always test any strategy before I apply it, including gambling-type strategies. The sad thing is that most published strategies don’t really work, and I suspect the strategies mentioned here don’t work either, if they haven’t been properly tested.

  • Brendan November 18, 2009, 8:34 pm

    I am most certainly not picking my stocks via dart board. Please read what I wrote and read what FT wrote/asked.

    What I do works. I buy stock for growing income. I have NEVER lost money (income).

    Read the single best investment by Lowell Miller. It outlines the dividend growth strategy and shows how it works. I am not gonna sit and argue with you.

  • Ms Save Money November 18, 2009, 8:36 pm

    @sco,

    I think the best way to pick a stock is knowing how popular the company is. If you use the products or know that the brand is popular – that’s a good indication the company is doing well (for those who are unsure of what stocks to pick); also keep them for long term – short sells don’t really work in these cases I think.

  • Ed Rempel November 20, 2009, 4:02 am

    Hi FT,

    Do you focus on Canadian dividends (for the preferred tax treatment), or the best companies anywhere in terms of yield and dividend growth?

    What do you do to avoid looking like a TSX index fund?

    Ed

  • Used Tires November 23, 2009, 10:54 pm

    Pretty awesome to read your strategy when it comes to buying Dividend Stocks, we’ve been learning in our Corporate finance class to do all the math and calculations when it comes to stock and determining the stock values based on the dividend that will be paid out, etc, pretty fun stuff =D

    Till then,

    Jean

  • cannon_fodder November 25, 2009, 6:52 pm

    I look at a couple of other criteria – payout ratio and overall return. If the payout ratio is too high for the industry (financials don’t have the same acceptable payout ratios as REITs for example which often go above 100%) then it is a no go.

    The comment about telcos is a great example for the 2nd criterion. There are a lot of telcos which have nice yields but lousy returns on the stock price itself. Look at Manitoba Telecom – yield is currently over 8% but the stock has a negative return in the last 1, 3 and 5 year periods. You are more likely going to see a dividend cut rather than an increase if the underlying stock price is going down.

  • Market Lessons November 26, 2009, 7:09 pm

    Well, I for one know that the Dividend Investment Strategy DOES work! But it takes time and patience, and of course good selection of the proper stocks that usually increase their dividends over time. In fact if you stay with the strategy long enough, your investment income will be beating the overall market returns over most years. And remember, this is actual income (money in pocket), not “just” capital gains which are always nice too. Most companies that increase their dividends will see an eventual increase in their stock price over time (buy and HOLD) as well. How many here have seen an increase in their portfolio’s income this past year? Mine did! By using this strategy faithfully you will get the same results. Learn and DO………………….

  • cashback cards December 23, 2009, 2:56 pm

    Would you suggest any free screeners for trying to find dividend? I know I have used yahoo’s before but there should be some other ones that are better.

    Also, what other factors beside the dividend can you look at to know that it’s a or at least has the potential for a dividend growth?

    Thanks for all that you do and share!

  • DogsFan January 5, 2010, 6:25 pm

    In my early twenties I built up my porfolio through DCA (monthly deductions off my pay-cheque) on an indexed mutual fund. Once I reached $25k (magic number for waiving discount brokerage fees) I converted the portfolio to TD WaterHouse. I am a firm believer in sticking with your strategy, not chasing the latest fad…so after careful consideration I chose the Dogs of the TSX approach…buying the 10 highest yielding stocks on the TSX 60, then selling them and re-balancing after one year (For some reason May 25th is that date).

    I do agree that the high yields are not sustainable, but that’s why you re-balance after one year. Typically these stocks (Dogs because they were “beat up” the previous year, thus leaving a bargain price and a high yield) have a run-up in price, which reduces the Yield and knocks them out of the top 10 the following year. Re-balance and repeat each year. One note, I did cheat this year and take 1 REIT (RioCan) and one Income Trust (Liquor World). There are several variations of this approach, one being to spread out your 10 selections amongst 10 sectors…which I like in theory, but there aren’t any real dividend payers in Health Care and some other sectors.

    Two negatives that I find are that you are heavily invested in finance and energy, and my trade fees of $29 are not so attractive…especially if I’m selling and re-buying 10 stocks each year. But once I hit $100k those fees will be reduced to $9. I suppose I could find a cheaper trading site, but I am a lazy investor.

    If you are interested in reading more about this approach, David Stanley has done tremendous research on the benefits of the Dogs strategy and how it has out-performed the TSX over the past 25 years.

  • cannon_fodder December 11, 2010, 4:14 am

    As a follow up to my post almost a year ago, look at Manitoba Telecom and notice it’s down almost 15% while XDV (a collection of dividend paying stocks traded as an ETF from Barclays) is up about 10%.

    In both cases dividends are excluded.

  • Jungle December 15, 2010, 2:33 am

    Just look at Manitoba telecoms EPS, does not even cover the dividend!
    They are waiting to be bought out, surprised its not happened yet.

    The company MUST be making a profit. If not you are speculating, not investing.

  • David December 10, 2012, 6:21 am

    Thanks for the article! I am quite new to investing and trying to test this strategy. Am I calculating the average dividend yield correctly?

    1) Average all historical closing prices for a year. I am obtaining my data from the historical prices at finance.yahoo.com. Should I pay any attention to the adjusted price?

    2) I then divide the annual dividend by the average share price for each year to obtain the average dividend yield for that year.

    3) lastly, I average all the calculated dividend yields of the last 5-10 years.

    • FrugalTrader FrugalTrader December 10, 2012, 9:20 am

      @David, a shortcut is to use ca.dividendinvestor.com which will give you a 5 year average. I sometimes use “bigcharts.com” which has “yield” as one of it’s indicators in “advanced charting”.

  • Interested August 21, 2014, 11:56 pm

    Thanks Frugal. If one is a new investor/Smith Manoeuvre investor, does this analysis apply? I.e. Should I be waiting for the right share price before I purchase or should I jump in? I want to get blue chip, dividend paying stocks. It seems to me that this is for those who have an established, growing portfolio, isn’t it? Thanks!

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