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I used to struggle with the same issues millions of small investors deal with on a daily basis. Which stocks to buy? When to sell them? How to find the time to manage my portfolio? How to diversify? I wasn’t into dividend investing until looking at my portfolio returns in depth to realize I was having difficulty keeping up the with the market.  The root of the problem was a very poorly built portfolio that lacked structure and the components required to build a sturdy base.  I made good money from the stock market but I was taking unnecessary risk to achieve my investing goals.  From that point on, I was determined to create a portfolio strategy that would allow me to benefit from dividend growth stocks as a solid foundation.

I’m not exactly following the buy & hold strategy recommended by many dividend investors. I like to build a core portfolio of stocks I would probably never sell but I also like trading a few more stocks in and out to make a healthy profit. Imagine if you could still invest actively in individual stocks while building a rock solid portfolio.  Imagine if you could use the fundamental principles of investing without getting bored or having to read hundreds of pages of stock research.

Dividend Stocks Rock (DSR) follows the same dividend growth model I use to manage my own portfolio. I didn’t come up with these investing rules out of the blue. Each rule has been written after these four years of trading dividend stocks, reading through many financial research publications and listening to top investors and portfolio managers’ wisdom.

Principle #3: A Dividend Payment Today is Good, A Dividend Guaranteed For the Next 10 Years is Better

The first question that comes to mind as an investor is: why choose dividend investing over all the other investing strategies used by investors? In 2011, Ridgeworth Investments highlighted the main benefits of dividend investing:

Corporate Finance Health. The dividend evolution of a company is a transparent image of the company’s ability to generate wealth for its investors over time. Dividend growth is a direct translation of management’s confidence in the company’s future.

Significant Source of Total Return. From 1926 to 2011 Dividend paying stocks are responsible for over 43% of the S&P 500 returns (source JP Morgan Asset Management). Therefore, almost half of your total return is found in dividend payments.

Important Impact on Stock Returns. Research has proven the impact of a dividend announcement. On average, a dividend increase pushes the stock higher by 2% (Aharony and Swary,1980), a dividend initiation increases the stock value by over 2% (Michaely, Thaler & Womack, 1995) and a dividend cut decreases the stock value by 9.5% (Healy and Palepu, 1988).

Lower Relative Volatility. Have you ever heard of the expression “getting paid to wait”. During bearish markets, dividends are like a buffer to your portfolio valuation. While the value of your stocks fluctuate, you still receive your dividend payout which reduces your portfolio volatile.

Higher Returns Regardless of Interest Rate Movements. Bonds holders think they hold safe securities until the day the FED raises its interest rate. Then, they realize bond values can drop as fast as a stock in a market crash. With interest rates at their lowest, dividend stocks become a great solution for income dependent investors.

Okay, now you know why to look for dividend paying stocks. But which kind of dividends should you aim for? High yield? What about Dividend Growth? Which kind of payout ratio is reasonable? Here are my answers to these questions.

Some investors look for the highest dividend yield possible. Did you know that the highest dividend yield stocks underperform more “reasonable” yielding stocks? The Hartford Mutual Funds company wrote:

“The study found that stocks offering the highest level of dividend payouts have not performed as well as those that pay high, but not the very highest, levels of dividends.”

Following this principle, I usually aim for dividend yields over 2.50% but under 5%. During a bullish market, I’ll even start being cautious with stocks paying over 4% in dividend yield. I’ve done my own research and even built a case against high dividend yield.

Beyond dividend yield, there is dividend growth. To be honest, the dividend yield doesn’t matter to me. I even picked stocks with yield as low as 1% (Disney:DIS) for example. What really caught my attention is management’s will to increase this payout year after year. Here’s an interesting quote from Saturna Capital:

“Indeed, dividend growth has been a much larger determinant of equity returns in this new era of low benchmark rates and higher levels of uncertainty.”

At DSR, we look at dividend growth over 5 and 3 years. We ensure both metrics are positive to ensure that management is dedicated to return more wealth to investors over time. This is also a great indicator of management’s confidence in the company’s future. In addition to including dividend growth stocks in our DSR portfolios, we also provide a list of Pure Dividend Growth stocks updated weekly.

Since 2009, companies have been very careful managing their payout ratios. The dividend payout ratio tells you what percentage of the earnings per share (EPS) is used to pay the dividend. In an ideal world, the dividend payout grows at the same rate as the EPS in order to keep the same payout ratio. We can see that recently, companies have grown their EPS faster than their payouts:

Dividend Payout Ratio of Stocks in S&P 500 Index 30-Year Average vs. 2014, period ended June 30, 2014

Source: Compustat via FactSet. Indexes are unmanaged, and one cannot invest directly in an index. Past performance does not guarantee future results.

This graph shows us there is plenty of space for more dividend increases in the future if you select the right stock. Companies included in our portfolios… Read more…