The Dividend Growth Model

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One of the ways that you can screen for a good dividend stock pick is to make use of the dividend growth model. You can calculate what the value of the stock should be, based on its dividend, to provide you with the return that you need to make it worth the purchase.

Calculating Stock Valuation Based on Dividend Growth

This stock valuation model takes a look at divided growth and uses it to help you decide whether or not the investment is a good buy. The formula use is based on three factors:

  1. Current dividend (per-share – full year dividend pay out)
  2. Growth of the dividend (per year – the five year dividend growth can give you a good idea)
  3. Required rate of return: What you “need” the investment to return in order for you to think it worth it to purchase the stock.

Once you know that information, you can plug it into the following formula:

(current dividend x (1 + dividend growth)) / (required return – dividend growth)

Dividend Stocks Online has handy lists that show you current dividend yield, and other information about yield growth. So, for our example, we’ll use Verizon (VZ). According to The Motley Fool, VZ is on track for a full year pay out of $1.95 per share. DSO puts the five-year annual dividend growth at 3.51%. Now, let’s say that I would need 10% for a required rate of return. As of Friday, May 27, 2011, VZ has closed at $36.67.

It’s time to plug in some numbers, and hope that I can still do junior high school math with a calculator:

  1. Current dividend = 1.95
  2. Growth of dividend = 0.0351
  3. Required rate of return = 0.1

(1.95 + (1 + 0.0351))/(0.1 – 0.0351) = 1.9851/0.0649 = $30.59

Basically, this model means that this stock should be at $30.59 in order for me to get a 10% annual return, based on its dividend growth.  It is also worth noting that this model could also be interpreted as an indication that VZ is currently overvalued, since it seems to indicate that VZ has a price higher than its valuation.

Problems with the Dividend Growth Model

There are weaknesses in almost any model, and this one is no different. Dividends do not always remain the same; they can be cut. Dividend growth is not going to remain constant, and this model assumes constant growth in perpetuity. In addition to looking at the dividend growth model of stock valuation, consider a few other factors when making a decision:

  • History of regularly dividend increases (dividend aristocrats are those that have raised dividends every year for 25 years)
  • Business model of the company
  • A dividend adequately covered by earnings

There is no way to completely predict what any investment will do. However, you can do a little research, and choose stocks that show good promise going forward.

Roundup: Better Investing

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There are a number of ways to become a better investor. It can help to read a little bit, and get ideas from others. Some investing blogs provide a wealth of helpful ideas on becoming a better investor. Here are some hints from around the blogosphere:

  1. Investment Advice From an Unusual Source: When looking for solid investment advice, you have to be willing to keep your eyes open. Dividend Partisan offers a look at how you can learn from even the unlikeliest of sources. The key is to always be willing to learn.
  2. Why Do We Think We Are So Good A Investors?: Before you can be successful, you need to honestly evaluate your investment ability. The Dividend Guy looks at the emotions behind how we perceive ourselves as investors.
  3. Step 6: Start Small: As you begin investing, you might not want to take on more than you can handle. Indeed, the Dividend Monk encourages you to start small. This is a great article and part of a series on building a successful dividend portfolio.
  4. How to buy your first index trackers: Ready to get started with index tracking? Monevator provides you with a helpful guide. After you read this post, you will be ready to get start; it’s even a good refresher for the seasoned investor.
  5. Investing For Income: A basic look at how you can invest for income. Buy Like Buffett breaks it down and gives you an overview of your options for building an income portfolio.
  6. Valuation-Informed Indexing #43: The Most Important Number in Stock Investing: As you figure out which numbers to pay attention to as you invest, it’s important to keep a few basics in mind. ValueWalk takes a look at long-term market timing. It’s an interesting concept that can help you over the long haul.
  7. Vanguard Wellington: Is it a Good Fund?: Using an example from real life, Oblivious Investor illustrates how to evaluate a fund. This is a great resource that can help you evaluate future purchases.

Roundup: Investment Picks

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Sometimes, it’s nice to know what others are choosing in terms of investments. Many great investment bloggers have some ideas of what’s coming. Here are a few of their ideas about what might make a good investment, and some of the issues surrounding popular investments:

  1. 5 Tech Titans Suitable for Every Income Investors Portfolio: The Dividend Pig offers a look at a few tech titans that can help you income portfolio. As you build your income portfolio, consider the options and think about adding these tech giants.
  2. Top 20 Dividend Stocks – May 2011 Edition: The Passive Income Earner lists the top 20 dividend stocks. Arranged by technical screening and by yield, you can get a good look at some great investing ideas.
  3. It’s Time To Buy Hewlett Packard: Buy Like Buffett thinks that now is the time to buy HP. An analysis of quarterly results and other factors is presented. Read the post, and see if you agree.
  4. Novartis (NVS) Dividend Stock Analysis: Dividend Monk takes a look at Novartis. Do you agree that it is an attractive investment. Read through the analysis, and see if you think you want to add NVS to your portfolio.
  5. Weekend reading: Grab those index-linked certificates: This great roundup from Monevator offers some investing ideas in the form of NS&I certificates. They might be just the thing you need.
  6. Will Oil & Gas Stocks Rise Again?: Beating The Index takes a look at oil and gas stocks. Before you buy energy stocks, it’s a good idea to consider what you think will happen next. This analysis looks at the market, energy and what could be around the corner.
  7. The College Education Bubble: The say that education is an investment. However, Expected Returns takes a look at this investment, and wonders about the education bubble. What happens when it bursts?

Building Your Income Portfolio: Showing Patience

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As I’ve started putting together an income portfolio that includes dividend stocks, I sometimes find myself feeling discouraged about the income that I receive. This frustration was further underscored when someone I know said that dividend stocks were a waste of time. “Getting 2 cents a quarter? What kind of income is that?” she scoffed. (Incidentally, she and her husband both plan to work for 30 more years in jobs they don’t particularly enjoy, relying on 401ks. This helped me get beyond her sneering remark.)

However, as I’ve kept with it, I’m becoming less frustrated. Sure, if you buy a few shares of a dividend stock, and then let it just sit there, you will never end up with anything approaching a stable income. A successful income portfolio often requires time to build up. Many of us don’t have the capital necessary to invest in dividend stocks and then enjoy a decent income.

Patience as Your Income Portfolio Grows

If you want success in your income investing efforts, you have to show patience. A portfolio needs to be built over time. Choose the investments you want in your portfolio, and then buy shares regularly in order to build it up. The more shares you have of a company, the greater your dividend will be when it is paid. Looking at statements, and watch my dividend rise, has been a great motivator.

Of course, you do need a plan. Right now, my income portfolio is growing rather slowly. This is because we have other obligations right now. However, it’s not as important to us to see big leaps and bounds in our dividend income. This is because we have a longer timeframe. I have my own home business, and my husband just finished his Ph.D. Up until this point, we have been expecting that our built up portfolio won’t need to provide substantial income for at least 15 more years. Now that my husband is done, though, we can start thinking about increasing what we put in, allowing us to speed up our timetable if we wish.

If you want income from your dividend stocks more immediately, you will have to increase what you put in now. Sit down and do the math. Decide if you can put more into building up your income portfolio now so that in five to 10 years you will be able to pay certain expenses with your dividend income.

Without a realistic plan, and a little patience, it can be tempting to just give up on your efforts to build an income portfolio. However, if you focus on the essentials, and stick with a good plan, you might be surprised at what you can accomplish.

Roundup: Strategy Session

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Every now and then, you need a strategy session as you assess your portfolio. The good news is that there are plenty of great bloggers out there that can offer some insights into strategies and how to use different dividend stocks. Have a look at what’s been going on in the blogosphere:

  1. ETF risk – a personal action plan: If you are interested in ETFs, it is a good idea to double check your strategy. There remains risk, and you need to be aware of it. The Accumulator at Monevator offers you ideas for a personal action plan to help limit your risk.
  2. Assessing Your Risk Tolerance: Need and Ability: As you put together your portfolio, you need to be aware of your risk tolerance. Mike, at Oblivious Investor, provides an overview of these two aspects of risk tolerance. A great primer.
  3. Book Review: The Ivy Portfolio: If you are looking for a great read, you might consider this book, reviewed by The Aleph Blog. The book offers a look at how you can invest like endowments do in order to limit your exposure to bear markets.
  4. RSI — Overbought, Oversold, or Overplayed?: Sometimes you have to ask yourself some tough questions about a particular investment. Kenny at the Market Club Trader’s Blog allows a guest post to analyze RSI. The illustration can be applied to other investments.
  5. Star of the Day – Rovi (ROVI): Get an idea of why ROVI might be a great addition to your portfolio. TraderMark at Fund My Mutual Fund goes through some of the pros and cons of this stock.
  6. Third Point Adds To Xerium Technologies (XRM) Position: Do you want to learn from fund managers? Market Folly offers a look at one of the latest additions to Dan Loeb’s fund. A look at the move, and resources to help you manage your own fund.
  7. How Microsoft Caused the DotCom Bubble and why their Skype ‘Hail Mary’ is irrelevant: Everyone seems to be talking about Microsoft and Skype. Barry Ritholtz at The Big Picture takes us through the deal — and why it may not matter.

3 Times to Consider Selling a Dividend Stock

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Many of us invest in dividend stocks for the long haul. We expect that we will hang on to the stock, either enjoying regular income from the payouts, or using DRIPs to help build up nest eggs for the future. Few of us think about selling our dividend stocks. However, at times, it is prudent to consider selling your dividend stocks. Here are 3 times when you might consider selling a dividend stock:

1. The Company Cuts Its Dividend – Or Eliminates It

One of the most obvious reasons to sell a dividend stock is if the payout is cut, or eliminated. After all, the point of owning a dividend stock is to receive the regular payouts. When a company cuts its dividend, it means things are going poorly. When a company gets rid of a dividend, it could mean something even direr, and be an indication that you should sell – and get what you can.

Of course, in some cases, the cut might be relatively small, and in response to the economic situation. If a dividend is cut in such circumstances, it might not be a bad thing to see if dividends recover as the economy does. However, if other companies in the sector are raising dividends again, and your stock is left in the dust, perhaps it’s more than just the recession holding the company back.

Also, watch out if the annual yield drops below 1%. That could be a warning sign that it’s time to sell.

2. Your Position is in the Stock is Down Significantly

While many dividend investors don’t worry much about the fluctuations in the stock when they are small, matters can become worrisome if a bigger drop is seen. Day to day, and even month to month, the stock market can be quite volatile. However, if you see a huge drop – perhaps by half or more – it might be time to move on. Even though you invest in dividend stocks for the payouts, you also have to think of your initial capital and your investment. If you are taking a beating that will take you too long to recover from, you might need to sell. Besides, with that kind of drop, a dividend cut probably isn’t too far behind.

3. The Company Changes Management or Ownership

This isn’t always a bad thing. But if it appears that there will be changes made in management or ownership, and you are unsure about the results, it might be time to sell. You might not have a high opinion of the company doing the buying, and that might be an indication that it is time to sell. And, of course, if the sale results in the company going private, dividends are likely to be non-existent anyway. Carefully consider your options in such a situation, and decide what would be prudent for you.

Roundup: Life Beyond Dividend Stocks

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Sometimes, the things that worry us, and what is going on in the larger economy, can have an impact on the way we invest — and the level of success we see with our investments. This week, some of the dividend investing blogs looked at what’s going on beyond the world of dividend stocks:

  1. Big Miss in ISM Non-Manufacturing at 52.8: TraderMark at Fund My Mutual Fund looks at today’s big disappointing economic news. With the ISM lower than expected, concerns about economic recovery — and the ability of the U.S. to outgrow its deficit — are on the rise again.
  2. Weekend Edition: Markets Hate Uncertainty: Before sharing a roundup, Beating The Index offers a great look at the uncertainty that may be coming. A look at recent disappointments in Canada and the U.S. shows that the markets may be unhappy soon.
  3. Make Sure You Aren’t Falling Behind: Andrew Hallam, The Millionaire Teacher, offers a look at where you should be with your portfolio. Are you falling behind?
  4. The New Reality: Retirement Planning For Your Children: It’s not always about you. Mark at Buy Like Buffett offers a look at retirement planning will be like for your children. Are you — and your children — ready for what’s coming?
  5. Bye bye Gilles Duceppe! Héléne Laverdiére NDP wins Laurier/Ste-Marie: Sunny at The Dividend Girl gets excited about the possible demise of Bloc Québécois in Canada. Whose in power can influence economic policy, after all.
  6. Holding Our Leaders Accountable: Over at Expected Returns, the case for holding leaders accountable is made. Looking at the debt ceiling in the U.S., and considering what is going on, there does seem to be a need for some level of accountability.
  7. Things That Worry Me: The College Investor has a lot to think about. Some of the things that are worrisome for that blogger, though, should be worrisome for you. What are some of your concerns for the economy?

Use Dividend Funds to Build Your Portfolio

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There are a number of people out there who like investing in funds. I’m one of them. I’m a big fan of index funds and ETFs. And, as I learn more about dividend investing, I have been excited to discover that there are dividend funds. You can find index funds and ETFs comprised of dividend stocks, providing you with a way to build your portfolio while enjoying income in the form of dividend payouts.

Funds: Instant Diversity and Income

One of the reasons that funds are so popular amongst some investors is that they provide almost instant diversity (if you pay attention to the investments in the funds and choose funds accordingly), and there is a certain expectation of better-managed risk with many funds.

If you combine an index fund or an ETF with dividends, then you have a dream from many investors who are somewhat cautious about the whole investing thing. Dividend funds are composed of investments that offer regular payouts. There are high dividend funds, funds comprising dividend aristocrats, and other specializations. Chances are, there is a dividend fund out there to designed to help you reach your goals.

And, of course, you can use your dividend fund as a source of income, or as a way to boost your portfolio building efforts. You can usually choose to receive regular payments from the fund, providing you with a regular stream of income, or you can decide to have those funds automatically reinvested. Reinvested dividends buy you more shares, helping you build future wealth a little bit faster.

Choosing Dividend Funds

If you decide that dividend funds are the way to go, you will need to choose which to include in your portfolio. When choosing dividend funds, one of the most important things to consider is the cost of fees. Many investors like index funds and ETFs because the have low costs. Additionally, you should find out what stocks are in the fund. Make sure that the stocks in the fund are in line with your goals. If your goal is diversity, choosing a sector fund may not help you reach that goal.

A number of brokers provide access to dividend funds. If you already have a broker, you can look through the dividend fund options, or perhaps open another account if someone else has what you are looking for. In many cases, you can use dollar cost averaging to get started, gradually building your portfolio. Whatever you decide, you might discover that dividend funds provide just what you need.

800 Dividends Started But Only 100 Remain

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A few days ago we built and published our new dividend lists for May. We started out with dividend stocks that met our criteria of a dividend yield of 2.9% or higher and removed any stocks that had a negative dividend growth rate. The result was just over 800 stocks.

From there we rate each dividend stock based on it’s yield, dividend growth rate, net income growth rate, payout ratio and one year return. Based on that criteria we are able to filter the list down to the top 100 dividend stocks.

Safe Dividend List

Stocks that make the safe dividend list get a few extra points in their rating because they have been raising their dividend for 25 years or more. There are 28 stocks on the safe dividend list that are rated 90 points or higher by our standards. 10 of these have a dividend yield of 3% or more.

Past Performance

Our dividend lists are based on past performance and not an indication of how any stock will perform in the future. Here are a few statistical averages for stocks on the most popular lists.

Top 100 Dividend Stocks (more)
Average Yield: 4.79%
Average 5 Year Dividend Growth Rate: 14.11%
Average 1 Year Return: 22.73%

Safe Dividend List (more)
Average Yield: 2.64%
Average 5 Year Dividend Growth Rate: 13.1%
Average 1 Year Return: 18.36%

High Growth List (more)
Average Yield: 5.9%
Average 5 Year Dividend Growth Rate: 27.42%
Average 1 Year Return: 22.85%

View all of the top dividend data here. Members can logon here . To become a member join here: Top Dividend Stocks.