Building A Solid Dividend Growth Portfolio

Updated: Dec 10, 2021

Investors are always looking for the best way to grow their portfolios. If you have a long term time horizon in mind, utilizing a dividend growth investment portfolio strategy is a surefire way to build a massive portfolio that pays you large sums of income over time.

What is a dividend?

Dividends are a share of the earnings of a company that are returned to its share holders. These are most often paid out on a quarterly or sometimes monthly basis. Dividends are paid as cash and you have two options of how to use the proceeds. The first option is to have the cash paid directly into your account. You can use this cash however you wish; you earned it for holding the stock through the date the dividend was declared. Your second option is to automatically reinvest the dividend. This is also referred to as a DRIP. Taking advantage of this reinvestment option you are acquiring more shares of the stock, thus increasing your proportional holdings in the company, at no cost. If you own $10,000 in stock, and have 1000 shares at $10 each and the dividend rate is 5% you'll have $10,500 worth of the stock and 1050 shares at year end, even if the price never went up or down.

Why Dividend Stocks?

A recent study by Factset shows that dividend paying stocks outperform their non-paying counterparts by a dramatic amount. From 1991 through 2015, non-dividend paying stocks earned only +4.18% return per year while dividend paying stocks significantly outperformed with a +9.7% average annual return. Many people are always looking for the next growth stock that will yield huge returns, however individual stock picking for the next Amazon, Tesla, or Netflix, is extremely difficult to pull off for the average investor. Companies that pay dividends, particularly high or growing dividends, are well established and have a proven track record.

What is a Rising Dividend?

Rising dividends are one of the greatest financial windfalls an investor can experience who is seeking to build a long term portfolio that will create exponential growth over time. Companies have a balance sheet and they factor in dividend payouts to investors. The best companies pay a rising dividend, meaning they increase the dividend payout amounts over time. Some companies do it regularly, such as on a quarterly, or annual basis. All dividend raises need to be voted on and approved by their board of directors. When this occurs, investors win big. To put it in perspective, how often do you receive a raise at your job? Maybe once a year, but certainly not quarterly. Having this concept work for you will allow you to build a massive financial wall around yourself and your family.

What to look for...

When I evaluate a dividend stock as a candidate for my portfolio I am looking for a few key characteristics and metrics. Number one, I identify companies that have a history of paying a rising dividend. This is the most critical component of your dividend growth investment strategy. Second, I look at the dividend payout ratio of the company. This a crucial piece of information to evaluate. The dividend payout ratio is the total amount of dividends paid out relative to the net income of the company. The lower this number is the better. Third, I look at the dividend coverage ratio. The dividend coverage ratio illustrates the number of times a company could pay dividends to its common shareholders using its net income over a specified fiscal period, expressed as percent. The higher this number is the better. You can use the previous two metrics to calculate how much room a company has to raise dividends in the future. If the payout ratio is too high and the coverage ratio is too low, that's not a good long term prospect for now. Last, I look at the Free Cash Flow To Equity metrics. This tells me how much cash is available to pay shareholders after all the the expenses and debts are paid by the company.

How To Do Your Research

The first thing to look up is the dividend history of the company you are interested in. The fastest way to do this is to Google: (Ticker Symbol) Dividend History. Your search will yield a link that will take you to a Nasdaq chart that displays the date and the amount of every dividend payout from that company. Here is an example from Realty Income: Ticker Symbol "O."

This is a fantastic company that is a core holding in my dividend portfolio and continuously raises the dividend every quarter. In addition, this is a monthly dividend payer to my portfolio and an extremely reliable cash builder. At the time of this article, they have had 93 consecutive quarterly dividend raises, and 606 monthly dividend payouts through their history. Learn more about the company by clicking here: Realty Income.

Your broker will have research tools built into the platform where you can research the other notable metrics I mentioned. Here is an example of one of the richest companies in the entire stock universe, Apple. They continuously raise the dividend at a rate of 10%, or so each year. Compare that to your raises you receive at work and you'll truly understand the power of this investment strategy. Make a note of the dividend coverage ratio at a massive 451.83%, along with a dividend payout ratio of only 22%. These are the numbers I want to see as an investor, as they highlight the financial strength of the company to pay well-covered, rising dividends far out into the future.

Additional Tips and Tools

Once you have created your list of companies that fit your investing criteria based on your research, you can open small positions in your best picks. Since you are building a long term position, you don’t want to buy your largest chunk at once. Scale in over time and purchase more shares at a discount when the market decides to take a dip.

The most important part of this plan is your exit strategy from companies that violate the cardinal rule of dividend growth investing. If one of your holdings announces a cut of the dividend, sell out of your full position immediately and replace that stock with the next qualified company on your list that meets all the criteria as a candidate for your dividend growth investing strategy. A dividend cut is usually a sign of financial headwinds and you want to get out, at least temporarily, and continue to monitor their results over time. Only consider reinvesting again when they have returned to full financial strength and have shown a history that aligns with your investment criteria. This may or may not happen, so always have a backup list of companies handy for when a dividend cut occurs.

A very powerful tool you can utilize to predict your future dividend income is a dividend calculator. Plug in the numbers based on the stocks you own and are evaluating and run projections on the future cash that will pour into your portfolio over time. This is a very exciting thing to do, as you can conveniently calculate your future income down the line that you will earn as a result of compounding rising dividends year after year.

Here's the calculator I like to use:

Quick Example: Let's say you find a company you like and shares cost $10 per share. You buy 1000 shares for $10,000 and your never put any more money in again. You see that they have raised the divided every year by a rate of about 8-15%, but let's assume they only raise it by 8% for the next 20 years. Currently they are paying a 6% dividend to you. If they paid a dividend monthly, and we assumed a compounded dividend rate with 8% annual dividend increases for 20 years on your initial $10,000 investment, the results would be phenomenal.

You started with $10,000.00 and you'd end up with $186,081.16 for a total gain of 1,760.81%. This was over 20 years so that makes your average annual gain 88.04%. What if you had five or ten investments like that? What if you started with more money? What if they raised the dividend rate by 9 or 10% instead of 8%? You can play with the numbers yourself to see that if you have long term thinking in mind, then you will create true wealth if you implement this plan and have the discipline to follow it instead of chasing the fast money out there that is enticing to so many traders. Our goal is investing and we must think long term.

Last one, pretend we have the same scenario as above, but the company raises the dividend just 4% a year and we add ten more years of compounding. So with $10,000 initially invested, a 6% starting yield, a 4% annual dividend raise, and a 30 year hold period, the money you started with would grow to $315,543.85 for a total gain of 3,055.44%, making your average annual gain 101.85%.

The final thing I want to highlight is a method I use to consistently grow my dividends every year. Many people use portfolio performance percentage gains to calculate their success in the stock market. This is a good thing to track, however for a dividend growth investment strategy I track a different method for my success. The thing you want to track is your overall dividend income based on all your holdings and you want to focus on growing that amount year over year. For example, If you have $25,000 worth of stock in your portfolio and you're averaging 6% overall returns on all your dividend stocks, then you are earning $1500 per year in cash to your portfolio. That's pretty awesome, right? The next year, you will see dividend raises on your portfolio and maybe with a little rebalancing you can see an overall yield of 9% on your dividend income for the year. So with $26,500 and a yield of 9% you would see $2,385 worth of dividend income the next year! How much money do you need to cover all your expenses and pay your bills? If you follow this method, over time, you will build your portfolio to the point where your incoming cash is covering your expenses and you can begin to live on your portfolio income.

I hope I have given you something to consider and you now see the power of using a dividend growth investment strategy to build exponential gains in your portfolio over a long period of time. This is real, it works, and more people that want to invest on their own without the help of a professional should absolutely be doing this. This is the strategy that I have in place that is creating generational wealth for my family into the next century. Stop trading. Stop chasing the past gains in growth stocks that you missed and start your dividend portfolio today.

*This article and the information contained therein is for educational purposes only and is not intended to be investment advice.

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