The Best Investing Strategy?

Just about Financial Independence and Retire Early

The Best Investing Strategy?

Do you prefer stocks like Apple Inc. with a very low dividend yield of less than 1% but a seemingly continuous dividend increase or stocks like Occidental Petroleum Corporation (OXY) with a high dividend yield. The latter had to drastically reduce their dividends (to US$ 0.01) probably because they had not planned for a crisis accordingly. Also see Ford for another example.

If we leave out the capital gains, dividends are a good tool to get interests on your money. And at this low-interests times, we definitely don’t want a devaluation of our money. Both of the two examples from above are not ideal for this scenario. There is no continuity for OXY and the interests would be very low for Apple, so that the compound interest would not be considered acceptable.

So what should you look for if you want to invest in dividend yielding stocks? Here are a couple of indicators for quality payouts of dividends. These should be seen as set of rules that belong together. I will call those stocks satisfying the conditions Dividend Nobility tied to the German word Dividenden Adel that is coined in a German book by Christian W. Röhl.

You can think of the below criteria as a model similar to the RGB color model (but with four dimensions) where you do not want to lean towards any extreme and get a good mixture of all colors.

You can start with a set of shares. You can pick your favorite index and set it as the pool of stocks. After that you can filter through the following criteria.

Continuity

You know how there is always a friend that never pays the check when meeting him? On the other hand there is also a friend that always pays their debt. (For example, a Lannister always pays his debts.) Well, you definitely want the latter. So the first criterion is that the dividends increased or at least remained constant for the past 10 years. Depending on the region or your personal likes, this could also be 5 or 7 years.

Payout

You definitely don’t want your friend to be broke if he pays the bill, so you can split the bill. But you also don’t want him to be cheap. Paying out between 25% and 75% to the shareholders sounds reasonable. But instead of taking the payout ratio of the past year, we take it over the past three years. If a company has a single bad year for example and the payout is slightly higher (or lower), then this way would not result in a dropout. Of course, one could also adjust the range to 33% and 75%, which again depends on the personal goals/likings.

Return

As mentioned above, the yield should not be too low to get a good compound interest. Many times you find the yield to be the ratio of the dividend divided by the share price at the end of the year or at the time of the purchase. This might not be very representative, because you compare the dividend to the price on a single day. Also a slightly lower yield for one year shouldn’t be punished too hard. Therefore, we take the cumulative dividend yield of the past 5 years, which is ratio of the mean of the dividends by the mean of the share price of the past 5 years. This should be at least 1%. Now note that it is not the goal to maximize the dividend yield for a single year, but the total return in the long run.

Growth

Last but not least, we are interested in growing our wealth. For example, if a company increases its dividends by 15% each year for five years, then your income will double in that time. You want the last dividend payout to be higher than in the year before. This translates as the company being optimistic with regards to the future and speaks growth. Also you want a second raise within the last 5 years. (Or 3 raises in the past 7, or 10, or whatever you chose above at Continuity.)

Picks

Once you have filtered through the companies, you sort the remaining by the compound annual growth rate of the past 5 years, i.e. the (geometric) mean of the annual dividend growth rate. Remember that you want the mid/long-term growth. So why are we choosing with respect to the compound annual growth instead of the yield? Let’s say you have a return of 3% at the time you make your investment and the compound annual growth rate is at 10%. Then, after only 5 years you will get almost 5% return on your investment.

Finally, if you have a list of values you can then pick the top 10. But note, that you might want to skip a couple of companies for diversification, i.e. if you have two (or more) companies in the same industry, pick the higher rated one and skip the other. To see the best stock picks for Germany and Switzerland check out the blog post I wrote about the DividendenAdel index.

After a year it is then time to reevaluate to sell some of the stocks and buy corresponding new stocks that meet the criteria.

The Bottom Line

While I do not think there is such thing as the best investing strategy, it is better to have one than just cherry-picking your shares. It is important to stick to the strategy and to keep your feelings out of it.

Compared to tech values, dividend yielding stocks might not be the most interesting investment strategy out there. But over the long run, using time-tested investment strategies with these will achieve returns that are anything but boring.