Having a sweet spot of where I’d like to purchase my dividend stocks is very helpful to me. I have a target zone of dividend yield and dividend growth that I ideally look for when making purchases. I call this my “Dividend Zone”.
My ideal sweet spot for dividend investing is an area where I can have an initial starting yield of between 2.75%-5%, with dividend growth of anywhere from 10-15%. This criterion helps ensure a healthy initial yield, and rapidly growing dividend income over the long term.
I view the total return of dividend stocks as being comprised of initial yield plus long term dividend growth. I should be able to earn a total long term return of at least 13% per annum if I am able to find any stocks that fall into my Dividend Zone sweet spot. Certain types of Dividend Payers have a higher likelihood of falling within my Dividend Zone than others, just given the yield and growth characteristics that I am looking for.
These are the big, slow moving companies that tend to pay large, inviting dividends, but typically only offer dividend growth of 2-3% per year. The large initial dividend yields are what tend to get investors excited in these types of companies. Getting a 5-6% dividend return per year from a fairly stable business such as an ATT or Verizon is a pretty attractive proposition versus cents on the dollar from government bonds.
Dividend Sloths unfortunately provide dividend growth that is typically too low to fall within the Dividend Zone. While the yield is tempting, dividend growth is too low to be compelling.
If you consider the combination of Dividend Yield and Dividend Growth as providing total return, a Dividend Sloth typically falls way to short of being able to make the numbers work to get anywhere near total returns in the low teens. With a 4-5% initial yield, plus dividend growth of just 2-3%, that will typically leave you well under a 10% total return.
The big exception is where there is either stock specific or general market panic that happens to send the stock price tumbling. In such a situation, your 4-5% can occasionally jump to 10% +. Thats a situation I experienced with my purchase of Telstra.
This can help make your Dividend Sloth a buy, and get you low double digit returns.
These companies pay smaller initial dividends than the large cap slow growers, but their dividend growth tends to be much better. While they tend not to be regulated entities, the fact that they have been growing dividends at significantly above the rates of GDP growth mean that these companies have pretty strong barriers to entry.
You can typically find dividends with a starting yield of 2.5-3.5% and dividend growth near 10% p.a. It takes a while to generate reasonable dividend income from these companies, but over the medium term, dividend growth really kicks in to take the dividend income to the next level.
Most Dividend Classic payers typically meet the required initial yield to put them in my Dividend Zone, but sometimes, dividend growth falls a little short, being slightly less than 10%. Periodically though, you’ll find market mispricing that puts Dividend Classic payers into the Dividend Zone.
Consider McDonalds. The stock currently provides a yield above 3%, with dividend growth greater than 10% over the last 5 years. That puts McDonalds squarely within my Dividend Zone. That’s the reason I’ve been buying recently.
My experience with buying Dividend Classic payers is that they almost always experience a period of very strong capital growth after they fall within my Dividend Zone. This is particularly for so for those companies with a strong moat and a wide business model.
When Dividend Classics happen to show up in my Dividend Zone, I don’t waste any time accumulating them.
My purchase of Western Union earlier in the year was done when it happened to be squarely within my Dividend Zone (3.5% yield, with dividend gr0wth exceeding 10% annually). Needless to say, that didn’t last long, the stock is up greater than 30% and is now outside my Dividend Zone.
These stocks tend to be well established businesses, still in a high growth phase as far as revenue and earnings growth are concerned, but which typically don’t pay out much in the way of dividends because they are reinvesting their earnings back into the business going after these growth opportunities.
The dividend characteristics of these companies are payouts that are less than 2% initial yield, but which can provide in excess of 10% pa dividend growth
While Dividend Upstarts provide strong dividend growth, the challenge typically is getting a large enough initial yield to make them worthy of consideration. Thus picking up these stocks during times of market correction can turn a small initial yield into something that’s significant enough to make it fall within the Dividend Zone.
Given present bullish market conditions, there have not been any Dividend Upstarts that have found their way onto my Dividend Zone in recent times.
These are the small cap or mid cap companies that are still fairly immature in terms of growth and business model but hold the greatest potential in terms of long term dividend growth and capital appreciation. Given their relative immaturity, they come with the highest risk, but offer significant potential reward.
Hidden Gems typically have very strong dividend growth, but may not offer a high enough initial yield. As Hidden Gems become more widely, they tend to get “bid up” and the initial yield on offer goes down. Lesser know Hidden Gems can offer an attractive combination of initial dividend yield and growth that puts them within the Dividend Zone.
The Female Health Company (FHCO) is one such candidate that I own that falls within my Dividend Zone today. With an initial dividend yield of close to 3%, FHCO has provided an average dividend growth of close to 20% in the last 3 years of paying a dividend, putting it squarely into my Dividend Zone.
While I generally try to accumulate candidates for my Dividend Machine within my Dividend Zone, its not always possible to accumulate stocks in this range all the time, so this represents more of a guide for me.
Having said that, fueling your Dividend Machine with high quality purchases made within the Dividend Zone will be a good way to ensure a solid growing dividend income and long term total return.
More importantly, sticking to your own target Dividend Zone can help you see opportunities when they arise and make sure that your purchase of quality Dividend stocks is done in a disciplined way.