I have received a number of emails and comments from new investors about how to construct a dividend portfolio and steps that someone should take. In this post, I will set out my thoughts about how I think about constructing a dividend growth portfolio.
Constructing a dividend portfolio is not a very difficult thing in my mind. It requires some basic research and due diligence to set up, some discipline to implement and follow the strategy and then ongoing monitoring to ensure suitable progress of the business you invest in. The key thing I try and look for is dividend growth rather than just dividend yield.
So where do you begin?
Large Cap dividend stocks
I believe that these should be the anchor points of the portfolio. Large cap growth stocks tend to have a solid dividend yield of at least 3% and a proven ability to grow this dividend over long periods of time, at a minimum of at least inflation if not higher.
The majority of my own portfolio is comprised largely of these stocks. They tend to have less volatility and steady and consistent growth. In fact, the total return from these dividend payers is generally comprised the initial yield that they pay plus the rate of increase in the dividend, according to The Ultimate Dividend Playbook.
The types of Large Cap Growth stocks that fall into this category are once such as McDonalds (MCD), The Coca-Cola Company (KO), Pepsi Co (PEP) .
If you are new to investing or just starting out with a dividend portfolio, you should likely source most if not all of your dividend income from these stocks.
Large cap growth stocks will be characterized by many years of dividend growth, good consistent increases in revenue growth, earnings growth and operating cash flow growth. They will also have sustainable competitive advantages which may be in the form of a strong, well recognized brand, solid intellectual property or some type of network effect.
International Dividend Stocks
For those that are feeling more comfort with their investing, it can be well worth your while to add some international dividend exposure to the mix. This can be valuable for a few reasons, particularly stronger economic growth overseas as well as favorable exchange rate consequences. Many economies overseas have been experiencing higher rates of growth than the US and the dividend growth from some of the dividend payers in these economies is indicative of that.
Also, many of the emerging economies will experience an appreciation of their exchange rate versus the USD over time as their economies grow and attract additional investment. So investing in an international dividend stock from an emerging economy can not only give you higher organic rates of dividend growth, but you will also be able to ride an exchange rate tailwind over the years.
There are a few considerations to keep in mind with international dividend stocks. They typically only pay dividends once or twice a year, in contrast to the quarterly schedule that you get with US stocks. Also the tax consequences can be a little messy, particularly if the country doesn’t have a tax treaty with the US.
Examples of stocks worth considering in this category are Novartis (NVS) and Westpac Bank (WBK).
Low Yield/High Growth Dividend Payers
While I prefer dividend stocks with higher dividend yields, it can be worth your while to look at slightly lower yielding dividend stocks with high rates of dividend growth, particularly if you have a long term horizon. Over time, these stocks will rapidly increase their dividend income paid by virtue of the rapid growth they experience.
Visa (V) is one of the stocks that I hold in my portfolio that fits into this category. While its current yield is much lower than I would ordinarily prefer, the fact that Visa has been growing its dividend so rapidly, and will likely continue to do so into the future makes this stock an interesting one for me to continue to hold.
Mid Cap and Small Cap Dividend Payers
Dividends from this category of stocks, while probably the most risky, can get you the highest rates of dividend growth over an extended period of time. I tend to have a little more difficulty finding these types of dividend payers in the US. The Australian market tends to have many mid cap and small cap dividend payers that pay a reasonable dividend yield and then show consistent ability to grow that dividend at rates exceeding 15-20% over an extended period of time.
It takes time to unearth quality companies that fall into this space, but doing so can be very rewarding. One company in this category that I have a recently initiated an investment in is a company called Quality Systems (QSII) that I feel could provide reasonable long term dividend growth.
I don’t suggest new investors look too long at mid/small cap dividend payers, as one can do just fine focussing on large cap dividend growth stocks that have consistently increased their dividends over many years, have strong competitive advantages, and will likely increase their dividends for many more years to come.
If you are looking to at some stronger growth for your dividend income, then looking at dividend payers in this category can certainly be worth your while.
What are your thoughts on constructing a dividend portfolio? Have you considered looking outside large cap US dividend stocks?