When you decide that dividend investing will become the core of your portfolio this is usually because you are looking to cash dividend payments. The idea of receiving monthly checks while doing nothing is attractive. But not all dividend payouts are equal and the yield seems to preoccupy many investors. In fact, the dividend yield is often at the center of many DGI’s.
Why is the yield so important?
A relatively high dividend yield is mandatory for many investors. Many companies offering a smaller yield tend to be ignored by dividend investors. This is mainly because many investors are looking to cash their dividend as a form of income. Touching their capital is a “no go” and they rather invest in higher dividend paying stocks than catching smaller fishes.
For example, if you are looking for a $3,000 monthly income, you will need $1,200,000 generating 3% yield. If you invest your money in different stocks and your average yield is 4%, then your minimum capital requirement drops to $900,000. We are not talking about pocket money here.
Another reason explains why the yield is so important. Many investors are also looking at reinvesting their dividend and aim at beating inflation. Therefore, a 1.75% yield will not make the cut if we expect a 2.00%-2.25% inflation. Even with a 10% dividend growth, it will take a couple of years before you reach the inflation rate!
The highest yield possible with the lowest risk
In an ideal world, we would all invest in companies paying 5% yield and showing a steady 5%-10% dividend growth rate. Unfortunately, this plan looks more like a fantasy than an investing strategy. On May 26th, I’ve pulled a search looking for all 5%+ dividend yield stocks showing a dividend growth history of 5%+ over the past 5 years. You will not be surprised if I tell you I found 82 U.S. companies and 45 Canadian ones. You will tell me this is isn’t too bad? If I only add one metric (which is dividend growth positive over the past 12 months), the number of companies goes down to 50 U.S. and 17 Canadian. This doesn’t leave you with much options when you want to build a strong and diversified portfolio.
Since finding the golden hen is nearly impossible, we all have to turn around and review our yield expectation. To be honest, I’m not that greedy and I don’t look at companies paying over 5% yield…
What is my minimal acceptable yield then?
When I started investing in dividend stocks back in 2010, my minimum yield in most of my screeners was 3%. I expected to beat the inflation and 3% seems logical. I also have to mention that after the 2008 crash, most stocks haven’t had the time to recover fully in 2010 and many great companies were showing very interesting yield. Then over the years, I got tempted by companies paying smaller yield. I started to look at stock closed to 3% (e.g. 2.50%+) and eventually got down to consider companies paying as low as 1.50%. I now could say that my minimal acceptable yield is 1.50%. The reason why I accepted to purchase shares of lower yielding companies is because I found many gems in this territory.
Companies like Canadian National (CNR.TO), Apple (AAPL) and Disney (DIS) are not only at the center of my portfolio, they are also responsible for a good part of my total returns over the past 5 years. I had to sacrifice 1% or 2% in yield to find companies that went up over 100% (Apple and Disney) in a short period of time. I think this is the time of sacrifice I’m willing to make in the future! This leads me to my final point…
Why not going for Dividend Growth rate instead?
When selecting low yielding companies, it doesn’t mean that their yield must remain low forever. Many low yielding companies shows high single digit or even double digit dividend growth over the past 5 years. When a company is able to raise their payment that fast, it’s often because it is showing growing revenues and profit. When you select companies that shows the perfect dividend triangle, you are almost certain of making both capital appreciation and dividend growth in the future.
I’m not going to live from my dividend for another 30 years probably. You may say that it influences my perception on low yielding companies. But the things is that I also consider withdrawing a part of my capital to generate a sufficient income. In this case, I’m better with the strongest stocks period, not only the strongest yield.
I’m curious to know about your strategy, do you have a minimum acceptable yield?