A Dividend Strategy
There are many ways to obtain a return on an investment, the most obvious to a great majority of investors is to buy, hold and then sell at a higher price. To others, a smaller group, it is to buy, hold and collect dividends. To the investor seeking income, we recommend a combination of both methods.
Whether to be concerned about dividends at all can be debated. Gerald Loeb, a well known broker and trader, and the author of The Battle for Investment Survival has stated that it is futile to try any method other than to strive for large price gains. Loeb called the "income ideas" a self-deception.
Jeremy Siegel, a Professor at the Wharton School, and the author of Stocks for the Long Run, says investors are missing out by looking for high growth companies instead of high dividend paying companies. Given enough time high dividend stocks will always outperform high growth stocks. He cites an example of where IBM, one of the greatest growth stocks of all time, was outperformed by Standard Oil (now Exxon-Mobil XOM), a steady stock that paid good dividends. He also notes that his statistics did not include the recent era of high oil prices.
The strategy to take advantage of high dividends is to create a method that not only pays a good income, but also a growing income. Here is a possible method:
1. Select dividend stocks using the same procedure that is presented in the article "How to Determine when a Stock is a Strong Buy.". Dividend stocks are usually more expensive than non-dividend paying stocks, so the foward P/E may have to be increased to 12 or 14 to find enough candidates.
2. Seek stocks of companies that have a good chance of increasing in price as well as paying a steady dividend. Seek a resonable dividend, because companies that have very high dividends are usually in some sort of trouble and are probably preparing to cut dividends or eliminate them completely.
3. Hold the stock until the price goes up about 10% then sell enough of the stock to return all of your investment including commisions. The stock that is left will continue to pay dividends. The investment that is returned can be placed in another dividend paying stock and the same cycle is repeated. If the stock that is sold is still a good buy, perhaps a few weeks later, then buy the same stock again. (See Below)
4. This is a slow process and must be monitored at least once a month when account statements are available. Quarterly dividend totals should be entered into a column and checked to make sure they are always increasing. Better yet, enter amounts on a graph.
5. Also, if dividends are not withdrawn, then more stock can be bought with the dividends.
To find the stocks that might be considered for investments, a stock screen can be used, perhaps screening for all stocks paying 5% or more dividends. There are lots of places to look. REIT's, Business Investment Companies (BIC's) and Oil Trusts must pay out most of their earnings to keep a tax-exempt status. Tele-communications, tobacco, and ocean shipping companies have traditionally paid dividends well above any rate that can be obtained from money market accounts or C. D's.
Here is an actual example of this strategy from our broker's statements. This is how we accumulated 109 shares of Horizon Lines (HRZ) for one of our clients. Horizon was yielding about 8% at this time. Read from the bottom and move up to see the sequence from where we started on 7/17/2008.
Date Symbol Description Commission Amount 7/27/2009 HRZ SOLD 78 SHARES OF HRZ AT $5.06 ($7.02) $387.66 6/19/2009 HRZ BOUGHT 100 SHARES OF HRZ AT $3.8099 ($7.00) ($387.99) 5/6/2009 HRZ SOLD 65 SHARES OF HRZ AT $5.77 ($7.01) $368.04 3/27/2009 HRZ BOUGHT 100 SHARES OF HRZ AT $3.59 ($7.00) ($366.00) 2/10/2009 HRZ SOLD 70 SHARES OF HRZ AT $4.03 ($7.01) $275.09 1/23/2009 HRZ BOUGHT 100 SHARES OF HRZ AT $2.6899 ($7.00) ($275.99) 7/30/2008 HRZ SOLD 20 SHARES OF HRZ AT $11.845 ($7.01) $229.89 7/30/2008 HRZ SOLD 58 SHARES OF HRZ AT $11.83 ($0.01) $686.13 7/17/2008 HRZ BOUGHT 100 SHARES OF HRZ AT $9.0099 ($7.00) ($907.99)
About $18 of dividends were paid during this period.
In summary, we paid $1,937.97 for 400 shares and sold back 291 shares for $1,946.81. Our client then had 109 shares paying 8% dividends at no cost to him. This client has about 4000 shares in his account and 774 of them, as of this writing, were accumulated using this strategy at no cost to the client. This process took about four years and was transacted in a down market most of the time.
This is not a perfect strategy. Gerald Loeb would warn you that if a stock bought for dividends declines in price 30%, it will take many years of collecting dividends to just break even.
This is, of course, why the stocks purchased must be those that meet the strong buy criteria.