By: Dividend Sensei
This series has already looked at some of the most important aspects to good long-term investing including:
- Understanding The True Nature Of Risk
- Keeping Stock Market Volatility In Context
- Having A Realistic View Of Your Long-Term Goals/Needs
- Mastering Your Emotions To Avoid Costly Mistakes
- How To Construct The Right Portfolio For Meeting Your Individual Needs
This article explains the four critical steps to building a stock portion of your overall portfolio. In other words once you have gone through the process of planning for your long-term future, including understanding your individual goals, risk profile, and optimal capital allocation, then it’s time to actually build the dividend stock portfolio that will hopefully serve as the cornerstone of your financial prosperity.
Step one involves picking the right stocks. The key here is you want to avoid taking on too much risk, by “reaching for yield”. Remember there is a big difference between a quality high-yield stock and a yield/value trap. A stock whose dividend isn’t safe isn’t worth owning. There are basically three factors that make a good dividend stock:
- Stable cash flow that covers the payout
- A strong balance sheet that allows the company to invest for future growth without putting the dividend at risk
- A good business model, (well managed), in an industry that’s growing, (not in secular decline)
Now these are just rules of thumb of course and general ones at that. As with all complex things in life there is as much art as science to selecting the right companies. So here’s a good short cut. You can just select from a predetermined list of stocks that have already been screened for quality. The master watchlist that I maintain in my portfolio summaries, (which is expanding to eventually cover every low/medium risk dividend stock traded on US exchanges), is one such place to look for ideas.
Another is the list of dividend champions/contenders/challengers, the so called “CCC” list, maintained by Dave Fish. These are stocks that have raised their dividends for 25+, 10-24 years, and 5 to 9 years in a row, respectively. In other words: well run and proven blue chips whose management is highly disciplined, conservative, long-term focused, and shareholder friendly. Step two, once you have a good idea of what the right companies are, is to make sure you buy them at the right price. After all studies have found that the number one factor in achieving good long-term returns is buying the right company at a good price, meaning fair value or better.