The Personal Finance Podcast - How to Invest in Dividend Stocks (I Reveal My Exact System!)

Episode Date: July 14, 2021

62. How to Invest in Dividend Stocks (I Reveal My Exact System!) Got questions? Ask me on Instagram Here. @mastermoneyco This is the fastest way to get a response from me.  Sponsors Thanks to Mint Mobile for Sponsoring the Show! Get your new wireless plan plus free shipping at mintmobile.com/pfp. Thanks to Policygenius for Sponsoring this episode of the podcast! Get your insurance quote at Policygenius.com  Thanks to our sponsor Manscaped (Manscaped.com) for sponsoring this episode of the podcast. Use code PFP20 at checkout for 20% off + Free Shipping! Thanks to Mini Cooper for Sponsoring the show! Check out the all-electric Cooper SE. Reserve yours at MINIUSA.com Want to Support the Show? Follow on Spotify or Follow and Leave a 5-Star Review on Apple Podcasts! Today We Discuss:  Why invest in dividend stocks.  How to build a compounding machine.  The best way to find dividend stocks.  What are the best dividend stocks? What is a dividend aristocrat?  Lowell Millers Book: The Single Best Investment  More Episodes You Will Love:  How much you need to save to retire  Why Understanding Your Savings Rate Will Change Your Life (and Allow You To Retire Early) The Roth IRA Millionaire  The 401(k) Millionaire  Check out all the Stuff I Recommend!  M1 Finance Open a Roth IRA Personal Capital Free Wealth Management + Budget App and Fee analyzer!  CIT BANK (Best Savings Account) Best Personal Finance Books  The Simple Path to Wealth - J L Collins  The Millionaire Next Door - Thomas Stanley I Will Teach You To Be Rich - Ramit Sethi  Rich Dad Poor Dad - Robert Kiyosaki ** Some links may be affiliate links and we earn a small commission at no extra cost to you. We only recommend products we truly believe in.  Check us out on social fam!  Twitter Dollar After Dollar Instagram www.thepersonalfinancepodcast.com www.dollarafterdollar.com Learn more about your ad choices. Visit megaphone.fm/adchoices

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in dividend stocks. If you have any questions about this episode, hit me up on Instagram at dollar a F-T-R dollar and follow us on Spotify, Apple Podcasts or whatever. podcast player you love listening to this podcast to. And if you want to help out the show, leave a five-star rating in review on Apple Podcasts. So today, I'm going to go through the dividend stock investing strategy that I utilize because I want you to understand this from the start. The purpose of building a dividend portfolio is to produce an income producing portfolio. It's not to beat the market because an index fund can typically beat out what a portfolio of

dividend stocks can do, but the beautiful thing about dividend stocks is that they can produce an income and cash flow for you every single month. Now, if you're not willing to research companies and you're not willing to dive into actually looking into stocks and seeing how they're performing and seeing what their financials are doing, then investing in individual stocks may not be for you because that's what it takes to be successful. Most people will tell you differently. Most people will say you can just look at a couple ratios or you can look at day trading indicators and that will make you successful. and it absolutely isn't true. Because what you have to do on a day-to-day basis

is dig into what the company is actually doing. Because guess what drives performance in any company? Guess what makes a company successful? It's the financials. Because if a company has strong management and strong financials, then they will propel themselves to the next level and become successful.

It makes complete sense. Just think about this for a second. Now, there are meme stocks and companies like AMC or GameStop that get pumped up, but eventually that bubble's going to burst, my friends, and that's not going to last for the long term. And what dividend stocks are is you're looking for companies who provide staples to consumers. They provide options to consumers and they are longstanding companies that increase their dividends over time.

The biggest risk in investing is investing outside of your circle of competence or investing in things that you don't understand. And if you don't understand how to invest in dividend stocks, I'm going to show you how I, do it today. And we're not trying to beat the market. We're not seeking out the best stocks in the market. We're trying to create a compounding machine. What we're trying to do is create a machine that produces cash so that we can reinvest that cash back into our portfolio so that it can produce more cash. And over time, the compounding machine truly grows tremendously. And it's very cool to watch your dividend portfolio grow over time because you're going to start off and get, you know, two, three dollars of dividends as you're first starting out. But as those dividends,

reinvest. And as you put your money back into the compounding machine, that's when it starts to grow. And that's a perfect segue to what the key of a dividend portfolio is. The key to investing in dividends is what is called drip investing. And what drip investing is when you're reinvesting your dividends back into the stock that you're investing in. Let's say, for example, that you bought a share of Apple. Every quarter, Apple's going to pay you a dividend. Let's just say, for this example, Apple pays you $3 every single quarter. Well, every quarter, you're going to put that $3 back into Apple stock. And as you can see here, it's going to start to grow. And then all of a sudden, in a couple of years, you're going to buy another share. And a couple of years down the line, you can start to buy two shares

a year. And then three shares, then four shares, because it's spitting off additional cash for you to be able to invest right back into that stock. And this is very simple to understand, because what's happening here is the dividend is being reinvested. And so you have more shares. And the more shares you have, the more dividends you can collect. So that's why it's so powerful. That's why it's extremely powerful to be reinvesting these dividends to ensure that you can grow that way. Now, if you're not familiar with dividends, if you've never heard the term dividends before, all it is, it's very simple. All it is actually you're sharing the profits with the company that you invest in. So you buy a share of stock. And what that company does is it takes a portion of the profits and gives it back to

the shareholders as a reward for investing in the company. So when you actually buy companies like this, you're an owner of the company, whether you think you are or not. No matter how many shares you have, you're a part owner of that company because they're sharing the profits with you. And we're going to get into how you can actually find dividend stocks to make sure that those profits are safe and that the profits that they're sharing with you are going to be long lasting. And here's the basic formula I look for at the bare bones minimum when I'm looking for dividend stocks. I want a high quality company with a high yield and all the yield means is the percentage or the dividend that they pay out, a high growth of that yield, and high total returns.

And the reason why I like to start with a higher dividend yield is because over time, it does take time for dividends to grow enough if you start with a low yield. Let's say you start with a half a percent yield. Well, there's plenty of dividend stocks out there that are three, four percent. So you want to start with something substantial so that over time you're growing that much faster because you can reinvest those dividends and make your portfolio larger. Now another thing to note, before we jump in, is you will not succeed in dividend investing if you trade a lot. If you like to trade in and out of stocks, then dividend investing is not for you because dividend investing is a long game. It's for your retirement. It's pushing towards your retirement so that you can spit off

cash later on when you get to retirement. It's not about playing the market. It's becoming a partner in business. And the thing about compounding, it's brick by brick. So it's a very slow process, but over time, and as you get into decades, all of a sudden the portfolio starts to build. And up and it will replace your income. Because if you look at the annual returns and you run the math, even annual returns of 10% can produce gains of nearly 600% in 20 years. So time is the only thing you need when you're investing in a dividend portfolio because if you're buying high quality stocks, which I'll show you how to find them, then time is going to be on your side and time is your best friend. The growth of that individual dividend is the key to this whole thing.

because the growth of the dividend is what's going to increase your portfolio and serve you over years. This is a super simple idea. Dividend investing is a very simple concept. It's just making sure that you're disciplined enough is the hard part because a lot of times what's going to happen is there's going to be big companies that are surging and you want to get into those companies. But you have to stick to your plan if this is your main plan to be able to grow your dividends over time. Now you can have multiple different types of portfolios. My main type of portfolio is index funds. but I have a dividend portfolio as well

because I want a diversification of cash flow over time. Now, if you are not maxing out your retirement accounts and things like that, then you need to stick to just one plan. You don't want to jump around and have multiple portfolios of these small accounts. But if you're maxing out your retirement accounts and you want to diversify your portfolio a little bit more,

then dividend stocks are fantastic to move from if you're only invested in index funds. And the thing about dividend growth is it's a true indicator of a prospering company. So if you're looking for a company who's actually doing well, you can look at the dividend growth as a key indicator. Because the more a company grows and the more the dividend grows over time, that stock price is also going to appreciate. So they go hand in hand. So you're going to reap the benefits of the dividend and you're going to reap the benefits of the stock price.

So it's a double whammy when you look at it from that perspective. So if dividend investing sounds like something you're interested, let's get into how I invest in dividend stocks. I remember when I needed to hire someone fast, but finding the right person quickly felt impossible. And if you've ever been there, you know how stressful this can be. That's where Indeed comes in. When it comes to hiring, Indeed is all you need. Instead of struggling to get your job post noticed, Indeed's sponsor jobs help you stand

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An IG Private Wealth Advisor creates the... the clarity you need with plans that harmonize your business, your family, and your dreams. Get financial advice that puts you at the center. Find your advisor at IGPrivatewealth.com. So when I first started investing in dividend stocks, I kind of did it blindly. And I quickly learned that there's a much better way to do this systematically. And the book that I read, and this is one I highly recommend for anybody who wants to invest in dividend stocks, is a book by Lowell Miller.

And it's called The Single Best Investors. And that book completely changed my perspective on dividend stocks and how to build this compounding machine. Because what it did was it gave me a system to put into place. And in that book, there's a set of rules, which I'm going to go through because they're my personal rules now, but I've tweaked them significantly to fit my needs. And I think they're better for this day and age. But what he does in that book is actually puts the parameters for you to figure out which

company should I invest in and which one should I put by the wayside. Because that's the biggest thing when you're looking at dividend stocks. There's so many options out there between dividend stocks or REITs or any companies out there that are actually producing a really, really high dividend. A lot of times people just want to go for the highest dividend, which is not the best way to do this. It's not even remotely the best way to do this because if a dividend is extremely high, many times that dividend is not safe. So what you want to do is find safe, reliable, extremely profitable companies that you want to invest in that can serve you for a long period of time. throughout your entire lifetime, if possible. So I'm going to go through these rules and let you know these are the ways that you can find

dividend stocks. These are the rules that you put into place or the system that you put into place so that you can be wealthy with dividend stocks. So the first one, the company must be financially strong. Now, we talk about this all the time. If you're looking at a business and you want to buy a physical business or if you want to buy a stock, the company must be financially strong that you're purchasing. So a quick rule of thumb and a quick way to find this is that it must be at least a

B plus on the value line stock ranking system or a triple B plus in the standard and poor's credit ranking system. So you can Google both of these. You can look at value line stock ranking system or the standard and poor credit ranking system and you could put in the stock that you're looking for and see what the rating is. That's a quick way to look it up. But what I like to do is I like to dig into 10Ks and financials and look at the company's actual financials.

If you do how to read financial reports, you can look at their actual financials and figure out exactly how well they're doing. Now, this is something that Warren Buffett has always done, is he digs into the financials physically reads them every single quarter so that he can find the best companies possible. And that's why he's outperformed the market. Now, will you outperform the market? Probably not because even 90% of people who do this professionally can't outperform the market. And that number, the 10% that do isn't the same every single year. So understanding that going in, almost nobody can outperform the market is the reason why we talk about investing in index funds. so much. The second rule, the company must offer a relatively high yield or dividend percentage.

So the dividend yield, and this is a rule of thumb that I use, should be at least 150% of the current average yield of the S&P 500. Now, when you buy an index fund, the S&P 500 actually gives you a dividend. At the time I'm recording this, the S&P 500 yield, like let's say you invest in VO or the S&P 500 ETF. If you invest in VO, your dividend yield usually goes between 1.75 to 2% somewhere in that range. So when you're looking at dividend stocks, you want to be one and a half times that. So you want to be at least a 3% dividend to make it worthwhile. Otherwise, you might as well just invest in the market because you're looking for cash flow. You're looking for higher cash flow than the market can provide. And that's why you want to make sure that number is at least 1.5%. Now, if you can

get double the average, if you can get up to 4%, that's even better. So if you're trying to weigh out which stock to buy, if you can double the average, then that would be even better. Number three, the dividend must be expected to grow substantially in the future. So one big way to look at this is when you're looking up stocks, you can look up what is called the dividend payout ratio. And what that is, is the dividend payout ratio is how much of their profits the company is actually paying out to dividend investors. Because the high, the high rate is, higher that number is, the less safe that dividend is. So if you look up a dividend payout ratio, and let's say it's 80%, that means they're paying 80% of their profits out to you the investor.

That is not a good thing. So you want to make sure that the dividend payout ratio is less than 50%. The only exception to this is for utility stocks and REITs, because both of those have different criteria where they have to pay out a certain percentage of their income to the shareholders. but every other stock, if you're looking at a company, say, like lows or Target, something like that, you want to make sure that the dividend payout ratio is less than 50%. Otherwise, the company's dividend growth in the future can be in jeopardy. Number four, the company should have a history of consistent earnings growth, meaning you can look at a company's earnings and say, has this consistently grown for the last five to 10 years?

Now, this is a reason why I don't look at a lot of IPOs, because, Typically nowadays, a lot of IPOs are tech stocks or initial public offerings, if you've never heard the term IPO. And what that means is a new stock is coming on the market for the first time. So recently, a cryptocurrency company called Coinbase just came onto the market. And they surged and went flying super high. But I don't have a historic earnings on this company. So I can't look at a company like that and say, I know what this company is done historically.

I think this is a sound investment. So looking at a company's earnings growth over time, five to 10 years will give you an indication, hey, there's probably a good chance this company's going to grow for the next couple of years as well, which leads us into the fifth indicator, which is looking into management. Now, this is a big thing Warren Buffett and Charlie Munger do, is they want high quality management in place because if a company's being mismanaged, it's only a matter of time before that company does not do well unless they switch over management. You can look at companies like Microsoft. When Bill Gates was in position, he was

managing the company great. Then Steve Balmer came in. Microsoft did not do well throughout Steve Balmer's entire tenure. I think he's a great salesperson, but as a CEO, he's not a good manager to be in place. And then now with the current CEO, Microsoft has taken off again. Management is extremely important because if they're not making the correct decisions at the executive level, then that company is going to have to suffer because of the CEO's decisions or his management team's decisions. So having a long record of success is one way to look at this. or how did they do during expansion in poor economic periods? Or how many shares does management own themselves?

Do they actually believe in what they're doing is another indicator? But looking into some of these indicators will tell you if this management is actually a good fit for you and your dollars. Number six, look at valuation measures. So there's things like price to sales ratios that you could look at, and that should be less than 1.5. Another one, number seven, is price over earnings ratios or book value ratios should be less than the markets ratios.

There's things like this that you can look at that'll give you indicators of where you are. Number eight, growth of cash. So you can look at a company like Apple, for example. Apple's cash has grown significantly overtime. Apple has a crazy amount of cash on their balance sheet. And it continues to grow because they have super high margins on their products. If you think of any Apple product out there,

you've probably spent an arm and a leg and you have the whole triage of Apple products. So if their cash is growing over time, they have a big pile of cash and it's growing more and more and more. That means the company's safety net is extremely large. You can think of the same thing as when we talk about emergency funds. A company's emergency fund is their cash balance, is their cash on the balance sheet. So how big is that number? Because that can help them when economic times are tough.

Or if the dividend becomes in jeopardy because the company is not doing as well as it usually can, they can use that big pile of cash to pay out on investors for long run. periods of time. Number nine, think through the company's story. So what a lot of people don't do is they look at, especially dividend investors, is they look at dividend stocks with long 10 years, and they say, hey, this company has been increasing their dividend for the last 20 years. Why should I not just go ahead and invest in them right now? And what you have to consider is the backstory. Where are we in our current economic times? You could think of something like, let's say, for example, that you started investing in a REIT, and you see a REIT has been increasing their

given it over time. But this REIT only invests in office buildings. Well, as we know at the time of recording this, leasing office buildings has gone way down. Because when the pandemic hit, a lot of companies realized, oh, you can work from home and be just as efficient as if you were in an office building. So would that be the best thing to invest in instead of investing in, say, a company like Apple with huge cash reserves? Probably not.

So this is where you have to think through some of these options and say, hey, what is the current economic times? what is the backstory of this company? And do I think they're going to be profitable in the future? Which leads us to number 10 to picture the future. Because when you picture the future, you can say, hey, I think I see this company going in great places and new heights. And I think that this company is going to do well in the future.

That is extremely important just for you. Sometimes this is one of the things that you kind of have to do off a feel, but you can look at market segments. Maybe it's in hospitality. Well, which direction is hospitality going? Maybe it's in the medical field, something like teledoc or things like that, where the medical field is going more and more digital. Can you find something that has high earnings growth that is also going in that direction? Number 11, and this is extremely important.

We talk about this all the time when we talk about investing on this podcast. Hold for the longest period possible. Because the longer you hold that dividend stock, the more time you give that stock to compound, the more time you give that stock to produce cash for you so you can reinvest that cash and start the snowball. because as that snowball starts rolling downhill, all of a sudden, influx of cash could be more than what you originally invested. That's the cool thing about dividend stocks is typically over the course of time, when you start to reinvest those dividends,

all of a sudden, what you're going to see is you're reinvested dividends every single year. It's going to be producing more cash than you originally put into it. That's what happens, specifically over the course of 30 years. For example, Warren Buffett bought a company called Seas Candy, and he bought it for $25 million. And after 25 years, Seas Candy pays him in dividends every year $100 million. He's quadrupled his initial investment on a yearly basis just by holding the company for a long period of time.

And this same thing happens with dividend stocks as it starts to compound and as it starts to build up. Those stocks are going to be paying you more than you initially put in. That's the beautiful thing about it. So you can see how you can build up a full-time income by investing in dividends. stock over the long haul. Number 12, when do you sell these dividend stocks? Because when is the situation you actually need to sell? You sell when the dividend is in jeopardy because we're trying to get income here. And if you think the dividend is in jeopardy or they're starting to cut the dividend

two years in a row, three years in a row, something like that, then you need to sell that stock, take that cash and put it into a company that's going to be paying you and increasing that dividend over time. That's when you sell. So a lot of people don't understand a lot of other strategies when you're day trading or you're investing in options, they have a hard time telling you when you're supposed to sell. In dividend stocks, it's much easier because the indicator is if that dividend is in jeopardy, if there's going to be a problem with your dividend, with your money getting to you, you need to sell that stock and put it into a company that will actually be paying you every single year. It's very simple. So if you're buying strong companies, you don't have to do

this very much. If you're buying super strong companies that are actually producing cash, they have a pile like cashes their safety net. You don't have to do this as much as if you were buying companies that have a little bit more risk. The next one, diversify among many stocks and many sectors. So once you start buying dividend stocks and your account gets large enough, you want to start diversifying into different industries. Maybe you buy some in healthcare, you buy some in tech, you buy some in commodities, you buy some in reeds. And you start to diversify this portfolio so that over time, if one industry is not doing well, you still have all these other industries that are doing well. The next one, when deciding between two stocks, always prioritize dividend aristocrats first, if all else equal.

Now, what is a dividend aristocrat? Because this is what I look at first when I'm looking at my dividend portfolio. So what a dividend aristocrat is, it's a company that has increased their dividend every single year for at least 25 consecutive years. So you can see the power of that number, because for 25 years, these companies have increased their dividend. That's a massive, massive advantage. And what you can do is look at some of these companies and say, hey, there's a lot of companies in this list that you're going to know of. Things like 3M, the people, they make all kinds of stuff at 3M.

You can look at Coca-Cola, Johnson & Johnson, Procter & Gamble, Target, Lowe's, Pepsi, Clorox, Walgreens, Walmart, McDonald's. Aflac, AT&T, Chevron, Caterpillar, the list goes on and on and on. And the thing about the dividend aristocrats is they have typically strong balance sheets. And within these strong balance sheets, these dividend aristocrats have increased that dividend for over 25 years. So this is the first place I look. If I want to deploy my dividend capital, I look here first. But if there's companies that are coming up on this list, let's say they've been increasing their dividend for 15, 17, 20 years,

companies like UPS who are really prevalent right now, then you can look at some of these stocks and say, hey, would these be a better fit for my dollars if apples worth the apples? And that's how you have to look at it. Because safety and security of your income, the income that you're actually chasing after, and the reason why you're doing this is the biggest reason why you do this. You can look at companies like Abbey V or Legget and Platt or Procter and Gamble or Johnson and Johnson or Coca-Cola or Colgate or 3M. All those companies have actually been increasing their dividend for longer than 50 years. And that's absolutely fantastic.

Now, companies that are going to be approaching this over time are things like Apple and some of the tech stocks because they just haven't had enough time to actually get to this point. So if you look at some of the tech stocks that have been producing income, you know tech is the future. So that's something I would definitely look at starting with as well just to see what stocks in the tech sector are actually paying a dividend that's growing over time. And then the last one is to be willing to hold a company for at least 10 years or more, but at a minimum 10 years.

Because the duration that you hold these companies is extremely important. So like we said in the rule before, you got to hold them as long as possible. But the minimum, you've got to look at a stock. And if you're going to buy a stock, you've got to say to yourself, am I willing to hold this for 10 years? Because it's the minimum I need to hold it unless the dividend becomes in jeopardy. Because the dividend is in jeopardy, then you don't have to hold it for that 10 years. That would be stupid.

But if it's not, you need to be willing to hold that for a minimum of 10 years. That rule comes straight out of Warren Buffett's book. because any stock he buys, he looks at and says, will I hold this for at least 10 years? But his true rule is, will I hold this for a lifetime? Do you see this company growing for your entire life? Because when you get to retirement, your portfolio today may look slightly different

than your portfolio does in 50 years or 30 years. But how much of that actually stayed the same? Because that is a indicator of your decision making early on. Now, you're going to make mistakes at the beginning. Everybody does. but the rule is simple. If the dividend is in jeopardy, sell the stock and buy another company

that's way stronger financially. That's how we do this. That's how we make money doing this. And as you can see over time, as all these companies start to grow and the value of the stock has 10, 20, 30, 40, 50 X'd over your lifetime, and it's spitting out cash every single quarter for you,

what you're going to see is a beautiful compounding machine that can produce a very high income for you that goes up every single year. Because as those dividends increase, your income goes up every single year. So you may retire and your dividend portfolio is making $80,000 a year. And then 20 years later, all of a sudden, your dividend portfolio is making $140,000 a year. That's how this works.

Now, can you invest in dividends inside your Roth IRA or your 401K? If your company offers it in your 401K, absolutely. But can you do it in an IRA, which is the same as a 401K? Absolutely. And in your Roth IRA, you can as well. And the cool thing about a Roth IRA in investing in dividend stocks is the dividends, the cash that it produces, are tax-free because your money grows tax-free in a Roth IRA. So a lot of dividend investors try to invest in dividend stocks inside their Roth IRA because that is

how they grow their dividends tax-free over time. Listen, I hope this gave you guys some insight on the baseline in how I invest in dividends. We could talk all day long about dividend stocks and I could go on and on and on. We will have future episodes about dividend stocks as well on how we'll be. we evaluate them and some different indicators that we look at that go beyond what we talked about in this episode. But if you have any questions at all, hit me up on Instagram at dollar a F-T-R dollar and follow us on Spotify, Apple Podcasts or whatever podcast player you love listening to this podcast to.

And if you want to help out the show, just head on over to Apple Podcast and give us the old five-star review. Just give us the old one, two, five-star clickeroo. I appreciate each and every one of you guys. Thank you so much for listening and we'll see you on the next episode. Thank you guys so much for listening. And if this is your first time listening, consider subscribing so you never miss an episode. And share this episode with a friend.

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