How to Pick Dividend Stocks When You’re First Starting Out
I’m not a professional investor or analyst. Far from it. I have been writing in the financial media since 2011 for a variety of platforms. Presently, I focus on Medium and crowd-sourced investment research platform, Seeking Alpha.
I attribute any personal, professional, and investing success I have to learning from reader response to my work and making a ton of mistakes. I used to call them “stupid mistakes.” Now I just call them integral mistakes. Without them, I’d be nowhere and nothing. Same, with regards to the people I have had the opportunity to work with, observe, and read over the years.
We’re living through one of the most exciting times in history.
Forget the bull market. Set aside arguing over whether or not we’re in a bubble. Disregard politics. Try to put the pandemic further back in your mind. As life goes, these are all blips on the radar screen.
Opportunity to “do” and make money exists like never before for an increasing number of people, irrespective of age.
I’m heartened by something I see in response to my writing here and at Seeking Alpha. Young people are engaging financial media. They want to avoid making mistakes. I hope they still make some. Mistakes are worth it. However, if the letter today’s 25-year old writes to his or her 25-year old self in thirty years ends up a bit shorter than it might otherwise have been, this will be a good thing.
The best thing we can do for new investors — and not so new investors like me — is keep them out of trouble and provide straightforward, accessible ways to make decisions on stocks. And, oh, we can preach the merits, the ministry, the majesty of buying and holding dividend-paying stocks.
The strategy I use to buy stocks is called dividend growth investing (DGI). It’s popular at Seeking Alpha. A dividend is simply a portion of a company’s profits its returns to shareholders via what is usually a quarterly payment. Investors can take this money as cash or reinvest it in new shares (or fractional shares) of stock. We refer to the latter as dividend reinvestment.
As an investor, you really don’t have to go much further than Medium’s Money page and Seeking Alpha. You’ll find everything you need to learn sound approaches to budgeting, spending, saving, and investing at places. I write a fair about dividend stocks at Seeking Alpha and intend to do more of it on Medium going forward.
In this article, I outline what I do before I buy a dividend stock and every quarter thereafter. I contact virtually all of my research at Seeking Alpha.
Step One: I pull up the quote for the stock I am looking at or own on Seeking Alpha.
I scroll down to the section that includes latest analysis and news.
I review recent articles. I review recent news. Nine times out of ten, I see something in an article or news story that references something meaningful from the company’s prior history. When this happens, I search for information on the event at Seeking Alpha and elsewhere.
CVS Health (CVS) is a perfect example. As I started reading articles several weeks ago, I saw references to the company’s acquisition of Aetna. I had almost forgotten it happened. So I refreshed my memory on it. This helped me put two and two together on CVS’s aggressive push into the broad health space and its decision to halt dividend increases.
This early research helped me start to craft the company’s story in my head. Was it going to mesh with my intuition and educated guess based on what I have seen happening on the ground in and around CVS stores here in Southern California? As this took shape, I put the growth story aside for a second.
Step Two: I pull up the dividend page from Seeking Alpha’s CVS quote.
I rarely buy a stock based on its dividend yield. However, it’s a useful number. It essentially illustrates the ratio of the company’s dividend relative to its stock price. In CVS’s case, one share of stock @ $58.51 gets you a $2.00 annual dividend. That’s a roughly 3.49 percent return. I think Seeking Alpha calculates the yield on the stock’s previous close ($57.34), which is why the math is off on $58.51.
Anyhow, a number I do consider as a direct buy or don’t buy decision when evaluating a dividend stock is payout ratio. Here’s a nice definition and primer on payout ratio:
I used CVS as my illustrative example because the company makes it easy to get your head around payout ratio.
CVS has a low payout ratio at 27.66 percent. Combine this with the company’s decision to cease dividend increases and its aggressive growth strategy and it makes sense. Countless companies do not pay dividends — think big tech names such as Amazon.com (AMZN)— in part because they, theoretically, return their cash to the business rather than shareholders. In other words, the cash funds growth and expansion rather than dividends or share buybacks.
Step Three: Verify your assumptions and conclusions in earnings conference calls and other events where company executives speak and provide color.
Seeking Alpha offers access to just about any and every conference call or event transcript, SEC filing (including quarterly reports) and company press releases you need or want. This is always my next stop. I literally scour and read through (with some skimming) every document for the last few years in the “Transcripts,” “SEC Filings,” and “Press Releases” tabs. Slide show presentations are also great. Always check a company’s Investor Relations area on its website for presentations Seeking Alpha might not have.
In my most recent Seeking Alpha article on CVS, you can see how I used the company’s most recent conference call and event comments to help piece together the growth story. I also go back and gather information. In addition to searching for comments on the company’s growth plans, I also simply search the transcripts for “dividend.”
I went back to the Q4 2017 CVS earnings conference call transcript for this from CEO Larry Merlo:
First as I typically do, I’ll begin with a review of last year’s capital allocation program. For the full year of 2017, we generated $6.4 billion in free cash, delivering all of this cash back to shareholders through both dividends and share repurchases despite the suspension of share buybacks during Q4.
We paid $510 million in dividends in the fourth quarter and $2 billion during the full year of ’17. Our dividend payout ratio currently stands at 30.9% over the trailing fourth quarters, retreating slightly due to the non-cash tax reform benefit we captured in net income during the fourth quarter.
Now going forward, as we previously announced and due to the Aetna transaction, we are keeping dividends flat until we get back to a leverage ratio that is more in line with our credit ratings category.
During the fourth quarter, we did not repurchase any shares. However, for all of 2017, we repurchased approximately 55 million shares for approximately $4.4 billion, averaging $78.68 per share. We ended this year with $13.9 billion left in authorization to repurchase our shares. And as with dividend increases, the share repurchases are suspended until our leverage ratio comes back in line.
This article isn’t meant to analyze CVS. It’s designed to show how I evaluate stocks. So the important thing to pull from the quote is that Merlo explains the flat dividend in relation to the Aetna acquisition. If you’re a DGI investor, a cessation of dividend increases can be troubling. However, in CVS’s case it’s not. At least not to me. The company still pays out $2.00 per share annually and it has done so for the last three years. Expect the dividend increases to resume as soon as CVS gets it debt down to its target level.
My analysis takes objective fact, what the company says, and attendant analysis (largely from Seeking Alpha authors) and puts it together so I can come to my own conclusions and decisions.
A quick note on company executives.
As I get older, I get LESS cynical. I give people the benefit of the doubt. But, beyond that, executives have a legal responsibility to tell the truth on calls and at conferences. While I’m not going to take every thing they say at face value, I’m also not going to take the jaded view that they’re out to game investors. I think they say what they say based on real conviction and the information they have on hand 9.9 times out of ten.
When I was super bearish Netflix (NFLX), I made the mistake of assuming everything Reed Hastings said was a lie. More often than not, it turns out I was flat wrong about Netflix. Hastings was telling a growth story that I didn’t get. He took risks with the financials, but they were well-calculated risks coming from a thoughtful visionary.
This said, frauds exist. And you can use conference call transcripts to sniff them out. In my early days on Seeking Alpha, I did this with two now long gone companies — Green Automotive Company and Sino Clean Energy.
The former is/was an American company that threatened to sue me because of my reporting. The latter was what amounts to a Chinese fraud. If you read the Sino Clean Energy article, you can see an example of using a company conference call to sound the alarm. Companies can get angry all they want. All I did was listen to what they said, connect it to objective facts, and make an informed analysis.
So, dividend stock or not, it can go in any direction. But the bottom line is the only thing holding people back in most areas of life is knowing how to access information. Access for investors is there. It’s either free or costs very little money. You have to use these resources to make decisions.
I don’t undertake a sophisticated process to make my investment decisions. While there’s some quantitative reasoning and analysis involved, I don’t wade through complicated sets of numbers to decide. I don’t like to make readers do this in my articles. I don’t think this resonates or makes sense to lots of investors, even if they’re mathematically minded. I loved and used statistics in college. I use it to this day. But I don’t get bogged down in it. The story associated with the numbers (particularly dividend metrics) matters more.
Anyhow, I hope this helps. It’s a more methodical look at my process. I can only endorse it for myself and offer it up to you. Whether you’re a new or “old” investor, there’s probably something you can pull (even if you throw it right away) from what I spend my time doing most days.