Dividend Strategy – Investing in High-Dividend Stocks

The dividend strategy involves investing in stable stocks with high dividend yield and a solid dividend history. It is a passive, long-term investment strategy that also acts as a form of “hedge” during market downturns.

The dividend strategy is suitable for those who save regularly and with a long-term perspective. You prioritize stability and appreciate receiving an annual return on your investment without needing to sell your holdings.

“Building an investment strategy around dividend stocks is excellent for those who want to own stocks more passively and let their capital work for them” / Aktiespararna

The Dividend Strategy in Brief

The dividend strategy involves creating a portfolio of stocks that pay dividends at least once a year. The focus is on good, reliable dividends, and ideally, the dividend should increase year over year.

By reinvesting dividends, you create a “compound interest” effect, resulting in a relatively high return at low risk. Since the strategy focuses on dividends rather than strong price appreciation, it also creates a hedge against stagnant or falling stock prices.

• If the price goes up, the portfolio value increases, and the dividend acts as a “bonus”.
• If the price stays flat, the dividend will still create value growth for the portfolio.
• If the price goes down, the dividend yield on your holding increases, while reinvestment can occur at lower levels.

🔗 We started testing the dividend strategy with real money on 2020-06-26; follow the progress.

Advantages of the Dividend Strategy

Hedge during market downturns

Company A has a share price of $100 and has decided on a dividend of $4. This results in a dividend yield of 4%. If the price drops to $80, your holding will decrease in value, but the dividend yield on your holding will rise to 5%. In this way, dividends can be seen as a hedge against price declines. Furthermore, many use dividends for reinvestment, which then occurs at a lower price.

Clear indication of a healthy company

Dividends can be seen as an indication that a company is healthy and has strong finances. Simply put, they earn enough to give back to shareholders. In theory, however, a company could borrow money or use funds that should go toward investment to pay dividends. In such cases, the dividend is not a sign of a healthy company.

There is also no rule stating that a healthy company must pay dividends. A well-known example is Amazon, which has so far chosen to reinvest the profits generated.

Dividends compensate for inflation

A stock that has not moved upward during a year has, in reality, decreased in value due to inflation. Stable dividend stocks, however, compensate for inflation through their dividends.

Does not require timing

Since the focus is primarily on good dividend yield, the timing of purchases is not particularly important. Many choose to save monthly or buy at a few points during the year and then hold the stocks as long as they provide good dividends.

Disadvantages of the Strategy

High dividend yield can be misleading

It can be tempting to invest in stocks with high dividend yields. However, there may be underlying, negative reasons for the high level. For example, it could be a cyclical company or one with generally low growth. The yield may therefore not be sustainable in the long term. It is therefore important not to look solely at the dividend yield, but also at whether the dividend has increased over time and what the company’s dividend policy is.

Can indicate low growth

High dividend yield can also be an indicator that the company has very little growth. Examples here include large, mature telecommunications or utility companies—stable firms that are not expected to grow by more than a few percent per year. In the US market, companies like Verizon or AT&T are often cited as classic examples of such dividend-focused investments. In this case, it is the high dividend yield that influences the price, not expected growth.

Requires patience and a long-term perspective

If you save regularly with a long time horizon, the dividend strategy can be a very good choice. If, however, you want to rebalance your portfolio several times a year and actively time different trends, other strategies should be chosen. In this strategy, stocks are held even if the price goes down (because the dividend yield increases). The focus is therefore on current and future returns rather than price development.

Misses out on “rockets”

It is primarily companies that invest all their profits into expansion that become “stock rockets.” These will never be purchased under this strategy. Therefore, the strategy can potentially be “spiced up” with additional investments with slightly higher risk.

Affected by interest rate levels

Many choose to invest in dividend stocks instead of putting money in a savings account or buying bonds. When a savings account gives about 1% annual return, it is not difficult to get 4–6% with dividend stocks. Owning stocks, however, carries higher risk as the value of the stocks can go down. It is this risk that is factored into the “premium” provided by higher returns. The risk of stocks must be reflected in higher dividend yields.

If interest rates were around 3%, dividend stocks with 4% might not be an alternative. The difference is simply too small in relation to the increased risk. Even though the entire stock market is affected by interest rates, the demand for these stocks can be more clearly linked to interest rate levels—because it is security that is being sought.

Strategies within the Dividend Strategy

The foundation of the dividend strategy is to choose companies with good dividends. But there are several paths to get there. Which path you should choose depends primarily on your risk level and investment horizon.

Growth in focus

Look for stocks where the dividend has historically increased and is expected to increase over time. In this strategy, it is better to seek stocks with small increases in dividends year after year than those that had a high dividend one year, significantly lower the next, etc., even if both options have the same average increase over 10 years.

In this case, this year’s dividend yield does not weigh heavily in the choice of stock. Instead, you can expect higher returns over time. Additionally, an increased dividend often leads to a higher share price. This is an investment strategy for those with a very long-term perspective.

Growth and history (10–10)

Look for stocks that have increased their dividend for 10 consecutive years and have had at least 10% dividend growth. Very few companies meet these criteria, but it means you choose stocks that have both good dividends and strong dividend growth.

High dividend

High-dividend stocks are often large and safe stocks with lower growth. As previously mentioned, examples include large, mature telecommunications or real estate companies. In the US market, companies like Verizon, AT&T, or Realty Income are often cited as classic examples of such dividend-focused investments. Here too, you should look at history and growth to ensure that the dividend is expected to increase or remain at a similar level in the future.

It may also be worth looking at the payout ratio, i.e., what portion of the profit the company pays out as dividends.

Dogs of the Dow

Buy the ten stocks with the highest dividends each year. The concept comes from the American investor O’Higgins and was applied to the Dow Jones Industrial Average, which consists of only 30 companies.

Dividend Kings

Dividend Kings are stocks that have increased their dividends for at least 50 consecutive years. These are often US-based companies, such as The Coca-Cola Company or 3M, known for their extreme reliability even through historical economic crises.

By choosing these stocks, a very stable portfolio is created. This is considering that the companies raised dividends even during the financial crisis, oil crisis, corona crisis, etc. Examples of American stocks in this category are 3M Company and Coca-Cola.

Dividend Aristocrats

Dividend Aristocrats are stocks that have raised dividends for at least 25 consecutive years and are found in the S&P 500 Index. Like Dividend Kings, it implies extra security as the stocks have been able to provide higher dividends even during economic turmoil. That they are also found within a large index creates further security.

Dividend Champions

Dividend Champions, like Aristocrats, require 25 years of consecutive increases. However, the stock does not have to be in the S&P 500 Index.

REITs (High dividend percentage)

Real Estate Investment Trusts are real estate stocks that pay out at least 90% of their profit as dividends. These are found in the USA and generally pay dividends once a month or per quarter. The reason they choose this high level is that the company avoids paying corporate tax in this case. Instead, it is the shareholders who get to pay tax on the dividends that occur.

Equity REIT
Real estate companies that own and manage properties. Often within a certain industry or a specific area. The income is the rent from tenants.

Mortgage REIT
Investment companies that invest in real estate loans. These companies can thus finance a company within Equity REIT. The income is the interest.

Preference shares

Regarding dividends, preference shares differ from common shares primarily in that preference shares have a fixed dividend. You therefore know the dividend in advance, which is thus less affected by the company’s financial development than common shares.

The company must always prioritize dividends on preference shares over common shares. This can mean that preference shares give their predetermined dividend while common shares give nothing at all.

Read carefully which rules apply to dividends and redemption. For example, the dividend could be at one level for the first three years, after which it is lowered. Regarding redemption, this could, for example, happen at a fixed price or a ladder where the price is determined by how long the company waits to redeem.

A slightly more advanced stock to own within the dividend strategy, but one that provides a fixed and clear return. For better or worse.

Preference shares mean more stable returns—with the risk of getting lower returns than common shares.

Choosing stocks within the dividend strategy

• How many years have they paid dividends?
• How high is the dividend yield?
• What diversification is desired?
• How large is the payout ratio?
• How many industries should be chosen for diversification?
• Should the focus be on high dividend yield or growth—or a mix?

Who is the dividend strategy suitable for?

Investors with a long-term perspective and low engagement

The dividend strategy is suitable for those with a long-term investment horizon. You review the holdings once a year and adjust them based on certain rules. Generally, there will be few changes as many companies with high dividends keep their dividends at a similar level year after year.

Those who prefer to invest in large and stable companies

Small companies reinvest and expand to a greater extent than larger companies. There are also small-cap companies that pay dividends, but generally, it is among larger companies that high dividend yields are found.

Those seeking low risk in stock savings

Investing in large companies with such good returns that they can pay dividends means you take a lower risk in the stock market. Furthermore, the dividend means a kind of hedge against lower stock prices.

Overall, these advantages of the dividend strategy show that it is a long-term investment for those seeking stability and security in their portfolio.

Historical returns

A couple of examples show how much return the strategy has historically given, in relation to OMXS30. The return includes both price development and dividend yield.

The ten companies with the highest dividends are chosen from Large Cap.
Dividends are reinvested. Historical return May 2010 – 2020.

The ten companies with the highest dividends are chosen from Small Cap.
Dividends are reinvested. Historical return May 2010 – 2020.

As long-term dividend hunters, you want to own stable dividend companies with a good dividend history. / Aktiespararna

The ten companies with the highest dividends are chosen from NGM.
Dividends are reinvested. Historical return May 2010 – 2020.

Glossary

• Dividend – A portion of a company’s earnings paid to shareholders.
• Dividend yield – Dividend/share price
• High-Yield – High-dividend stocks
• Dividend trap – A company gives a disproportionate dividend in relation to turnover and profit. This can be done to push up the share price, something that can quickly backfire with a lower price.
• Preference shares – Stocks with a fixed dividend within a certain time period. Also has rules regarding redemption which thus also affects its price.
• Payout ratio – How large a part of the company’s profit is distributed as dividends. A company that makes $1,000,000 in profit and has 10,000 shares makes a profit of $100 per share. If $40 were distributed, the payout ratio is 40%. It is the board that makes a proposal on how large the payout ratio should be. Then it is the general meeting that approves, or votes down, this proposal. The general meeting can only approve, lower, or reject the proposal—never increase the dividend.
• Total dividend yield – Ordinary dividend + Extra dividend/share price.

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