About a year ago I got really excited after reading Stop Working by Derek Foster. His basic idea is that you buy stable, well established companies that are leaders in their industries which have paid a regular increasing dividend for a long time when they’re on sale. You determine this by looking at the Dividend-Yield (which is basically the last quarterly dividend, multiplied by 4, divided by the share price). The Dividend-yield tells you how much of your purchase price you’ll get back annually (so a $100 stock with a 4% dividend yield would pay you $4 per year, $1 each quarter).
His idea is that these companies aren’t going anywhere, their share price should increase over time, and since the dividends increase you can basically live off of the dividends and use the increases to compensate for inflation. Apparently Derek very aggressively built his portfolio, and he is now retired in his early 30’s with a family of 4.
After reading his book and looking at some stocks I was excited to buy Merck and General Motors. The problem with this strategy is that these companies will only have a decent dividend-yield after there is bad news, so everyone will tell you you’re crazy to buy (which could be considered another good reason to by – they call this contrarian investing). At the time, the bad news scared me off (GM was losing money every quarter, and Merck has a lot of its patents expiring soon with no other popular drugs in the pipeline to replace them).
I never gave up on the strategy, and have recently begun mulling it over again. With the new Canadian tax laws giving very favourable tax rates for dividend income combined with the abysmally low interest rates currently (great news for mortgages, not so great news for GICs), I finally bit the bullet this week and put $6773.77 into the account and have bought 242 shares of Rothmans (a tobacco company) for $5349.87 (including a $20 trading fee, which gives a dividend-yield of 5.45%) and today I bought 65 shares of Bank of Montreal at $68.88 (which would give me a dividend yield of 3.95%) for $4477.20.
For the mathematically astute, yes 4477.20 + 5349.87 > 6883.77. I’ll discuss buying on margin in a future posting.
So far since buying the Rothmans its gone up 5% (so I’ve made a cool $270). Share prices for dividend stocks are somewhat unimportant if your following a buy-and-hold dividend strategy (as you only really care how much you’re getting per quarter – if you’re not planning to sell, the current price doesn’t matter).
One modification on the general strategy that I’m considering is to sell any stock that drops to a dividend yield of 3% or less. This would mean that either they’ve cut the dividend (which would suck if you’re counting on the dividend payments for your retirement) or the price has gone really high (which it might make sense to sell at that point and buy stocks with higher yields). Most people who write about this strategy seem to favour a hold-forever outlook, so I’m not totally committed to this approach yet.