Rules For Better Dividend Investing
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Rules For Better Dividend Investing

Rule #1: The Quality Rule

The quality rule is based on the common-sense notion that high-quality businesses have greater wealth compounding abilities than low-quality businesses. The problem is how to define a “high-quality business.”

One of the key characteristics of a high-quality business is a long history of steadily increasing dividend payments.
A company must have a strong and defensible competitive advantage to increase its dividend payments for years on end.
High-quality businesses is a long corporate history.
The Quality Rule rank stocks by their dividend history and their corporate history (the longer the better).

Rule #2: The Bargain Rule

The bargain rule is based on the idea that buying cheap items is better than buying expensive items, all else being equal. This is true as a consumer and even more so as an investor.
“Price is what you pay; value is what you get. Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.” Warren Buffett

When stock prices are cheap, dividend yields are higher.

Accordingly, the bargain rule ranks stocks by their dividend yields (the higher the better). This provides the two-pronged advantage of generating more portfolio income and also helping to identify stocks with low valuation metrics (such as the price-to-earnings ratio, the price-to-book ratio, or the price-to-free-cash-flow ratio).

Rule #3: The Growth Rule

It seems very logical that we seek to invest in fast-growing businesses where possible.

Indeed, business growth will eventually translate to a higher share price if investors can ignore the short-term vicissitudes of the stock market.

 

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”– Benjamin Graham

With this in mind, the Growth Rule recommends ranking stocks by their earnings-per-share growth estimates. This benefits investors through both share price appreciation and higher dividend payments, as there will be more corporate profits to be distributed to shareholders.

Rule #4 – The Survival of the Fittest Rule

If a company cuts its dividend, there are two potential causes:

  1. Management is financially unable to make the dividend payment
  2. Management is unwilling to continue paying dividends

Both of these reasons for cutting a dividend are very worrisome for investors. If you buy a stock to generate rising passive income over time, a dividend cut is the exact opposite of your goal.

Accordingly, the Survival of the Fittest Rule requires investors to sell a stock that has cut its dividend payment.
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