How to boost (even more) your dividends

Selling your stocks is usually not the way to go when following a growing dividend strategy. This is indeed a great catalyst for income. In addition to being stable, the distributions resulting from increasing returns can be very significant over the long term, no matter what happens in the market.

Let's take the example of Chevron (CVX). In 2003, the stock was trading at 43.50 $ and paid an annual dividend of 1.43 $. This amount corresponds to a yield of 3.29%. Let's say you bought 100 shares at that time for a total investment of 4,350 $. CVX has increased its dividend every year since you bought the stock in 2003, and it now pays a dividend of 4.76 $ per share. If you haven't purchased any additional shares since then, the total cost is still the same, 4,350 $, or 43.50 $ / share. Therefore, the yield over the purchase cost is today $ 4.76 / $ 43.50 = 10.94%! In other words, CVX offers 3.8% in dividends today, but the shares purchased in 2003 offer 10.94%!

We quickly realize that it is in our best interest to hold on to our dividend-paying securities for as long as possible. This is of course valid on the condition that the dividend continues to increase. Readers of my e-book, as well as my loyal readers remember that there are only three reasons that can push us to sell a stock paying increasing dividends.

Selling your shares when dividends stop growing

The first is that the dividend has been static for two years in a row, or has been eliminated/reduced. This is a very easy element to control and extremely effective. According to Ned Davis (2010), dividends that grow show a better performance than static dividends which themselves are better than those that decrease or stop their distributions. This is quite logical since the dividend historically represents almost half of the stock market performance. In addition, it is an excellent indicator of the health of a company.

Relying on good fundamentals

This brings us to the second reason: the fundamentals have deteriorated. Here too, it is quite easy to understand why. Dividends being a fraction of profit and free cash flow, if the latter stagnate or decline, distributions will happily follow the same path. Once again, this is relatively easy to control, since most financial sites indicate the distribution ratio dividends compared to profits. If this were not the case, we can even estimate it by multiplying the yield by the PER. Obviously the smaller this ratio is, the more secure the dividend. A payout ratio of around 2/3 (66%) is often considered a good compromise.

Sell your shares when they become too expensive

While we often think about these first two points (dividend progression and distribution ratio), we often forget The last reason that can push us to sell a title:The title has clearly been overbid. Indeed, when you acquire growing dividends, you think, sometimes wrongly, that it is for life. The snowball effect of distributions that increase each year can easily make us miss the fact that some of our positions are trading at irrational prices. This is a shame because it is possible in this situation to further increase your yield on purchase cost (which is often already exceptional with increasing dividends), by arbitrating with other less expensive securities.

Let us illustrate with an example

Let's take the example of the fictitious company "Proctologue & Gants bleus" (any resemblance to an existing company is coincidental), a company that has enjoyed sustained demand for several years and benefits from excellent prospects thanks to the aging of the population and junk food. It is followed by a large number of institutions and analysts and its share price has risen sharply since 2010. Profits are constantly increasing, like the dividend, but are not climbing as quickly as the share price. The PE ratio has therefore increased sharply and is in a situation of overheating.

The table below shows the evolution of P&GB's share price and fundamentals since 2010. The stock was cheap at the time, with a P/E of 15 and a yield of nearly 4%. The investor made an excellent investment since the stock doubled in five years and tripled in eight years. Its yield compared to the purchase cost (YOC) doubled in nine years. Buy&hold was clearly the right approach in this case and it is difficult to imagine the future in any other way.

Sell your shares to buy more

However, if we look at the evolution of valuations in recent years, there is reason to ask questions. The price now stands at 26 times earnings and the current yield at 2.27%. There is worse, of course, but there is also better. Let's say that the investor decides to sell Proctologue & Gants bleus at the end of 2015. He has some good reasons: the PER exceeds 20 and his position has doubled since the purchase. In addition, he has been eyeing another stock for some time, which is a bit like P&GB with the valuations of the time (yield of nearly 4%).

Thanks to the capital gain on his first purchase, he is able to buy a position twice as large as in 2010, with an identical yield, i.e. a yield compared to the very first purchase cost of almost 8% (YOC2). This is 1.65 percentage points more than the buy&hold and the gap widens with the years that follow (more than two points after four years). For the example, I started from the assumption that dividends progressed in a similar manner on both sides.

It is possible to have more income, even with cash

All this is well and good, you might say, but when the market is overheating, it becomes very difficult to find cheap stocks. It's true. As early as 2017, I started to sell off several of my stocks because they had become really too expensive for my taste, with PERs that were not around 20 as in the example above, but even 30 for some. At the same time, I went hunting for good deals, but at every opportunity I found, I sold at least two of my stocks that had become too expensive. At one point, I had sold so many positions that I was reduced to almost 50% in cash. A nightmare for an income-oriented investor. At least on the surface...

Taking stock of my performance 2018 I nevertheless had a surprise that I really did not expect: the income from my dividends had exploded compared to previous years. Never had I received so much distribution in one year even though at the same time my share of cash had never been so large. I was speechless. I, an apostle of increasing dividends, had managed to boost my distributions by selling aristocrats, all with a large share of cash.

Conclusion

This experience has the merit of reminding us that even if the strategy of growing dividends is above all of the buy&hold type, and that it must remain so, there are still certain situations which should encourage an investor to sell his shares.

I remind you to finish below the three golden rules :

• The company's fundamentals have deteriorated to the point of threatening future dividends
• The dividend has been static for two years in a row, or has been eliminated/reduced
• The stock has clearly overbid (and it is possible to arbitrage with other payers of increasing dividends)