The stock market crash of 2008 convinced me never again to invest in any company that does not pay dividends to its stockholders. The crash also convinced me never again to leave the fate of my portfolio in the hands of mutual fund managers, whom I found were just as much at the mercy of crowd panic psychology as any “ordinary” stock investor.
At first, I saw dividends just as a psychological defense line that would buffer me from that crowd panic psychology by establishing an “income value” for my investment holdings independent of their market value and which would keep me from selling out of fear whenever the market value of a stock in my portfolio fell. But when I actually started screening stocks to build this income value portfolio, I saw that here was an opportunity to apply dividend investing as an offensive high-yield (and admittedly high-risk) strategy to grow my portfolio and reach the financial independence that a strong stream of dividend payments would give me.
And so the idea of pursuing a high-yield, high-risk dividend income investing strategy took hold of me. I’m not a financial adviser and I’m not saying that anyone should do what I have been doing since I had that epiphany 5 years ago. I’m just saying that strategy has worked for me, and I’d like to tell how.
Managing The Risk
First I addressed the high-risk side of the equation. This strategy would be a stock-picking strategy. How could I protect myself against picking a stock that would crash on me by cutting or stopping its dividend? A three-part answer came to me: (1) screen the companies based on their financial fundamentals (I know, duh!); (2) diversify the portfolio so no one company’s weight in it was too significant (double duh!!), and (3) monitor the news on the companies daily to catch early any indication that the positive reasons for which I had picked the company were turning negative.
Basically, I wanted to check the company’s ability to actually keep paying its bills and its dividend. So on the balance sheet I would check to make sure that (1) current liabilities were less than current assets and (2) long-term debt was less than total assets minus the goodwill balance sheet line. I decided that I would bypass the income statement because too many non-cash and/or unrealized charges and credits incorporated into that statement could – and too often would — distort the company’s real financial picture. And on the cash flow statement I would make sure that net operating cash was greater than the sum of interest expense — no amortization of interest expense for me — and dividends paid. (Otherwise, the company would be borrowing money to pay its interest cost and/or its dividends – and that would be a very bad road to be on).
My personal sweet spot for diversification came down to the numbers 10 and 20. No more than 10% of my portfolio would be in any one industry – so, I would invest in no less than 10 industries. And no more than 5% of my investment capital would go into any one stock – so I would hold no less than 2 companies in any one industry and no less than 20 companies in my portfolio. Listening to my gut, I concluded that this would be enough of a hedge against a catastrophic business event hitting any one company (or any one industry) in my portfolio.
Finally, each morning I would monitor Yahoo Finance for company-specific news that might signal a significant change in fortune (good or bad) for a company in my portfolio and require quick action on my part.
Selecting the Stocks
Assembling a list of potential high-yield candidates turned out to be much simpler than all the document searching and mathematical calculating I would be doing to hedge against the high risk built into my strategy. By using my internet broker’s customizable stock selection screen, I would be able to generate a list of dividend-paying companies ranked by their percentage yields. And, after thinking about it, I decided I would cut off the list at a minimum 6% yield.
Constructing the portfolio was then straight forward. I just started at the top of my ranked dividend-paying stocks list and worked my way down. I vetted each company based on my financial fundamental criteria. If the company made that cut, I “fitted” it into its allotted industry based on my diversification plan. The result was a list of 20 stocks, 2 to 3 per industry, and those 2 to 3 being the highest dividend yielding stocks in their industry that had passed my financial fundamentals tests.
Oh, and one thing I forgot to mention. NO financial company stocks. Even to this day, I cannot trust them or feel good about them.
Four years after I started on this investing road, I still use the same portfolio construction approach. Every weekend, I run the dividend yield stock selection screen and target industry gaps in my portfolio with the cash that has accumulated during the week from dividends collected and capital gains realized from triggered good-until-cancelled position sales.
As I said at the start, by no means am I recommending that anyone follow this approach to stock investing. But whether by method, skill, luck or a combination of all 3, this approach has worked well for me. Certainly I have hit my share of high-risk potholes on my investing road, but I’ve never been tempted to panic and on the whole my portfolio has moved steadily forward.
So Far, So Good
After cashing in my mutual funds in 2008, I started my high-yield, high-risk investing adventure with the $143,000 I had left in my IRA account after selling off the mutual funds. By late 2013, the portfolio’s book value had grown to just over $344,500. Much more importantly to me, that portfolio is now yielding just over $29,000 a year in dividend income. (And that does not count the realized gains from profitable position sales!)
It’s all very hands-on, I know. It requires a half-hour each morning monitoring stock news on the internet while I drink my coffee. It involves about 4 hours a week screening and vetting companies. It means analyzing quarterly reports and conference call transcripts for the companies in my portfolio (while sitting back in my recliner with a scotch!). It does take some work. But the payoff for me is that this high-yield, high-risk investing strategy has finally pushed me up and over the bar to make me financially independent YEARS before I otherwise could have.
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image courtesy of Stuart Miles at FreeDigitalPhotos.net