The 8 Rules of Dividend Investing are guidelines to help you determine what dividend stocks to buy and sell for rising portfolio income over time.
All of The 8 Rules are supported by academic research and ‘common sense’ principles from some of the world’s greatest investors.
The 8 Rules of Dividend Investing are more than just ideas…
They are applicable to real-world investments.
You can learn more about The 8 Rules of Dividend Investing in the following video:
Each of The 8 Rules of Dividend Investing are listed below:
- Rule #1: The Quality Rule
- Rule #2: The Bargain Rule
- Rule #3: The Safety Rule
- Rule #4: The Growth Rule
- Rule #5: The Peace of Mind Rule
- Rule #6: The Overpriced Rule
- Rule #7: The Survival of the Fittest Rule
- Rule #8: The Hedge Your Bets Rule
The infographic below gives a concise rundown of each of the 5 buy rules. Keep reading for more detailed information on each of The 8 Rules of Dividend Investing.
Dividend Investing Rules 1 to 5: What to Buy
Rule # 1 – The Quality Rule
“The single greatest edge an investor can have is a long term orientation”
– Seth Klarman
Common Sense Idea: Invest in high quality businesses that have a proven long-term record of stability, growth, and profitability. There is no reason to own a mediocre business when you can own a high quality business.
Financial Rule: Rank stocks by dividend history and corporate history length (the longer the better). Stocks must have paid steady or increasing dividends through the Great Recession to be eligible for the Top 10.
Evidence: The Dividend Aristocrats (stocks with 25+ years of rising dividends) have outperformed the S&P500 over the last 10 years by 2.88 percentage points per year.
Rule # 2 – The Bargain Rule
“Price is what you pay, value is what you get”
– Warren Buffett
Common Sense Idea: Invest in businesses that pay you the most dividends per dollar you invest. All things being equal, the higher the dividend yield, the better. Additionally, only invest in stocks trading below their historical average valuation multiple to avoid investing in overpriced securities.
Financial Rule: Rank stocks by dividend yield. Only stocks trading below their 10 year historical average valuation multiple are eligible for the Top 10.
Evidence: The highest yielding quintile of stocks outperformed the lowest yielding quintile of stocks by 1.76% per year from 1928 through 2013.
Rule # 3 – The Safety Rule
“The secret of sound investment in 3 words; margin of safety”
– Benjamin Graham
Common Sense Idea: If a business is paying out all its income as dividends, it has no margin of safety. When a business downturn occurs, the dividend must be reduced. Another form of risk is purchasing overpriced businesses. Companies that are repurchasing large amounts of shares are generating large amounts of cash flows. When times get tough, the money spent in the past on share repurchases can be used to support the dividend instead, creating a margin of safety. Additionally, a company repurchasing its own shares is signaling that shares are undervalued (or at the very least, at fair value).
Financial Rule: Rank stocks by share repurchase yield.
Evidence: The S&P 500 Buyback Index has outperformed the S&P 500 by 2.54 percentage points per year over the last decade.
Source: S&P Buyback Index Fact Sheet
Rule # 4 – The Growth Rule
“All you need for a lifetime of successful investing is a few big winners”
– Peter Lynch
Common Sense Idea: Invest in businesses that have a history of solid growth. If a business has maintained a high growth rate for several years, they are likely to continue to do so. The more a business grows, the more profitable your investment will become.
Financial Rule: Rank stocks by earnings-per-share growth estimates. If earnings-per-share growth estimates are unavailable or unreasonable, then revenue-per-share growth or dividend-per-share growth estimates can be used instead.
Evidence: Growing dividend stocks have outperformed stocks with unchanging dividends by 2.4% per year from 1972 to 2013.
Rule # 5 – The Peace of Mind Rule
“Psychology is probably the most important factor in the market – and one that is least understood”
– David Dreman
Common Sense Idea: Look for businesses that people invest in during recessions and times of panic. These businesses will have a relatively stable stock price that will make them easier to hold for the long run.
Financial Rule: Rank stocks by their long-term volatility and beta
Evidence: The S&P Low Volatility index outperformed the S&P500 by 2.00% per year for the 20 year period ending September 30th, 2011.
Dividend Investing Rules 6 & 7: When to Sell
Rule # 6 – The Overpriced Rule
“Pigs get fat, hogs get slaughtered”
Common Sense Idea: If you are offered $500,000 for a $250,000 house, you take the money. It is the same with a stock. If you can sell a stock for much more than it is worth , you should. Take the money and reinvest it into businesses that pay higher dividends.
Financial Rule: Sell when the normalized P/E ratio is over 40.
Evidence: The lowest decile of P/E stocks outperformed the highest decile by 9.02% per year from 1975 to 2010.
Source: The Case for Value by Brandes Investment Partners
Rule # 7 – The Survival of the Fittest Rule
“When the facts change, I change my mind. What do you do, sir?”
– John Maynard Keynes
Common Sense Idea: If a stock you own reduces its dividend, it is paying you less over time instead of more. This is the opposite of what should happen. You must admit the business has lost its competitive advantage and reinvest the proceeds of the sale into a more stable business.
Financial Rule: Sell when the dividend payment is reduced or eliminated.
Evidence: Stocks that reduced or eliminated their dividends had a 0% return from 1972 through 2013.
Dividend Investing Rule 8: Portfolio Management
Rule # 8 – The Hedge Your Bets Rule
“The only investors who shouldn’t diversify are those who are right 100% of the time”
– John Templeton
Common Sense Idea: No one is right all the time. Spreading your investments over multiple stocks reduces the impact of being wrong on any one stock.
Financial Rule: Build a diversified portfolio over time. Use The 8 Rules of Dividend Investing to rank high quality dividend growth stocks. Buy the highest ranked stock of which you own the least each month to build your diversified portfolio over time.
Evidence: 90% of the benefits of diversification come from owning just 12 to 18 stocks.
Source: Frank Reilly and Keith Brown, Investment Analysis and Portfolio Management, page 213