Income Investing: How To Select The Right Stocks To Build A Sustainable Dividend Income Stream
This article was written in partnership with The Fifth Person. Views expressed in the article is the independent opinion of DollarsAndSense.sg
Many Singaporeans aspire to live financially-free – not having to rely on the salary our job pays to sustain our current standard of living.
To achieve this, we have to live prudently and save regularly. However, both of these are still insufficient on its own. This is why we need to get our money to work harder for us – by investing.
Even as we invest our money, we have to understand our own investment objectives. We cannot blindly follow or copy someone else just because they are successful, without asking ourselves whether their investment objectives and approach makes sense for us.
Understanding Why We’re Investing
Around the world, there are many investment approaches that may be very effective, but not all may be suitable based on our investment objectives.
One method is growth investing, where investors try to spot and invest into companies that are primed for growth in the mid- to long-term. It’s not uncommon to sometimes find that some of these companies are still loss-making, generating limited revenue and profits as they seek to ramp up growth.
Companies facing these scenarios typically cannot pay out high dividends, if any, as they try to build their business. The reason why investors still want to invest in the right growth companies is to be able to enjoy a very good rate of return once these companies start delivering results.
Another method is value investing, where it really doesn’t matter if a company has a stable business model or are just starting out. What matters is that the market is currently underpricing the company, and we spot scope for price appreciation in the future.
If we’re trying to build an investment portfolio that may eventually replace our salary from our jobs, income investing or dividend investing may be more suitable. This means we should invest in companies that are able to regularly pay out dividends. In turn, we can start living off these payouts, or we could reinvest these payouts to attain higher dividend payouts in future years.
The next important thing we need to do is to select the right companies and invest in its stocks. Here are a few ways we can narrow down the suitable stocks to add into our income-generating portfolio.
#1 Companies With A Long Track Record Of Paying Dividends
One of the easiest ways to begin narrowing down potential companies that you should invest in includes find out which companies have been paying good dividends over the years.
There are many ways you can get this information – logging on to SGX’s StockFacts portal to screen for companies with a good dividend yield, doing some desktop research on investment-related websites (like The Fifth Person or DollarsAndSense) or you could even ask your friends who are currently investing in dividend stocks.
After shortlisting some possible companies to invest in, you still need to do more research on your own. Look into the company’s annual reports and announcements to check if they have been paying dividends on a regular basis over the years, and judge if they are able to continue doing so.
You should also find out if these companies were able to continue paying stable dividends during past financial crises or industry downturns, or if they were forced to reduce their dividend payouts when the going got tough. That’s not to say it’s a bad thing, especially if they were able to ride out the downturn and increase dividends to previous levels or even higher.
These companies tend to be blue-chips that are part of the Straits Times Index (STI) and companies with a large-market capitalisation or a natural business advantage in their industry.
#2 Companies That Have Increased Dividends Over The Years
Companies that have the ability to increase their dividends over the years are strongly signalling their business aptitude and confidence in their future growth. Again, resources for research include SGX’s free stock-screener, StockFacts, and the individual companies’ own Investor Relations portals.
You should look into individual companies’ annual reports and past announcements to understand how much they’ve been paying out in dividends over the years, and whether they’ve been able to increase their dividends over the years.
Going even deeper into this, you could look into whether this increase in dividends has been on the back of improvements in their business, revenue and profitability over the years, rather than just because they have stopped trying to reinvest into their business.
#3 Understand Financial Ratios
Thirdly, you need to learn some simple financial ratios to evaluate companies. Rather than simply invest in companies that pay out the highest dividends at this current point in time, these ratios can give you greater insights into the companies.
Some simple ratios you should learn include Dividend Yield (Dividend Per Share / Share Price); Dividend Payout Ratio (Dividend Per Share / Earnings Per Share); and Current Ratio (Current Assets / Current Liabilities). Click on the links to better understand what these ratios mean.
These simple financial ratios let you dip your feet into analysing financial ratios, and can spur you into learning about more complex ones in the future. While doing this, you could also pay closer attention to companies’ free cashflow and debt levels.
#4 Diversifying Your Investment Portfolio
As you shortlist suitable companies to invest in, you also need to ensure that your portfolio remains well diversified. This means you don’t put all your eggs into one basket, no matter how attractive that basket looks.
The main reason behind this is because all your research is on the basis of companies that are still in existence. Many companies, which may have displayed good investment thesis in the past, are either no longer around to be researched or don’t even show up in your shortlist as they no longer display attributes of good investments.
Apart from investing in different companies, you can further diversify into real estate investment trusts (REITs), country indexes, such as Singapore’s Straits Times Index, and even bonds. These are investment classes that can also deliver returns on a regular basis.
#5 Always Monitor And Rebalance
Remember we said that your research may not even show companies that used to display all the positive attributes of a good investment but no longer does? This is why you need to continue monitoring and rebalancing your portfolio regularly – because some of the companies you’ve invested in may change in business direction, fundamentals or have lost certain competitive advantages that initially drew your interest to invest.
This may include companies embarking on new business expansions, reducing dividends or facing strong headwinds in their industry. Other companies could also be displaced by innovation and new technology from competition.
Building A Stable Stream Of Income To Replace Your Salary
Even if your objective isn’t to replace your salary and retirement today, you will be reducing a lot of your stress and worries in life by simply setting in place an additional income stream. This means you can be free to do your best work, afford to switch to a more meaningful role (when required), or even take some time off to look after your loved ones if the need arises.
Investing in stable and strong companies offer you an in-built hedge to inflation at the same time. Strong businesses will always provide valuable services that people seek, and to remain profitable, they will always pass on costs to customers.
This means that even as Singapore gets more expensive, our investments in these strong businesses will remain relatively sheltered from inflation. Of course, we need to continuously monitor our investments to ensure this train of thought is actually accurate.
Get Started On Your Dividend Income Investing Journey Today
To help you get started on your income investing journey, you can sign up for Dividend Machines, an affordable course that takes you through the ropes of identifying solid and stable dividend stocks and REITs in Singapore as well as in Malaysia.
Run by the guys from the popular stock investment website The Fifth Person, Dividend Machines is a course that runs once every six months, with registration for the next course closing on 18 March 2018.
At just US$297, it is reasonably priced course that can help anyone who wants to get started dividend investing the head-start they need.
On top of what we’ve listed above, Dividend Machines also teaches you how to spot the best types of businesses for such investments, how to spot red flags and the best time to buy and sell such stocks.
If you are keen to get started on dividend income investing, we recommend that you check out the Dividend Machine website first to understand what is it that you will be learning. At the same time, we also encourage you to read the articles written by the Fifth Person, who are the guys running this popular investing course, to see if you are able to relate to the kind of investing approach and mindset that the team has.
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