Dividend Investing: Two Common Questions?

Whenever I have a conversion about dividend investing, I get few different types of questions. It is very natural for people to ask questions. What is interesting is often these questions can be grouped into following two:

  1. If any dividend stocks in your portfolio become overpriced, do you sell?
  2. How many number of stocks do you need in a dividend portfolio?

Selling a dividend stock when it is overpriced? This comes from the thought process that say any of my dividend stock is overpriced by 1.25x or 1.5x. In that case, it is likely that the dividend I expect in 10 years, I may get by selling the overpriced stocks. Why wait for that long for dividends to trickle in?

When we think about it, it may appear to make sense. However, I believe we should build a portfolio based on certain objectives. In my case, my primary objective is to build a portfolio for growing dividends. And hence, I buy stocks for that objective. The characteristics of such stocks are such that I do not expect to see such wild swings as 1.25x or 1.5x or more. Assuming, if they do, it is an opportunity to buy at very good initial yields (and increase your YOC). Furthermore, I also expect that as dividends grow over next 10 years or more, the price of the stocks will also grow i.e. capital appreciation. Assuming the dividends keep growing, the capital appreciation is likely to much more than 1.25x or 1.5x. So dividend investing is not for standalone dividends only. It is also accompanied by capital appreciation. It is about total returns.

What is good number of stocks? It depends upon individuals. For me, I have limited my self to 5% maximum dividends from any single company. This is for managing risk of dividend cuts. So this gives me a minimum of 20 companies. However, I am comfortable keeping around 40 to 45 stocks in the portfolio. I do not have any reasoning why this is number. I believe I would comfortable following that many number of companies. There would few stocks in those 40 that would cut dividends and I will need to replace them. While some of them would continue to increase dividends.

What is your comfortable level of number of stocks?

This article originally appeared on The DIV-Net on January 21, 2010

2 Responses to “Dividend Investing: Two Common Questions?”

  1. Josh says:

    If we assume that dividends drive the stock price, there shouldn’t be a good reason to sell a stock with rising dividends. If we are expecting dividend cuts or elimination, or a stagnating dividend, either driven by poor acquisitions or low earnings growth, that poses a good reason to sell. There’s no reason to sell a perfectly good dividend stock though.

  2. Matt says:

    Good post.

    In my opinion, a good reason not to sell an investment even if it is currently overpriced is that taxation will reduce gains. When I’m considering whether to sell a long-term investment due to it being overpriced, I have to ask myself, is this stock so overpriced at the moment that even after I sell it and pay taxes on my capital gains, can I still identify an investment that will give me better gains with my tax-reduced cash? Only if the answer is yes (and with an extra margin of certainty to make up for the hassle) do I sell my current investment and buy the other investment.

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