Wednesday, May 29, 2013

Diversification the Key to Our Dividend Investment Strategy

Our main strategy for generating post-retirement income is to attempt to live off the dividends from our stock holdings. In our book "Retired at 48 - One Couple's Journey to a Pensionless Retirement", we describe in detail how we try to reduce risk through diversification.  For example, we buy many different stocks in various sectors and set limits for the amounts we would hold in each stock depending on market capitalization, setting lower limits for smaller, riskier companies and higher limits for larger, blue chip companies which are presumably safer and have a history of raising their dividends. 

The book also describes how we use the Globe and Mail Watchlist tool to check on the performance of our stocks.  In particular, we regularly monitor the dividend amount for each of our stocks, prepared to take action if necessary if one of them declares plans to significantly cut their payout.  Since we started with our dividend strategy many years ago, a majority of our stocks have raised their dividends, some of them multiple times on a regular basis.

Recently we did have one of our stocks take a relatively large dividend cut.  We purchased a small-cap stock in the health industry called CML Healthcare (CLC-T) in an attempt to diversify into different sector from the financial, telecommunications, energy, utilities and REITs that we are mainly concentrated in.  Based on our strategy of limiting exposure to smaller companies, the shares we acquired accounted for only about 1% of our portfolio.  At the time of purchase, it was paying a relatively generous yield of over 7%.  For various reasons, the company's earnings declined to the point that the dividend payout was no longer be sustainable.  This resulted in the share price plummeting by over 25% and the yield rising to an unreasonable level of over 11%.  The writing was on the wall that there would be a cut in the dividend, so we evaluated our options. 

We realized that even after the proposed 30% dividend cut from $0.75/share to $0.53/share, the yield would still be higher than most of our other stocks.  Because we owned so little of this stock, the net loss in dividends did not noticeably impact our annual dividend income.  Selling these shares would generate a capital loss that was significantly larger than the minor loss in dividends, and there was no clear replacement stock that could do better.

So in this case we decided to continue to hold the stock.  Our dividend strategy is designed so that no dividend cut in any single stock should create a major blow to our portfolio.  So far, this has worked out well.

We also encountered two scares that turned out to be false alarms.  The first was when it appeared that Telus (T-T) had cut their dividend by 50%!  Further investigation showed that Telus had actually executed a stock split.  So although their dividend payout was now 50% less, we also owned double the number of shares, each worth half the price.  The net result was the same... phew!

The second scare came from a data error from the Globe and Mail Watchlist.  For one solid week, both the Watchlist and the Saturday Globe and Mail business page showed that Cineplex Inc. (CGX.T) had dropped its annual dividend from $1.35 to $0.48, changing the yield from 4.2% to 1.39%.  This didn't make sense, since there was no news announcement or drop in share price (which usually accompanies a significant dividend decrease).  Checking both Cineplex's corporate website and other websites such as Reuters indicated that the Watchlist data was not correct.  In fact, rather than dropping their dividend, Cineplex has announced they would raise their dividend to $1.44.  We contacted Globe and Mail's globe investor support and advised them of their data error, which has since been corrected.  Another bullet dodged!

All in all, our buy-and-hold dividend strategy for generating retirement income continues to work well for us and we are insulated from the impacts of rollercoast stock prices as long as we continue to concentrate only on the stability of the dividends. 

Our recent experiences also accentuate the importance of paying close attention to your portfolio and being prepared to take action to re-balance when necessary.

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