The difference between reinvesting your dividends and NOT reinvesting your dividends is astounding. Dividend reinvestment is probably one of the most powerful things you can do for your dividend portfolio today…
How Often Can You Perform Dividend Reinvestment?
I hear you. As part of my dividend investing strategy, this is an exercise I perform every
6 months 3 months. After holding all my accumulated dividends on account. There are no hard and fast rules. Some investors carry this out every 3 months, 6 months or per annum.
For me personally, 3 months is a nice balance. There’s actually a bit of work in calculating and ranking every single company. Once a year is too long, as I miss out on all that lovely compounding.
Re the ranking system/ table, I know some investors pull data through Google Finance, but I prefer to carry this out manually. Google Finance feels too cumbersome, but please prove me wrong?
Anyway…I reinvest all my accumulated dividends, to TEN of my existing positions. These existing positions happen to be the highest-ranking positions, I own the least. To reiterate, I will reinvest these dividend funds into the top-ranking 10 stocks (i.e. the top 10), that I own the least (i.e. the smallest sterling amount stock in the top 10).
Also, if more than one dividend stock has a similar number of points. Invest in the smaller sterling amount stock. That’s why I include the current price column.
The Ranking System and Key Performance Metrics
For example, let’s take the end of Q4 2016 and talk more about the highest-ranking position. This happens to be Savilles (SVS)…highlighted in green. The key performance metrics I use in my ranking system are:
- P/E – Price to Earnings Ratio. This is used to determine how much investors are willing to pay for a stock, relative to the company’s earnings. The ranking system merits lower PE’s
- Dividend Yield – A financial ratio that indicates how much a company pays out in dividends each year relative to its share price. The ranking system merits higher dividend yields
- Payout Ratio – Payout ratio is the proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage. The payout ratio can also be expressed as dividends paid out as a proportion of cash flow. The ranking system merits a lower payout ratio
- Consecutive Annual Dividend increases (CAD) – This indicates the number of years the share’s total annual dividends have been increasing. It’s a measure of how reliable and resilient the company is, and highlights their ability to weather market turmoil. The ranking system merits a higher CAD
- Discounted Cash Flow (Intrinsic Value) – These calculations outline how an intrinsic value for a stock is arrived at by discounting future cash flows to their present value. Analyst’s estimates of cash flows are used going forward 5 years. Nothing is 100% certain with this model, but a good portion of my dividend stocks are in the black now using this technique. I look to buy companies that are trading at prices below what they are fairly worth, to provide that margin of safety. The ranking system merits a higher discounted cash flow
- 5 Year Volatility (Beta) – Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the expected return of an asset based on its beta and expected market returns. The ranking system merits a lower Beta
Note: With regards to actually picking a stock for my dividend portfolio, I apply a different analysis. But we can talk about that in another post.
How to Add Reinvested Dividends to Existing Positions
Let’s talk about Savilles (SVS) again. How did I arrive there? Why was it the highest ranking stock?
Well, I didn’t take a lucky dip. I use my ranking system.
Let me run through it:
1. Obtain the live price, for every dividend stock in your portfolio. Take from your brokers account. Enter in Column D.
2. Obtain the P/E, Div Yield (%) and Payout Ration (%) from a good stock picker. Enter in Columns E, F and G respectively.
3. Obtain CAD (consecutive annual dividend increases) from the dividend stock’s company website, under Investors and Dividend History. Enter in Column H.
4. Obtain the Discounted cash flow/ intrinsic value and 5 Year Volatility (Beta) from a good stock picker. Enter in Columns I and J respectively.
5. Use the points system (go to 2nd Tab on spreadsheet) and allocate them to columns K-P on the spreadsheet. For example, Savilles P/E was 14.9. From the points system, this falls in the 10.01-15 range. Hence, 4 points would be entered in Column K, in the ranking system. And so on.
6. Once you have allocated points for all the key metrics in columns E-J and entered their associated points in columns K-P, then total the points in column Q.
7. Work out the ranking and assign this in column A. The highest number of points is equivalent to the highest ranking position i.e. Savilles had a total of 18 points (highest number of points, hence was assigned the number 1 position and thus highest ranking stock in column A)
I also want to give a big shout to Sure Dividend and Retire Before Dad. They were the inspiration behind this ranking system, to capture the top dividend stocks in my dividend portfolio. It differs slightly from their set up, it’s more weighted towards parameters I believe will achieve my personal goals.
How to Add Cash Contributions to Existing Positions
Once I’ve added new positions and reached my limit of 30 core dividend stocks, I will also perform ADDITIONAL cash contributions. i.e. only after reinvesting my dividends during my build up to purchasing 30 dividend stocks, I will ALSO add Cash contributions to existing positions that are cheap. Again, I will use my ranking system to decipher which existing positions are better than fair value.
The cash contributions shall be allocated across several high-ranking stocks, as opposed to the one dividend stock. It wouldn’t make sense to sock, for example, 5K into one dividend stock (can you imagine if it nosedived). We want near to equal weightings across the highest ranked stocks.
Some dividend investors like to subtract from positions (sell off some shares) to keep an equal weighting. I don’t. I prefer to add to positions only.
I like to adhere to what is called the ‘Buffet Loan‘. By not subtracting i.e. not selling, I am in effect getting a loan from the government. What I mean is, I’m not having to pay capital gains to the HMRC (Her Majesty Revenue and Customs) and that money is kept invested. And more importantly, compounds over time.
Value Versus Weight
As I write this, I’ve only used my ranking system once. Hence, I never really needed to take ‘weightings’ into consideration.
My ranking system will pick out the best value dividend stock. But what if it’s overweight?
When I reach my core 30 companies, my average position size will be around 3.33%. For instance, if a specific position exceeds 6% (close to double the weight), I will stop adding cash to it….even if it’s the best value stock in my ranking system. I will then choose the next best ranking stock (ensuring it’s average or below weight).
And with regards to weightings, Hargreaves and Lansdown calculate this for me, which is a bonus. It’s not that difficult to perform, but saves me more time.
Reinvesting Dividends Versus NOT Reinvesting Dividends
With regards to reinvesting dividends and NOT reinvesting dividends. Let’s take one of the Dividend Kings, such as Proctor and Gamble. This is with NO dividends reinvested:
As you can see, if you invested $1000 over a time span of 30 years, you would net $17,916. That’s not too shabby.
But there’s a smarter way…The graph below is with dividends reinvested.
By reinvesting your dividends, you would have netted an EXTRA $22,285 over a 30 year period.
Some of you may be asking…Does this take into account rebalancing? How often was that performed?
What about periodic adjustment? i.e. adding or withdrawing fixed amounts etc.
These techniques are very important and will be discussed in another post.
But for now, I want to strip it all back and focus on dividend reinvestment.
And now you can see the magic of dividend reinvestment.
Of course, it’s important you pick a company with a reasonable stock valuation.Entering a low market or picking a low valued stock can seriously accelerate your wealth Click To Tweet
When stock valuations are lower, share repurchases (cash contributions) and dividend reinvestment buy more stock for the same amount of cash.
The key thing is investing in defensive, shareholder-friendly companies at reasonable stock valuations. And using your hard earned cash AND dividend income, pump all this back into your dividend growth portfolio (using a ranking system), to maximize your return on investment.
Now I would like to hear from you.
What were your biggest takeaways? How is your dividend reinvestment strategy working out for you?
Let us know in the comments…