Why dividend stocks could offer comfort in scary markets

Wednesday, Nov 01 2017 by
Why dividend stocks could offer comfort in scary markets

Halloween may have passed this year, but there’s still fear in parts of the market of sudden shocks and blood curdling drawdowns. A long bull run for equities has left some wondering whether prices could be slashed if confidence were to suddenly disappear.

Last week I wrote about how the present conditions are in some ways reminiscent of the run up to the nightmare crash of 1987. But while it’s easy to get spooked by uncertainty, there are ways to feel your way through the market and find shares that may offer better protection from the unknown. The latest data on dividend payments from UK companies, for example, is one area where there are reasons to be optimistic.

On the hunt for income

Dividends appeal to different investors for different reasons. For some, they’re a welcome bonus but not the priority. Take, for example, Robbie Burns who is well known for his ‘Naked Trader’ approach to buying growth stocks, but who sees dividends as simply a good way of offsetting tradings costs.  

But more typically, dividend income is the hallmark of the classic ‘Owner’ persona, that Ed talked about in his article here. For this type of investor, dividends are a clear route to compounding wealth over long periods. While the exact strategies differ, and dividend folios can be built in various ways, the objective is generally the same - to find stable income.

Since the EU referendum in June 2016 - and the devaluation of the pound that followed - dividend payouts have been in an interesting phase. That’s because a big chunk of them are either made in dollars and euros or paid by companies that make large profits in those currencies. With the pound falling in value, those payouts were worth a lot more to UK investors.

But this exchange rate effect couldn’t last. The issue that was always coming was that after 12 months of supercharged growth caused by weak sterling, the effect would disappear. Year-on-year comparisons wouldn’t pick it up any more because the rates have been stable for so long. And that’s exactly what we’ve seen in the latest payout figures for the third quarter - exchange rates made hardly any difference.

The predictions were that dividends would drift as things started to normalise. But that didn’t happen, and dividend payouts actually broke records over the autumn.

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28 Comments on this Article show/hide all

lightningtiger 4th Nov '17 9 of 28

I do not agree the most important safety factor is diversification, it has to be a stop loss. Taking BT as an example say £40k invested about a year ago and now would be reduced to about 25K and dropping! It is no good saying BT is a good company, it will come back up. By that time you have lost too much capital, if in deed it does come back up again a few months down the road.That is a wopping £15k loss!

In contrast BDEV over the same time frame with £40k invested has increased about 40% to around £56 and this last dividend payment is worth about 5% more on top or around £2.8K..So the total overall return is the increase in share price plus the dividend payment.
It is certainly no good waiting for the dividend payment when the share price is tanking down, wiping out your capital.
I take your point Stephen, you need to diversify into different sectors, but the number one safety factor has to be the stop loss to protect your capital..
I like the compound income portfolio and the score sheet that goes with it..
I can't get excited with one of my banks Lloyds only paying 3.3p, when they are making £billions in profits.

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lightningtiger 5th Nov '17 10 of 28

Thought iLloyds needed checking out and in fact it has only paid out 3.2p not 3.3P this year, the last dividend of just 1p paid on 27/9/17 and perhaps another 1p might come in May 2018. Hargreaves is showing a yield of 3.79%. So depending when you bought Lloyd's shares would depend whether you would get the dividend payments. If you only caught the last XD date for your 1p payment then doing the calculation of dividend payment / share price, say 67p = only 1.49%.
Doing the Dickin's "real deal" I say to Lloyds "come on Lloyds we need some more money or we go to auction".

The same calculation for BDEV bought @ just under £6 and paying out 34.4p gives just over 5.7%. Therefor simply checking for decent payers each month at about 5% gives a return of 60% PA.That 's the plan.
You also have to remember that there is no guarantees with dividends, they have to be declared first and then look for the XD and payment dates. Dividenddata.co.uk is a good place to look Good hunting.

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pka 5th Nov '17 11 of 28

In reply to post #236518

Hi Stephen Bland, you wrote: "It's okay to double up in a sector but provided then that you invest half your sector allocation to each so that together they cost just the same as a single share in the sector, but that is not what has been suggested here. Diversification and a minimum of 15 sectors massively overtrumps any other filter for a high yield portfolio."

If that's what you believe, I don't understand why you advocate a rule of never 'tinkering' with the portfolio, because over time the relative percentage of the various sectors is likely to drift far from the initial allocation, due to some stocks doing better than others in capital terms. So after a few years, what began as a well-diversified portfolio becomes a poorly diversified one. Surely it would be better, for the purpose of diversification, to rebalance the portfolio back to the original allocation between sectors every year or two.

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Stephen Bland 6th Nov '17 12 of 28

In reply to post #236663

...I take your point Stephen, you need to diversify into different sectors, but the number one safety factor has to be the stop loss to protect your capital...

Irrelevant in my view and possibly even dangerous as far as an equity income portfolio is concerned. Income investors using stop losses are likely to end up with just that  - losses.

The reason is that once purchased, an income share will fluctuate in value, you'll agree. That should not matter to the investor who is there for dividends. Or if it does matter to them, then we are not on the same page because I'm talking about very long term, hold for income, approaches where capital fluctuations are ignored.

A stop loss would easily force the investor out of a share for no reason other than poor sentiment or the general market background, whatever, has pushed down the price. I stick to big caps, FTSE100 mainly, and almost all of those shares that fall in value after purchasing for income have no fundamental reason to do so. The number that fall due to some serious, long term, dividend slashing problem with the company is far too small to justify stop losses as a general policy in this strategy.

Stop losses might matter, I'd agree, to traders but we're not talking about traders here, at least I'm not.

Having seen the results of many income investors over a very long time, something that perhaps others have not been in a position to observe, I am in no doubt that diversification is the single most important criterion in constructing a high yield portfolio. Surely that's just common sense so as to spread the risks of industry specific problems.

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Graham Ford 6th Nov '17 13 of 28

In reply to post #236923

"Surely that's just common sense so as to spread the risks of industry specific problems."

By holding 'for eternity' as you term it, if any of the industries where you have a holding do run into problems it ensures that you are there for eternity (the dividend possibly never recovering having been cut).

If we are going to reply on common sense then does common sense not suggest that there is a middle ground, between trading too often (by using stop losses that are too tight or for any other reason) and holding for eternity, which will perform better than both?

The main reason as I understand it that you want to hold for eternity and avoid stop losses is to avoid trading too often.  Why can avoiding trading too often not be achieved by simply having a rule that you trade just one holding every six months (or per year if you prefer) but only if there is another better yielding stock to replace it that passes all your other tests?

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tradebizzindia 6th Nov '17 14 of 28

In reply to post #235213

Hello Stephen Tasteless, you kept in touch with: "It's alright to bend over in an area yet gave then that you contribute a large portion of your segment allotment to every so together they cost only the same as a solitary offer in the part, yet that isn't what has been recommended here. Enhancement and at least 15 areas hugely overtrumps some other channel for a high return portfolio."

In the event that that is the thing that you trust, I don't comprehend why you advocate a manage of never 'tinkering' with the portfolio, on the grounds that after some time the relative level of the different parts is probably going to float a long way from the underlying designation, because of a few stocks improving the situation than others in capital terms. So following a couple of years, what started as a very much enhanced portfolio turns into an inadequately expanded one. Most likely it would be better, with the end goal of expansion, to rebalance the portfolio back to the first allotment between parts each year or two.

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Bonitabeach 6th Nov '17 15 of 28

In reply to post #236663

"Taking BT as an example" - It is very easy to extrapolate from the particular, but that does not always prove anything.

Personally, I do not use stop loss limits. It would be interesting to hear from those that do, how it worked for them after the Brexit referendum result and the election of Trump.


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Stephen Bland 6th Nov '17 16 of 28

In reply to post #236988

...Why can avoiding trading too often not be achieved by simply having a rule that you trade just one holding every six months (or per year if you prefer) but only if there is another better yielding stock to replace it that passes all your other tests?

It can. There are of course numerous ways and opinions on how to manage an equity income portfolio and not just mine.

The reason for my rules is that they were designed to overcome what I've seen as the weaknesses of many equity income investors such as inadequate diversification; permitting their own or others' long term forecasts to influence selection; overweighting sectors believed to have more potential; panic selling on short term news; over-concern about share price fluctuations and so on.

But as always with an off the peg design, it won't suit every single person but I believe it will probably suit most. If you think your version will improve long term results, defined in this strategy by long term income performance, then I wish you luck.

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dodge1664 6th Nov '17 17 of 28

Income stocks might do well if something bad happens, but what if the economy actually improves? I think most people would be better off with a selection of foreign and domestic index trackers.

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jjis 6th Nov '17 18 of 28

In reply to post #236518

Hi Stephen, you say - "Well, I've been writing about equity income investing and have personal experience of it going back a very long way." 

Well so does mine and while I would agree that diversification and low turnover are a great help in allowing returns from dividends to flow and compounding to work its magic, I wouldn't generally agree that you should neglect the portfolio forever as I believe is your suggestion. From my experience I remember perfectly respectable dividend paying stocks for example such as BTR, BT, GEC, Lloyds Bank, Sun Alliance & RBS all falling on hard times, slashing their dividends and destroying lots of shareholders capital along the way.

Your approach risks being caught by these (which I believe it was in the case of the banks) big changes, which if you keep on top of the portfolio, you may have some chance of avoiding.

Any way as you say plenty of approaches to income investing out there so each to there own and good luck.



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Stephen Bland 6th Nov '17 19 of 28

In reply to post #237138

...Your approach risks being caught by these (which I believe it was in the case of the banks) big changes, which if you keep on top of the portfolio, you may have some chance of avoiding...

That's why I stick to big caps which have a good chance of dividend recovery. Selective examples do not prove your point. If I did this I could show you many dividend-suspending shares that did resume payouts, including amongst those you mention BT and Lloyds, and many others such as Persimmon and BP.

Admittedly the waiting time and the resumption level varies a lot but I believe that on balance it pays to continue holding forever.

I know that many disagree and I accept that eternity holding is probably the most controversial aspect of my particular way of running an income portfolio. With experience too long to think about cos it reminds me how 'kin old I am, I have seen nothing to make me reconsider it.

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lightningtiger 6th Nov '17 20 of 28

Stephen, I don't need luck using stop losses. It keeps my losses to an acceptable minimum.As to keeping a share for a long time in your portfolio when it is dropping and reducing your capital has to be a bad move in my book dividends or no dividends. I will not allow it to happen in the first place.

We are supposed to be making some money and not letting our capital go down the drain. If you have 15 to 20 shares in a portfolio and one or two shares are falling in value by big amounts, surely it makes sense to replace them rather than to have a devastating effect on your portfolio.

The average return on Ben's 10 shares shown is only about 6.5%. Assuming you have equal amounts of say £10k in each share to make £100k portfolio. the hit from BT  means £10k is now only worth about £6,250 down £3750.

The dividends pay out £6,500, so that leaves the payout effectively reduced "worth" to less than half the payout when you could have stopped that loss in the first place.

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Graham Ford 6th Nov '17 21 of 28

Holding forever does not make sense for an income portfolio when the dividend is cut or discontinued and there are other better dividend payers around as income is not preserved nor is it maximised.

Hoping that dividends will resume or return to previous levels forgoes all the dividends that could have been received from another stock while waiting for the one where the dividend has been stopped or cut to resume.

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lightningtiger 6th Nov '17 22 of 28

Hoping that dividends will resume is like chasing rainbows, as a friend of mine once said. You have to nail them down before the XD date. VCP was supposed to resume paying dividends but that did not happen as yet.

Interesting to note that the 10 shares mentioned in the FTSE 100 only 5 have gone up over the year averaging +14.36%, but the other 5 have gone down by an average of -20.05%. the two worst "culprits" are BT @ -32.73% & CNA @ -21.6%. The two best shares are LGEN + 27.72% and IMB + 20.95%.

When we bring into the equation the "guaranteed"dividend payments of 6.5% it does have a big part in compounding the returns on the portfolio bringing the average gains to +20.86% and reducing the average loss to 13.05%.

By simply selling BT on a stop loss and replaced by BDEV, which is in the Dividend Dogs screen, (up 39.55%) would have made a huge difference in the total return.

Regarding holding for a long time as against a higher turnover of shares in a portfolio Mark Minervina, the US investing champion has proved that the power of compounding is better achieved with more smaller gains than less larger gains. The proven figures are as follows :-

Two 40% returnes = 96% return

Four 20% returns = 107% return

Twelve 10% returns = 214% returns

Before he enters a share he sets the stop loss and calculates the risk involved and when the target gain is reached it is sold, and simply repeats the process.

This sort of performance makes a dividend portfolio a bit sick, but still a place for investing this way.

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Stephen Bland 7th Nov '17 23 of 28

In reply to post #237383

Well LT, all I can say is that we are not on the same planet here so not much point in further discussion. My approach ignores capital fluctuations, trading and total return and concentrates exclusively on dividend income, whereas your comments show that you go for TR, you trade, and are very interested in capital gains. That's why you think stop losses work and why I think they have no place in my version of income investing. We're talking about two different styles.

I am not of course saying that I find anything wrong with going for TR, whatever rings your bell, but what you are doing is not really an income strategy. Mine is, so we are not discussing the same thing.

I go back to my original objection to the article, that the portfolio shown is inadequately diversfied and that - in an income strategy - diversification is the most important construction criterion of all.

In other approaches, for example value investing which is my own former trading strategy that I wrote about for many years, diversification is irrelevant. But income investors need the security of wide diversification above all.

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herbie47 7th Nov '17 24 of 28

In reply to post #237383

What has momentum trading got to do with income investing?

Minervini says he gets about half his stock picks wrong, he has an 8% stop loss, if he only makes 10% then he will not make much money. Income investing you are invested all the time, you will be getting dividends even in a recession, Minervini is not invested a lot of time, he has been mostly in cash the last few months because he thinks the market is too high. I believe he was out of the market for a number of years. It took him about 6 years before he started to make it work, quote "five or six years I did not make any money trading; in fact I was at a net loss."

What about all the dealing costs, spreads and stamp duty? Minervini invests in US small to mid caps.

To me it's like the tortoise and the hare.

Income investing you want to be picking shares that not only pay a dividend but also grow them. If you read about it you will see things like X shares has increased their dividend for 17 years running.

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lightningtiger 7th Nov '17 25 of 28

Stephen, we are on the same planet,and with regards to diversification I have not restricted myself to just the UK market FTSE 100 companies. I have used the US market as well as the UK that gives a much bigger choice of over 8000 to choose from and in spite of fluctuations in the exchange rate and higher dealing charges, double digit dividends are there for the picking. So perhaps I diversify rather more globally than you do by just sticking to the UK.
At the end of the day we are both seeking a decent income from the dividends. With the US monthly dividend payers, when the share price drops the dividend increases in payment so timing on entry can make a big difference. Thus when the market drops the dividend payments increase and become even more worth having.
Also with the tax cuts going through in the states, the prospects look a lot better,in my view for 2018 than here in the UK with the Brexit uncertainty going on at the moment. There is also some stocks from Israel in the portfolio that are pay decent dividends.So that is 3 countries at the moment.
AS for the average return on my dividend portfolio purely on the dividends, it is about 12.5% which I am reasonably happy with,but still room for improvement.

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lightningtiger 10th Nov '17 26 of 28

Hi Herbie, In answer to your question regarding momentum trading, I am not a trader, but I do invest like most of us do in momentum shares as well. The reason for a mix of both is that I can top slice with some that have made spectacular returns without affecting the overall general rise of the portfolio as a whole. It is no good top slicing too much out of the portfolio effecting the capital to such an extent that it effects the overall rise in capital content.
If you are careful with some shares that perhaps do not pay dividends at all, or even pay a small dividend then top slicing a few can give you a bit more cash in the bank to add to the other dividend income and then when the time is right buy another share or two. It gives another choice to draw extra income.from the portfolio.
Perhaps an example right now could be IQE where you could have top sliced between 5 to 15% today say but the main bulk of the capital, of IQE is kept in tact, and the general effect of your portfolio is still in good shape.

Minervini has put in thousands of hours into trading making loads of mistakes but in the end it paid off and he won the championship.
I first thought that getting 10% dividend income was impossible to get but the fact is ,it is possible and it can be improved on, and top slicing is another option to do it with.

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herbie47 18th Nov '17 27 of 28

I think many people are focused just on the current dividend. But income investing is a long term investment. A few that have done well are: Photo-Me International (LON:PHTM), share price up in 5 years over 3.5x, div. now 4.91%, 3.5 x 4.91% = 17.18%, £TW up 3.7x, div, 7.6% = 28%, Bioventix (LON:BVXP) 4.6x, Div 2.42% = 11.13% of course if you go back more years then dividends on capital invested can be much higher, take Taylor Wimpey (LON:TW.) again, over 9 years, shares up 24x, div 7.6% = 182%, so if you invested £10,000 then you would be getting a dividend of £18,200 per annum. 

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lightningtiger 20th Nov '17 28 of 28

Taylor Wimpey is a good example of how the dividends come to the rescue ,especially when the share price drops like it did last year 45% in 2 days from 192p to 115p or from a drop in capital of about 108K from 240k to 132k, scary stuff and has taken until October this year to recover. Also there was a big gap from June 2008 to June 2012 where no dividends were paid at all.. Would you have bought this as a dividend share at that time?
The magic of compounding comes in when the dividends are re invested.
All we need is a couple of dozen shares performing like that and we are sorted!

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