A Multistage Rocket Model For A Dividend Growth Stock Portfolio

rocketshipI view the construction of a portfolio of high-quality dividend growth stocks as a lot of fun, and something of an adventure all in itself. Now, I’ve made my fair share of mistakes over the years, and I’ll likely make many more before I’m all done. But I suppose that’s some of the fun, and every mistake makes me a more experienced investor.

One experience of note is that it’s possible to think of your portfolio as a rocket ship with multiple stages, each of which propel your portfolio in different ways. Each stage has its own unique engine, and each of these engines is comprised of different types of dividend growth stocks with different yield and growth characteristics to serve different purposes within the portfolio.

I’ve found that there are three general classifications of dividend growth stocks. Now, these aren’t hard and fast rules, and some stocks can move from one classification to another as companies mature and/or change, while other stocks may be a blend of more than one category at a time. But you’ll find that most stocks will fall under one of these three categories.

Stage 1 – High Yield, Low Growth

So if one were an engineer building a multistage rocket, the first thing you need to do is make sure the thing can actually get off the ground. And that’s where stocks that have a higher starting yield fit in. These stocks get your dividend income off the ground and into the lower atmosphere.

You see, stocks that have a higher entry yield provide plenty of propellant to really get your passive income rocketing from the get-go. While many stocks with a higher initial yield have lower growth profiles, the current income these types of stocks can provide allow a dividend growth investor plenty of regular, fresh cash with which to reinvest into other areas of the portfolio. Keep in mind you wouldn’t want your entire portfolio to be allocated to Stage 1 stocks only because the lower growth means your income will have a hard time keeping up with inflation over the long term.

So you might be able to build a nice Stage 1 chock-full of higher-yielding stocks and use that income to bolster your holdings in other stages. Typically, you’ll find stocks that fit well in this stage come from telecommunication companies, real estate investment trusts, utilities, and master limited partnerships, among other areas.

A couple of stocks that might provide the propellant to get things off the ground include:

AT&T Inc. (T) – Provides a 5.26% entry yield on shares right now. However, a five-year dividend growth rate of just 2.4% is barely treading water when it comes to increasing your purchasing power. But 30 years of dividend increases and a 53.6% payout ratio means this telecommunications giant is likely to continue increasing dividends for the foreseeable future.

Realty Income Corp. (O) – Offers investors a 5.04% yield on shares based on the current price of $43.47 per share. And 20 years of dividend increases on the back of ever-increasing funds from operations (a measure of profitability for a REIT) gives me plenty of confidence that the payout from this real estate investment trust should continue rising for years to come. However, a five-year DGR of just 4.8% is the trade-off for the higher yield.

Stage 2 – Moderate Yield, Moderate Growth

Stage 2 stocks offer a more moderate yield and growth profile, and if you’re busy reinvesting your heavy dividend income from the big payers in Stage 1 into these companies you’ll find yourself rewarded well. These stocks can take you from the lower atmosphere into the stratosphere and beyond with their more attractive growth profiles.

This is the “bread and butter” of many dividend growth portfolios, with mine being no different. Stocks that offer yields of between 2.5% and 3.5% or so offer moderate current yield, but also offer pretty attractive growth rates. You’ll often find many of the stocks in Stage 2 have dividend growth rates of 7-12%, which means your purchasing power increases well over the rate of inflation over time, allowing you to compound your wealth over and over again as you reinvest this income.

The reason these stocks typically don’t have sky-high yields is because investors tend to bid up the stocks to the point where the yields aren’t as attractive as some of the stocks you’ll find in Stage 1. And this is because they offer a lot of attractive qualities. Many of the companies that are able to grow dividends by 7-12% per year for decades on end have wonderful business models and sell products and/or services that people across the entire world want and/or need every single day. Think beverages, food, toothpaste, gas, cleaning supplies, toilet tissue, and literally bread and butter.

While many of the companies you can invest in that offer moderate yield and growth have great business models that are easy to understand and also sport lengthy dividend growth streaks, the trade-off is that neither the current yield nor the growth rates are particularly earth shattering. There are benefits and drawbacks to anything in life, but because many of these businesses are very defensive and traditionally deliver stable and secular profit growth, my portfolio is allocated heavily to stocks in Stage 2.

Two stocks that are great picks to get you into the stratosphere when Stage 1 growth doesn’t offer enough include:

The Coca-Cola Company (KO) – The world’s largest and most well-known beverage company offers investors an attractive yield of 3% right now, and that yield is backed by a five-year dividend growth rate of 8.1%. So you can see that you’re getting a pretty decent yield to start with, but the growth rate well above inflation is where a lot of the value is. Plus, they offer a very easy-to-understand business model, and 52 years of dividend increases is one of the most impressive currently available.

The Procter & Gamble Company (PG) – A consumer goods powerhouse that boasts 25 $1 billion brands and products in more than 180 countries, this is about as stable a company as one can invest in. The 3.23% yield on shares right now is pretty solid considering the low risk that you’re taking on when investing in PG. The company has given shareholders dividend boosts for the last 58 years, with a five-year DGR of 8.8%.

Stage 3 – Low Yield, High Growth

Stage 3 is perfect for down the road when your portfolio is comfortably off the ground and well into the stratosphere. While you’re cruising around thousands of feet off the ground, you’ll eventually want to get into outer space. And the growth these stocks can offer can do just that.

I personally don’t have a lot of allocation to these stocks myself, and that’s because I’ve been busy getting my dividend income off the ground and into the stratosphere. But now that I am up there I’m also interested in adding a better growth profile to really push my income growth possibilities. While many of the stocks in Stage 3 do not offer a lot of current income, their potential for huge dividends down the road means you’re trading off dollars today for even greater dollars years from now.

The big question, however, is whether these stocks can grow as fast as they may indicate. Potential is one thing, but living up to it is quite another. As such, I’ve tended to gravitate towards a little more bird in the hand, while also leaving a little in the bush as well. But I also know that many of the stocks that are currently Stage 2 stocks were once Stage 3 stocks that eventually slowed down. The key is to latch on to these stocks early enough to not only capture that eventual maturity and stability, but also that early growth as well. I would say that picking and valuing Stage 3 stocks is a bit more difficult because you’re doing a lot more forecasting.

I’m currently looking at adding a couple Stage 3 stocks to my own portfolio now that I’ve got plenty of exposure to high-quality dividend growth stocks that are pumping out thousands of dollars in dividend income.

Two stocks that offer lower current yield, but plenty of potential growth include:

Visa Inc. (V) – A global payment processor and one of the premier companies one can possibly invest in. A flawless balance sheet and a ton of growth over the last five years makes this an attractive investment candidate. The entry yield of just 0.76% means any current dividend income is negligible, but the company has a five-year dividend growth rate of 45.9%. Mighty impressive, but one has to balance that current income against expected growth, and therein lies the risk.

Starbucks Corporation (SBUX) – A global coffee retailer that currently operates in 60 countries, and perhaps the most well-known coffee marketer around. This company has grown like gangbusters, and investors who bought in five years ago are now doing very well. The stock offers a yield of just 1.39% right now, and they’ve only been paying and raising a dividend since 2010. But since then the company has raised its dividend four times. The compound annual growth rate in the dividend over the last four years is 26.98%, which is very solid. The question is whether they can maintain this growth and will they be the next Dividend Champion with 25+ years of dividend growth?

Conclusion

I’ve personally experienced the benefits and drawbacks of stocks in all three stages. I’ve allocated most of my portfolio to Stage 2 stocks because I feel they offer the best blend of current income and growth for future growth in that income as well, but the other stages offer unique characteristics that can be really attractive depending on your individual needs as an investor and the goals you’re attempting to attain.

Keep in mind that you can build a rocket to your specifications. You are your own engineer! If you’re an older investor much closer to retirement then you might want to focus more on Stage 1 stocks. You need more current yield which will generate more dividend income to pay your expenses now. The future growth of that income doesn’t matter quite as much, but it’ll be helpful if you can at least keep up with inflation to keep your purchasing power intact. Conversely, if you’re a really young investor then you might want to sway your interest a bit more toward Stage 2 and especially Stage 3 stocks as you have plenty of time for the growth stories to play out and eventually attain huge annual dividend income totals because you’re runway for takeoff is so long.

I’m personally aiming to become financially independent by 40 years old via the dividend income my portfolio generates. Therefore, it’s imperative that my portfolio not only generate sufficient current income which I can live off of in just eight years (I’m currently 32), but also must be able to grow that income enough so that inflation doesn’t eat into my purchasing power. Thus, I’m interested in selective opportunities in Stage 3 stocks as valuations make sense. Currently, I think Visa Inc. (V) is an interesting opportunity.

Full Disclosure: Long T, O, KO, and PG.

What about you? Do you have allocation to all three stages? Do you prefer one over the other? 

Thanks for reading.

Photo Credit: digitalart/FreeDigitalPhotos.net

Comments

  1. Aspenhawk says

    Yep DM, as I am a lot less younger than you, I will be long in T very soom. How do you see the valuations for HRS and OHI today ?

    Your post is very useful, thanks.

    • Ravi says

      T has been very interesting. It was one of the first stocks I bought in 2012, but has been quite a lag over the past few years. My initial hope was that I could count on solid single digit returns from 5-8% for the foreseeable future.

      Given it was yielding around 5.5% at the time (and just a bit below that today), it’s less than 3% that I would need in capital appreciation each year to hit a very solid total return.

      I think the “rocket” analogy is a great analogy for stocks like T (VZ as well), and to a lesser extent a utility like SO, which are great stage 1 companies to get the dividends flowing.

      It was tempting to sell T when it was up high in the $37-38 range, but I figured I have more to gain than lose (even though it’s closer to $34 now) over the long term.

      We shall see!

    • says

      Aspenhawk,

      The valuations for HRS and OHI both appear fair to me. HRS has been one of my best investments to date, and it’s been very shareholder friendly. And they’re actually due for a dividend increase here in August. So that payout is set to rise here pretty quickly.

      OHI has run up a bit since I bought in, but I still think it’s fair here. The yield is generous, and they’ve been one of the most aggressive dividend boosters in their space. The demographics favor them and they’re on solid financial footing.

      Although, with your time frame you might be better served with OHI over HRS due to the current yield.

      Best regards!

      • SR says

        Hi. I was just wondering if you could tell me what the total amount is that you have invested out-of-pocket as of the June 1st portfolio spreadsheet. Don’t include dividends. I’m just wondering what you’ve put in to date. I tried to find the info myself but if it’s there I’m missing it.

        Really enjoy the blog.
        Thanks.

  2. says

    Great discussion regarding the 3 stages. I actually only focus on the first two stages, and I beat myself up because I didn’t buy into Tesla when it was around 30 bucks. I like the security of the dividend stocks / mutual funds. I guess I don’t like too much risk. I would probably prefer Starbucks stock even though I am not a Starbucks drinker.

    • says

      RichUncle EL,

      You really nailed it there with the risk. The stocks in Stage 3 tend to be riskier simply because the valuations tend to be a bit richer and there is uncertainty regarding growth rates. And the low yields offer much less cushion. However, that trade-off is the possibility for greater capital gains and more aggressive dividend growth. Always trade-offs.

      I tend to stock up (pun intended) on Stage 2 stocks the most simply because the risk-adjusted returns usually make the most sense. However, there’s a time and place for the others.

      Cheers!

      • says

        “However, that trade-off is the possibility for greater capital gains and more aggressive dividend growth.” I would add that this aggressive dividend growth could lead to an impressive yield on cost. (Yield on cost is a concept that receives too little attention IMO.)

        • says

          Jake,

          I’m actually perhaps in the minority as I don’t track YOC or find much use in it.

          If I have a stock that has a YOC of, say, 10%, but the current yield is only 1%, and I could transition that capital into a stock yielding 3%, my dividend income would automatically triple from the capital being tied up. So there is opportunity cost at work there.

          I think of YOC as a “feel good measure”, but has no practical use. It’s wonderful to have a big YOC, and one would be hard pressed not to have one if they hold on to a dividend growth stock long enough. But to say you’re better off with a stock with a high YOC but low current yield (due to a high valuation) than another stock with a higher current yield might be shortsighted. Of course, one has to factor in tax implications and opportunities elsewhere as every potential investment competes with every other available investment.

          Best regards!

          • lou says

            Are you kidding me?? If you plan on being an “expert” and leading blog followers into investing, you better do all of your homework.
            Yield on cost is probably the most important metric of current income.

            Yield on your original capital is the ONLY thing that matters.

            • says

              DM has a point here. Let’s say you really do own a stock that is currently yielding 1% with a yield on cost of 10%. This means you would be receiving $1 a year for every $10 originally invested. If there was a company with equivalent fundamentals and growth prospects you would greatly benefit by trading the 1% yield for the 3% yield. Why? Because the current dividend of $1 a year would be immediately increased to $3 a year giving you an effective yield on cost of 30%. Yield on cost is important but it has to kept in perspective. (When I made the yield on cost comment I was thinking of a less extreme case. Something like a current yield of ~3% with a yield on cost of ~5%.)

              • dizzy7 says

                “DM has a point here. Let’s say you really do own a stock that is currently yielding 1% with a yield on cost of 10%. This means you would be receiving $1 a year for every $10 originally invested. If there was a company with equivalent fundamentals and growth prospects you would greatly benefit by trading the 1% yield for the 3% yield. Why? Because the current dividend of $1 a year would be immediately increased to $3 a year giving you an effective yield on cost of 30%.”
                —————
                Maybe I’m looking at this incorrectly, but I don’t think that yours or DM’s math is accurate. If you had invested $100 in a stock and your current YOC is 10%, that means you are collecting $10 in dividends. If you sell that stock and invest the $100 proceeds in a stock that currently yields 3%, your dividend would DROP from $10 to $3, not increase to $30. The only way your dividend would increase to $30 is if the value of your original stock had increased to $1000 and you invested the entire amount in the new 3% yield stock.

                • says

                  dizzy7,

                  You’re confusing current yield with YOC. If you invest in JNJ for 10 years and have a YOC of, say, 8%, do you think the current yield will also be 8%? The odds of Mr. Market allowing anyone to buy JNJ at a yield of 8% is extremely unlikely. That would imply a current price of $35 based on the current dividend. So you can see how unlikely this is with a lot of stocks, unless you’re starting out with a yield of 8% like ARCP.

                  So the premise is that YOC is a metric you might use, but it’s not really helpful in determining the best current investment for your capital. Typically, a high YOC also comes with a lot of capital gains. And whether or not you harvest those gains really depends on a lot of factors. But YOC shouldn’t be a major consideration, in my opinion.

                  I hope that clears it up!

                  Best regards.

                • Ron L. says

                  Let’s do an easy real world example.

                  Let’s say I bought 1 share at $100 invested with lets say a typical 3% dividend = $3 dollars a year in dividends.

                  Now, a few years later our stock is yielding 1%, but on YOC is 10%.

                  So 10% yield on cost = $10 in dividends on our original $100 invested.

                  That translates into a stock price of $1000.

                  $1000 x 1% dividend = $10.

                  So DM thesis is, I have now $1000 worth of stock. What is the better investment now. Stick with what I have yielding 1% or redeploy the $1000 asset into a higher yielding stock given my current goals.

            • says

              lou,

              I disagree that “Yield on your original capital is the ONLY thing that matters.”

              I tried to make my point above, but the current yield on the actual capital at risk is what will determine your current income. Your YOC is a metric that might make you feel good, but can blind you from the truth of what income you might be able to receive elsewhere.

              Best regards.

            • says

              “Yield on your original capital is the ONLY thing that matters.”

              Reducing valuation and analysis to one single number is the root of all financial evil.

              • says

                S.B.,

                I agree. Personal finance is so complicated and nuanced, and that’s especially true with investing. Trying to boil everything down to one metric is really just impossible.

                Cheers!

  3. says

    Enjoyable post as always.

    V is on my watchlist for my IRA (I’m 36), wondering what 23+ years of time will do with that!

    Got in on SBUX at 56.95 a couple years ago, when I still didn’t know what I was doing. Ended up being a good move, and I plan to hold on for a long time.

    • says

      Matt Griffin,

      Great job there on SBUX. I think that company still has a lot of room for growth, and coffee is damn near addictive. So you’ve got a lot to like there, and they’re continuously expanding into other areas that make sense for them. SBUX and V are among my favorite plays in the Stage 3 space.

      Glad you enjoyed the post! :)

      Best wishes.

  4. says

    Long time reader, first time commenter here. Great article, Jason. I like the differentiation between each type of DGI stock. I can definitely see the reasons for having each type in one’s portfolio depending on personal circumstances. I’ve gotta say though, you can’t go wrong with those bread and butter stocks – it’s hard to go wrong with solid initial yield and moderate growth of the dividend over time.

    • says

      Old Man Mase,

      Thanks for your readership! And I appreciate you taking the time to stop by and leave a comment. :)

      I’m with you there. Stage 2 typically offers you the best risk-adjusted returns of them all, and that’s where the bulk of my personal wealth is stashed. However, I think stocks in the other stages make sense depending on your age and how much income you may need right now and in the future. But, overall, it seems the benefits and drawbacks are aligned well with Stage 2 “bread and butter” stocks.

      Best regards.

  5. says

    I haven’t ventured into stocks yet (which are part of the reason your articles are so helpful) but I think I’d stick with stages 1 and 2 to begin with :)

    • says

      Nicola,

      If I were starting all over again that’s where I would look to as well. The risk is a bit elevated with the Stage 3 stocks, so someone just starting out may not be in the best position to properly asses that risk. Furthermore, it might be difficult to stick to the strategy if you’re getting $1 dividend checks here and $2 dividend checks there. The tangibility of collecting a few more dollars goes a long way.

      Best of luck as you start your journey. :)

      Take care.

  6. says

    I’m edging rather close to retirement, so I’m focused on the first two. I don’t feel like I want to wait around for Visa to give me a decent dividend. It certainly makes sense for a younger person though. Twenty years from now, a high DG stock could pay off handsomely. You’re doing great work, Jason.

    • says

      Steve,

      I’m totally on the same page as you. If I were closer to retirement I’d rather focus on current income, while still keeping a watchful eye on growth and inflation.

      I’m in an interesting spot as I’m still young at 32, but due to my desire to become financially independent at a young age I only have eight years until I want to live off of my dividend income. As such, I probably focus on Stage 1 and 2 stocks more than other investors in my age range. However, I think I’m eventually going to allocate a bigger percentage of my portfolio with a couple of low-yield, high-growth stocks like V. I might have room for two or three stocks like this when it’s all said and done.

      Best wishes!

  7. says

    Literally just stated this month buying dividend stocks using Sharebuilder in a new taxable account. This will be separate from my Vanguard retirement IRA and Roth IRA. I am making only one purchase at a time and I am sticking to qualified dividend stocks only. This means not buying etf’s, mlp,s reit’s, or anything else I don’t fully understand. So far here is what I have bought:

    Chevron – CVX
    AT&T – T
    Southern – SO
    and today bought Target – TGT

      • says

        JLH,

        I’m currently looking at BAX, V, SBSI, and DE. I’m most likely going to be adding to my position in BAX or initiating a position in V in the coming days. I’m leaning towards BAX right now.

        I hope that helps!

        Cheers.

          • says

            LiveNotWorkForever,

            Well, I’m lukewarm on DE. I still don’t think it’s a particularly great time to invest in DE because of headwinds over the next couple years, but I’m investing for the next 2-3 decades or more. And looking out over that kind of time frame I suspect DE will do very well as the global population climbs and demand remains high for their products. I have a hard time imagining that technology will rapidly change traditional farming in the next decade or two, so I suspect they’ll be fine. But falling commodity prices and strong sales over the last cycle means earnings will likely fall for the next couple of years. We’ll see!

            It’s certainly not my top idea, but I don’t think it’s a bad long-term investment here.

            Best wishes.

    • says

      J,

      Wow! Congrats on making the jump into investing. It’s a bit scary at first, but everything has a learning curve. It seems you’re already a bit up the curve with your recent purchases.

      Looks like some solid buys there. I think TGT probably offers the best value right now, as it’s been extremely beaten up. Without all of their recent troubles you’d have to imagine that stock would be well into the $70s.

      That’s a solid mix of yield and growth there, with TGT and CVX providing you the growth and SO and T providing a bit more current income. Nice job!

      Take care.

  8. says

    I actually own all of the stocks you mentioned here. I’m trying to lean mainly to the stage 2 companies and then sprinkle in some stage 1 and stage 3. The stage 3 is definitely for the long-term because the current yield isn’t anything great to start off. But most of the stage 2 companies started off as stage 3 and I’m hoping to have picked 2 long term winners in V & SBUX. While stage 1 companies are great for current income I’m curious how well they’ll do in the long term given the low growth rates typically associated with them. It’s definitely a balancing act to figure out the right mix but I think having the majority of your portfolio in stage 2 will do great.

    • Ravi says

      I think you also have to consider how well you do with whatever you reinvest (i.e. if you receive $5,000 in dividends over 10 years from T, your true return isn’t just the $500 in dividends, and the capital appreciation in T… it’s also the dividends and capital appreciation from whatever you buy with those reinvested dividends).

      It’s like playing with the house’s money! At least, that’s how excited I get about it. :)

    • says

      JC,

      I use the same basic strategy – mixing in a little Stage 1 and 3, but leaving the bulk of my holdings in Stage 2 stocks.

      Nice job with V and SBUX there. I’ll likely join you as a shareholder at some point here. I’m actually looking at V right now. I just wish that yield was a tad higher and the valuation just a bit lower. But I think, overall, V is pretty fairly priced here. I ran it through a two-stage DDM analysis and the price appears fair.

      I agree it’s a balancing act, with that balance being partially determined by how close you are to retirement. I suppose that’s part of the fun! :)

      Cheers.

  9. says

    DM,

    Great way to look at the three stages of dividend yielders. I lucked out with Visa back in 2010, picking them up in the upper $60s range and enjoying substantial dividend increases with obvious appreciation with that (funny, how the large dividend growth rate stocks have quite appreciation when they do so… keeping them at the low yield haha)..

    Regardless – T fits in nicely with your first slot, as well as O – definitely agree there.

    This fits with your strategy as well – as you accumulate the cash and don’t reinvest, and then use that excess cash to purchase the best opportunity available. I dig it.

    Thanks again for posting this, very interesting read DM! I’ll have to see which stocks fit in which bucket. Would be funny to see where my stocks lie. Great post!

    -Lanny

    • says

      Lanny,

      Nice buy there with V! I’m jealous. :)

      I looked at V pretty heavily when it was below $100 and mentioned my interest here on the blog. Unfortunately, I didn’t follow through with that interest and ended up buying something else. Of course, when V was below $100 many of the other stocks I was purchasing back then were also very cheap. So it’s not like I’ve completely lost out.

      Although, I am looking at V again right now. The valuation and yield is pretty much the same as when I looked at it when it was almost $100/share. Their EPS growth has been off the charts due to that massive buy back program. And their free cash flow is just ridiculous. Very, very impressive. And they still appear to have a lot of growth ahead of them as emerging markets convert to cashless transactions. Exciting stuff.

      And using big dividends from Stage 1 stocks to build up positions in Stage 2 and 3 stocks is a great way to round out your portfolio and allow your snowball to start working for you right from the get-go. :)

      Best wishes.

      • says

        I was extremely lucky with V, but as you’ve said – your other stocks were valued appropriately at that time – big key thing is – you bought assets that appreciate and place cash flow into your pocket at the end of the day.

        Thanks again DM, almost at the midpoint of the year!

        -Lanny

  10. Bruce D. says

    I didn’t read all the comments before posting (gasp!), so if I have duplicated the efforts of others, I apologize. For you and your readers, I offer a few other low yield, high(er) growth companies to research, though their valuation leaves something to be desired in most cases: NKE, MA, TJX, ROST, VFC, DFS, TRN, DIS, DFS, CVS, WAG

    • Bruce D. says

      Somehow managed to put DFS twice…that shows you how much I like it I guess. And how easy it is to make a mistake when glancing between multiple screens

      • says

        Bruce D.,

        Those are some nice picks there. I just very recently looked at NKE and they’ve had very impressive growth. And their margins are very strong.

        I also like DIS and the pharmacies. I passed on WAG a while ago, and that was one of my big misses. Can’t win them all.

        DFS is an interesting stock. Not a classic dividend growth stock to be sure, but the valuation is much lower than V and MA. I’ve never looked at it before. Although, I had a Discover card a few years ago and always had a hard time using it anywhere. I suppose that means that there is plenty of room for growth.

        Best wishes!

        • Bruce D. says

          I’ve had the good fortune of owning DFS for many years, so I know it pretty well. They have really improved and diversified their business into being sort of a hybrid credit card and bank. If I weren’t already overweight DFS as a result of price appreciation, I would have been adding it the past couple years. I think it should be able to grow its dividend in the double digits for years to come. As a testament to their dividend growth (and how low I bought it), my yield on cost is 4.89%…not bad.
          DIS and NKE are no-brainers at some valuation, simply because of their ubiquity and brand/pricing power. I think DIS is the better buy today if you had to pick one, but I don’t think I would, except through a monthly program perhaps.
          WAG seems to be “the one who got away” for a lot of people, I think. I bought a 1/4 position when I thought it was slightly overvalued, and it’s almost 20% up from there in a short time. I guess it’ll be a good exercise in patience =)
          Good luck

  11. says

    Jason,
    Great article as always man. When I first got serious about building up my portfolio, I put most of my money in stage 1 stocks (T, O, RDS.B, BP) and have been focusing on stage 2 since, plus Visa a few months ago. Do you have a certain percentage of your portfolio you plan on dedicating to any of the categories? I think the bulk in stage 2 makes the most sense for the majority of dividend investors with the amounts of stage 1 vs. 3 being decided by how close you are to retirement.

    Regards,
    SFZ

    • Ravi says

      I think Visa is a very well run company, and globally they have lots of room to run, but I think long-term, innovation in the payment space will compress their interchange fees, plus a host of competition from all over.

      I think it could grow a lot, but the long-term uncertainty in the business/industry itself concerns me. I’m not really sure how it fits in, and that makes it a riskier stage 3 holding IMO.

      I hope I’m wrong, and you just end up swimming in gains and sell after 5 years with huge gains and reinvest!

      Good luck

    • says

      Mr. SFZ,

      Thanks for the kind words. Glad you enjoyed it!

      That’s a great move there building up the current income with stocks like BP and T so that you can reinvest into more classic dividend growth plays. You’re basically allowing your snowball to start working for you right from the start. :)

      I don’t have an allocation percentage in mind for the three categories, but if I had to think of one I’d probably like to be 75% Stage 2, 15% Stage 1, and 10% Stage 1. I think that would be optimal for me considering my age, risk tolerance, and desire for current income.

      And I agree with you that the balance between the stages will be dependent on how close you are to retirement. If you’re a few years away then it will make sense to lean more towards your higher-yielding stocks like O, T, and the like. If you’re young (like you) then there’s more latitude there to stretch for growth and take on a bit more risk.

      Best wishes.

  12. Ron says

    Great Aritcle. Was wondering if you had any interest in ‘Stage 3′ stocks. Any advice on allocation of the stage stocks for the younger folks? Any thoughts on UA or CMG? I really like their products and brand and have great leaders.

    • says

      Ron,

      I do have interest in a few stocks that have lower yield, but higher growth. Namely, I like V and SBUX as I mentioned. But NKE and DIS are a couple of others that I like in this space.

      I don’t really have an opinion on UA or CMG because they don’t pay a dividend at all. They may be great investments, but no dividends is no bueno for me.

      Cheers!

  13. Steve says

    Great perspective on the different categories of stocks. Many DGIs bad mouth high yield/slow growth stocks and believe they have no place in a portfolio. However, I agree with you that in the beginning, they add a lot of thrust to a new portfolio. I believe it also creates an excitement for new investors when they see the dividends begin to roll in. It is often the encouragement they need to stick with the strategy.

    An additional thought–keeping with your rocket analogy, the first few stages of rockets are usually jettisoned. Is there a point at which high yield/slow growth stocks should be jettisoned? I’m not at the point where my portfolio is churning out dividends at a high pace so a few high yield/slow growth stocks provide essential income to fuel the accumulation of shares in other companies. However, I anticipate that at some point in the future I will dump stocks like T if they continue to fail to keep pace with inflation with their dividend growth. Thoughts?

    Steve

    • says

      Steve,

      That’s an interesting thought in regards to jettisoning certain stocks. I agree with you that if a stock isn’t living up to expectations then it would have to go. I have pretty clear exit criteria, but dividend growth below inflation needs to be added to the list. If my income isn’t keeping up with inflation then I’m basically investing in a bond. A big yield over 5% appears impressive, but if the dividend growth isn’t keeping up with inflation then you’re slowly losing ground. Compare that to a 3.5% yield that’s growing 9-10% per year and you can see that after just a few years you’d be much better off with the latter scenario.

      I don’t sell often, as you can see by my transaction history. However, I’ll likely have to prune some positions as I near 50 to make room for stocks with better potential. So I’ll be looking at stocks that continue to offer disappointing dividend growth and compare that to stocks that offer much better growth opportunities. Of course, I have to weigh that against the fact that I still need plenty of current income as I’m looking to cross over into financial freedom in eight years. It’s a balancing act. :)

      Thanks for adding that. Great question!

      Best regards.

      • says

        Steve,

        I wanted to add that the jettison scenario also depends a bit on your goals.

        If you started things off with a bunch of Stage 1 stocks and you’re a couple of years into building your portfolio and you’re steadily adding your Stage 2 stocks then it might make sense to slowly sell off the Stage 1 stocks as your income continues to build from the stocks that offer decent current income and solid growth. You may then want to reinvest that capital into Stage 2 and 3 stocks, but this depends on your goals and age. If you’re still 10-20 years away from retirement then you have plenty of time for the big growers to get you to where you want to be.

        I think one’s exposure to Stage 1 and 3 stocks will depend on how close or far you are from retirement. If you’re closer you’ll want more Stage 1. If you’re further away, then it might make sense to have more exposure to Stage 3 stocks. It’s all about balancing current income against growth in that income.

        Best wishes!

  14. KeithX says

    Jason,
    I have all six of your picks in my portfolio. I might offer the following alternatives for your readers:

    Stage 1 – Kinder Morgan (KMI) is basically in the business of transporting oil, natural gas, and other liquids/gases through a network of pipelines in North America. Current yield is 4.8%, but has only been paying dividends for 3 years, tripling from $0.14 to $0.42 in that time. This is a way to play KMP, but as a stock instead of an MLP.

    Stage 2 – Johnson & Johnson (JNJ) is a global healthcare company, dividend champion (52 years), current yield 2.75%, 5 year dividend growth rate of 7.5%. The current P/E of 18 is average for the S&P 500, and the PEG under 3 means a decent price for a company that should stay in your portfolio forever.

    Stage 3 – Nike (NKE) is a global maker of clothing and shoes, and we are all familiar with the swoosh. With 12 years of dividend increases, a 1.3% yield, 5 year dividend growth of 13.7%, and a PEG under 2, this might not fit in everyone’s portfolio. However, the earnings are forecast to continue to increase by double digits and this could reward patient investors.

    I really like the six stocks you selected, don’t get me wrong. But you can never have too many ideas when trying to build a portfolio.

    Best of luck,
    KeithX

    • says

      KeithX,

      Great stocks there. I’m long KMI and JNJ and big fans of both as they are both big positions for me. KMI is one of those stocks that offers high yield and pretty solid growth, so that’s a very interesting pick. And that’s why I’m heavily invested in Kinder.

      NKE is a great pick. I analyzed it not long ago for a freelance article and concluded that while it’s a bit expensive right now, the fundamentals are extremely solid. The margins are impressive, their sponsorship deals are fantastic, and the perceived quality in their brand is unquestioned. And they can still grow quite a bit, as I was surprised by how small their direct retail footprint really is. Earnings are indeed expected to grow at very healthy rates for the next few years, and I think they’ll continue to deliver. NKE and DIS are a couple of great stocks with lower yield and higher growth that I’m currently looking at in addition to V and SBUX.

      Thanks for adding those!

      Best regards.

  15. says

    I was thinking about Visa the other day but maybe since I’m about 6 – 7 years to retirement maybe not. On the other hand, to me the the time horizon once you retire can still be 20 – 30 years, if you’re healthy! Nice way to stratify the dividend stocks. Makes it easier to understand and also remember. You’d make a great teacher DM!

    • says

      debs,

      Well, with your time frame I don’t know if I’d be looking at a stock like V. It really depends on your goals and what you’re aiming for. If you’re looking to maximize capital gains and sell off stocks then V might make sense. But if you’re looking to live off of the income your investment provide instead, then V probably won’t work for you. Even if they’re able to keep up that blockbuster dividend growth rate your dividend income will still be marginal 4-5 years from now.

      Thanks for the support. I enjoy spreading the message and educating others. :)

      Take care.

  16. says

    Great article DM. I just want to clarify that Lanny already posted on this article and this is Bert, the other Diplomat speaking. I really like your discussion about the three different types of DGI stocks. I feel as if most DGI investors (myself included) spend a lot of time focusing on stocks in Stages 1 and 2 due to the higher yields. It is great that you are bringing this third category into the discussion as there are many great companies in this category. What I find most interesting about Stage 3 is that the category is applicable to many of the stocks that are considered Dividend Aristocrats. However I would usually disregard these stocks due to the lower yield.

    Right now I am heavily weighted in Stages 1 and 2 for the reasons you described. I am trying to get the passive income off the ground. But this has definitely opened my eyes to considering the stocks listed in your Stage 3 category.

    Thanks again for sharing.

    -Bert

    • says

      Bert,

      Thanks for stopping by!

      I think it’s really cool that you’ve got a bud to run the blog with. That must be awesome to have a friend to bounce ideas off of and mutually inspire each other.

      And I hear you on trying to get the income off of the ground. That was where much of my attention was spent over the last few years. It’s really just lately that I can finally take a bit of a breather and allow my snowball to start to roll itself downhill. And now that the income is going to start working for me I think I can start to look at some other interesting opportunities like V and SBUX.

      It won’t be long before you’re in a similar position. Trust me!

      Best wishes.

      • says

        Sorry for the delayed response here DM. Thanks for the kind words! It is a lot of fun having Lanny around while writing the blog. As you mentioned, I have been very inspired by him and he has taught me almost everyhting I know about investing.

        It seems like once the snowball starts rolling, it grows quickly. I am excited to continue to follow your portfolio and watch you add the lower-yielding dividend growth stocks to your portfolio. It is a new wrinkle that will serve your portfolio well. With companies like V and SBUX, I bet you will be reaching your goals much faster than you anticipated.

        Keep up the great work.

        ~Bert

  17. Greg says

    Nice analogy! I created a pie chart by annual dividends and compared it to the one based on market value. It showed what you discussed: The stage 1 positions (utilities & REITs) contribute more new dividend capital than the stage 2′s. Not all DGI stocks are created equal. They have different roles to play within a portfolio. Thanks for raising awareness again.

    • says

      Greg,

      Absolutely. Not all stocks are created equal, and many of them serve unique roles in a portfolio. I think Stage 2 stocks offer the best risk-adjusted return potential, but Stage 1 and Stage 3 stocks also have a place in many portfolios, depending on how far away from retirement you might be.

      And a pie chart is a great visual to show you exactly where your income is coming from. You might have $5k invested with this company over here, but your $4k investment with another company over there might actually be the big income producer for you. One always has to balance current income needs against growth in that income, and that’s why all three stages have their place in most portfolios.

      Best wishes.

  18. says

    Good post. I have allocated most of my stocks to the stage 2, with about 4 (T,O,EMR,LG come to mind) in stage 1. WAG I think has become a stage 3 by virtue of it going up like crazy recently.

    I used to own SBUX and like the business, but sold it when I was converting my portfolio to more DG stocks. I may take another bite if I can get it when it’s yield is above 2. That is lower that I like, but a good trade off for its potential growth.

    Take care!

    • says

      ILG,

      I hear you on not wanting to receive a really low yield. It’s always nice to know you’re going to get some serious dividend income with which to reinvest with right away. I personally aim to keep a rather small allocation to stocks with lower yield and higher growth prospects, simply because the risk is amplified and it’s hard to determine the growth rates with some of these companies.

      Cheers!

  19. says

    Good post… I have a lot of high yields in my portfolio. The income is nice, but there is little growth. I plan to concentrate on dividend growth stocks as I would like to have more exposure in this area.

    • says

      Investing Pursuits,

      Thanks for stopping by!

      The trick is balancing that need for current income against the desire for future growth of that income. If we didn’t have inflation to contend with it probably wouldn’t matter much, but since we do we have to be vigilant.

      Best of luck managing the portfolio and making those changes moving forward. That’s part of the fun! :)

      Take care.

  20. Josh says

    Great article DM! I think this particular article will be a useful tool to new investors. I remember first starting out back in 2010, and trying to come up with a winning strategy, all the while being completely clueless at 20 years old. If only i had discovered the dividend growth investing blogging community 4 years ago! I am currently looking to start a position in PG as it has fallen to the $79.50 range in recent days. While the P/E is a bit higher than i normally care to buy at , i feel this is a good buying opportunity for a company like PG. The price today will not matter in the long run for a dividend growth investor who plans to hold a solid company such as PG for the next 30 or 40 years. I think my purchase next month may have to be T. The yield is hard to beat especially for someone like me still constructing the foundation of a solid dividend growth portfolio…this article definitely reaffirms my thinking on both companies. I hope all is well with you in Michigan!

    Josh

    • says

      Josh,

      Thanks for the well wishes. Things are great here in Michigan. I’ve been spending more time than ever with the family, which is great. And I’ve got a little niece coming here in about a month. Good times!

      I think PG is a solid buy here. I just wrote a quick summary article on PG the other day for Daily Trade Alert, and although it’s probably just a tad overvalued here it doesn’t really matter if you’re in it for the next 20-30 years. Paying $80 or $76 matters little when it’s priced at many multiples of that level decades from now.

      Best of luck growing your portfolio. Very exciting stuff!

      Cheers.

  21. says

    I think a balance of all stages would also be effective. High yield, low growth is a good way to get started because it starts to generate cash flow right away that can then be used to reinvest in others. Personally, I try to have a balance of all since I don’t want to have all my eggs in one basket. For the long term I do prefer dividend stocks that have a history of increasing their dividend over time – a great way to fight inflation upon retirement

    • says

      Dan,

      I wouldn’t want all my eggs in one basket either, though if I had to I would definitely pick with the high-quality businesses that you’ll most commonly find among Stage 2 type stocks – your KO, JNJ, PEP, and PG names.

      It’s definitely a tough balancing act at times to balance quality, risk, income, growth, and valuations. But that’s part of the fun! :)

      Thanks for stopping by!

      Take care.

  22. Ravi says

    I’m surprised to see you break out the stage 1-3 in the way you did.

    In 2012, when I first started investing, this is exactly how I viewed the high-yielding stocks I bought into like T and MO. They may grow, or they may not, but a long term total return of 7% annually isn’t totally unreasonable to expect considering the yields are over 5% and 4.5%, respectively.

    Right now, I’ve got a portfolio of around $60k, with total annual dividends of ~$3.6k (6% yield). Yield has been slowly declining over time, as I have put more money to work in stage 2 and stage 3 type stocks, and in the future see a good target for my account at 4%, so plenty of growth names to add in the future. :)

    I hope one day for my taxable account to provide a solid income yield, while I’ll continue maxing out tax-advantaged accounts as long as I continue working. With such heavy market exposure in my portfolio, I need to pick out winners (either income or growth) in my own account, otherwise there’s really no point.

    We’ll see how it plays out!

    • says

      Ravi,

      That’s a hefty yield you’ve got there. If I had a yield of 6% on my portfolio I’d be looking at annual dividend income in the range of $10k. Wouldn’t that be nice?!

      You must have a really solid basket of higher yielding stocks there. I’m guessing plenty of utilities, telecoms, REITs and MLPs?

      Keep up the great work!

      Best regards.

      • Ravi says

        Sure is a bit nuts (it used to be closer to 7%, but declining mRETs have been offset by my stage 2/3 purchases).

        The big dividend spouts are definitely utilities, tobacco, and REITs.

        I think it’s a good base to have. The stage 1-3 model seems to explain (much more eloquently) what I have been trying to do. The big payers will constantly fluctuate, but the dividends will be reinvested elsewhere, so time just has to do its work along with a fair amount of steady new capital into the account.

        One day, it should be much more diversified with a loose target of 20%/60%/20% for 1/2/3 companies. At least, that’s the plan now, but I’m sure it will change depending on timing and what seems to be a good bargain at the time.

  23. says

    DM,

    I have a lot of Level 1 and Level 2 stocks. In the past I had held what are now Level 3 stocks when they were hurting in the recession and not going anywhere. I owned AAPL, F, and SBUX years ago when they were extremely cheap compared to what they are now. Howard Schultz was gone and stores were closing and none of these 3 paid dividends at that time. When he returned I figured they’d turn it around, but got impatient. I took a gain on AAPL and think a loss on F and SBUX (if I remember correctly F was $3 something and SBUX was maybe $18).

    I did the same thing with Disney at one time sold, but glad I got back in because I’m near tripling what I invested now.

    I’m back in with a little F and might still consider discovering those and others in stage 3.

    • says

      SWAN,

      Yeah, I don’t blame you for selling some of those when there was no dividend at all. At that point you’re looking at a turnaround story and no income to pay you while you wait. Although holding would have turned out great, it’s impossible to have that kind of foresight.

      DIS is a great company, and they really popped after the Star Wars property acquisition. I wish I would have gotten in a while ago, but the yield has historically been so small with that company. I’ll keep an eye on it.

      Cheers!

  24. Spoonman says

    This is a very nice post, especially for beginners. This is another one of those excellent posts that you can hand to anyone and they will readily appreciate it. I love the analogy of the rocket stages. My dividend rocket approached escape velocity a few weeks ago. It will allow us to reach for the stars, FI, in a few more weeks =).

    I remember a time when V was yielding 1.5%. I regret not jumping on it, especially since it’s had a DGR of around 50% for a few years. The same goes for mastercard. But hey, we can’t grab them all, can we?

    • says

      Spoonman,

      You’re just about in outer space over there, my friend. Exciting times. You’ll have to tell me how the stars look from your point of view. :)

      And you’re right: We can’t own them all. So many stocks, so little capital. The key is to be happy with the fact that we can even be in the position where we have excess capital and can participate in capital markets like this. It’s great to be us!

      Best wishes.

    • says

      Living At Home,

      Thanks!

      And nice job with V. I hope to join you as a shareholder at some point here.

      I don’t like MA quite as much with the higher multiple and lower yield. Plus, they haven’t had the regular dividend growth schedule V has.

      AXP doesn’t suit me here. The valuation and yield is similar to V, but offers much less growth and more risk via its loan portfolio. Plus, I believe they held their dividend static for a number of years there. Overall, I think V and MA are better plays here. And V is my favorite.

      I hope that helps!

      Take care.

  25. Daniel says

    Jason,

    Another fantastic article, I really enjoyed the analogy.

    It’s interesting to me that utilities work well as a “stage one” company, but perhaps an Exxon Mobil makes a good “stage two”. I like that one can spread his exposure to energy across different stages like this, for the simple reason that I like being heavily exposed to energy in all its forms (basically civilization ceases to exist without it, and these businesses typically have huge moats.)

    This got me thinking about your exposure to energy, so in the interest of picking your brain:

    I’m curious what your 3 all time favorite energy companies are (any category)?

    If you could only own one or two utility companies for the rest of your life, what would they be?

    Are their any energy companies with heavy exposure to alternative energy that you like?

    All of the above are of course in the context of a dividend growth strategy. Thanks for sharing, love the discussion.

    Best,

    • says

      Daniel,

      Thanks for stopping by!

      I might be confused by your language, but it sounds like there’s a possibility that you’re lumping utility and major energy companies together. An oil supermajor like XOM is a significantly different company from a traditional utility like your Consolidated Edison.

      Exxon Mobil would absolutely be a Stage 2 company, whereas many utilities would be Stage 1 companies. However, with the recent run-up in utilities, many of them don’t even have the high yield that traditionally makes them attractive.

      I don’t know if I could pick two utility companies. I’m honestly not a big fan of them in general. They’re heavily regulated, the growth is limited, and they usually have high debt loads. Plus, as more consumers switch to alternative energy like solar that puts additional strain on the network via less consumers to spread out costs and risk. But I like Avista. I also like Southern. Wisconsin Energy, at the right price, is a very well-run utility.

      As far as energy companies go, I’m heavily invested in the majors. If I had to pick just three they would probably Exxon Mobil, Chevron, and ConocoPhillips. They’re all high-quality and based in the USA. You would get a nice spread of yield, and they all offer something different to like. But I still like BP and RDS.B for the higher yield and potential for major turnaround. Shell and BP have both been very good investments for me thus far.

      I hope that helps. :)

      Cheers.

      • Daniel says

        Thanks Jason,

        Yes, I do consider power utilities and oil companies to be subsets of the energy sector. I understand they are very very different businesses, but they are all involved in providing mankind with energy at the end of the day, which is the thing I care about being exposed too. Morningstar analysts might take issue with how I lump together business categories, but they also take issue with many ideas of Warren Buffett. I’m making lots of money with my investments, that’s good enough for me.

        Anyway, thanks for you answers, I was leaning towards most of the companies you mention. It’s nice to get a confirmation from someone as sharp as you.

        Best

  26. Mike H says

    Hi Jason,

    I’m curious, what do you think about IBM? I bought some a few months back, unfortunately at levels of $195.5 so it’s fallen quite a bit from there?

    Love the article!

    -Mike

    • says

      Mike H,

      Thanks! Glad you enjoyed the post. :)

      I like IBM. I’m an investor, but it’s a pretty small position for me. The revenue growth is concerning, but they’ve been going through major changes over the last decade as they moved from a hardware provider to software and services. I like the bet on cloud and Big Data, and I think they’ll be fine over the long haul. They’re aggressively raising the dividend and buying back shares and I’m a happy camper.

      However, I’m leery of tech in general and that’s why IBM is a small position for me. But a dividend growth investor would be hard pressed to find a better play than IBM in tech at today’s prices. MSFT is another solid long-term play, and that’s one I really missed out on.

      Best regards.

      • Dividend Diplomat says

        This marks me feel better. I missed out on visa ad Starbucks too and was starting to get depressed reading the costs. But I nailed MSFT!. Over last 4 yrs I bought 100 shares every time it drifted below or near 25. I bought 800 shares for about 20k total. With dividend reinvestment I now have 867. I know you don’t like YOC but mine must be good.

        • says

          Dividend Diplomat,

          Nice job there on MSFT! I really missed the boat on that one. You just can’t with them all. But you’ve done very well with that one.

          Keep up the great work!

          Best wishes.

  27. says

    Good analogy DM. By now you know I prefer stage 2 and stage 3 versus stage 1 “lift off” investing. Better to work and save your money and invest right away in stage 2 and stage 3 stocks than have your hard earned money put in some high yield dividend stock that may not be sustainable. Better put your money into sustainable growing dividend stocks that are relatively safer. Thanks for sharing.

    • says

      DivHut,

      I hear what you’re saying. Overall, I prefer the Stage 2 stocks the most and that’s where most of my portfolio is currently allocated.

      However, I don’t necessarily think stocks with higher yield are less safe or not sustainable. Rather, the growth rates are typically much smaller. I don’t think T will stop raising dividends anytime soon, but those raises might not be able to keep up with inflation. And that’s where your risk is. You have risk of purchasing power reduction more than risk of unsustainable growth or capital loss. At least, that’s my view on it.

      Of course, there’s bird in the hand and opportunity cost at play there. The growth with many of the high flyers may not pan out, and so you might lose out on a lot of income there that you otherwise could have had.

      It’s a balancing act for sure. Part of the fun. :)

      Cheers!

  28. says

    Hi DM,

    Great summary of the three-types of bets a dividend investor can make. This has been something I have been wondering for a while now. Maybe I should follow that approach as well, I’ve seen many dividend investors invest in high-yield stocks to kickstart their portfolios, but I just can’t seem to do follow that.

    I usually first screen companies that pay a dividend and then I try to look for the companies that I admire the most, both in terms of balance sheet, track record, and future prospects. I usually pick companies that I believe have what it takes to be winners in the future and I tend to disregard the yield and dividend growth (Of course I make sure they are within an acceptable range). This has led me to buy essentially companies in stage 2 which offer a decent sustainable yield and usually have potential for sustained growth, this has resulted in an starting portfolio yield of around 3% with expectations to grow yield around 7% year-on-year.

    For stage 1, I usually find those companies to offer limited revenue and earnings growth which is something I deem very important. For stage 3, they usually seem very promising, but that’s their problem for me, they promise too much. For a company yielding less than 1% it takes a lot of sustained growth over a fairly long period of time. In this case, any macro-economic turmoil will probably have a big impact on the company, both price-wise and growth-wise.

    Great article!

    Best Regards,
    DividendVenture

    • says

      DividendVenture,

      I’m on the same page. The stocks you’ll typically find in Stage 2 (KO, JNJ, PEP, PG, CLX, CVX, etc.) offer the best balance of current income with growth in that income. As such, I have most of my wealth allocated to these types of companies. They just seem to offer the best risk-adjusted returns.

      However, I still see a right place and a right time for certain other stocks. It really all depends on your income needs, means, and goals. Someone who’s two years out from retirement might really need to kick the current income up, even if they end up sacrificing growth. Like a lot of things in life and investing, it depends.

      Thanks for stopping by and adding that!

      Best regards.

  29. Dividend Gremlin says

    I like the analogy. Anything with space and science is pretty awesome. Sadly, I am still in Stage 1/2. I figure might as well build in tandem. However, I cannot wait to reach S3. Once you’re there, you are half way home.

    Good luck,
    Gremlin

  30. says

    Informative breakdown. I read a lot about Dividend investing and Index investing.

    If you had $250k to invest right now, would you rather.

    1. Buy $250k of VTSAX (Index of 3,684 US stocks, Expense ratio = .05%, SEC Yield 1.84%)

    2. Buy 25 individual US stocks with your $250k, spread across the 3 categories you breakdown

    Possibly this could be a topic for a future post. Pros/Cons. I realize different paths go the same direction.

    I’m interested in theory of Asset Allocation and mixing in bonds to reduce risk. Most dividend investors would be 100% equities. Is there a higher likelyhood of “selling” during the next 2008-2009 with a 100% us stock portfolio?

    Good post again.

    • says

      Wade,

      I would pick option 2 every day of the week.

      I compared index investing to dividend growth investing last year here:

      http://www.dividendmantra.com/2013/04/why-i-vastly-prefer-dividend-growth/

      In the end, I think index investing is better for the majority of people out there. It’s easy, provides market-like total returns, and requires little time. Dividend growth investing, on the other hand, requires much more time and interest. However, I think it’s the superior strategy as I laid out above.

      As far as asset allocation goes, I would never allocate assets based on a model. I allocate assets as they make sense. To buy bonds simply to fulfill some age-old allocation recommendation even though bonds are horrible investments rightnow makes no sense to me. I’m hoping to have some fixed income exposure at some point in the future, however. But that will be when bonds offer much better long-term prospects. Overall, I just feel equities offer the best opportunities right now, even though they’re not particularly attractively priced as a group.

      Best wishes!

      • says

        A good read. Maybe one of your tasks should be to create a “Dividend Mantra Index Fund”.

        For DGI I have concerns with not using your $5,500 Roth, not reducing taxes by investing in a 401k/403B (if available) and tax implications of large dividends in a taxable account.

        One of the “mantras” of index funds is to have dividend producing funds in tax sheltered accounts. Pushing tax consequences out as far as possible and letting compounding interest do its thing over time.

        Thanks for the reply. It will be fun to follow along over the long haul and through the next “big dip”.

    • says

      Am constantly amazed that stocks that are solid investments become great buys do to short term issues. Just this week CBI dumped 7% in a day and 20% off its high. Its a “stage 3″ stock in this analogy. Its a buffett buy, too. I would confidently put money in that (instead I sold puts, but that is a different income strategy entirely).

      Last Fall AAPL was selling for a ridiculous value. I loaded up.
      Last summer both INTC and MU were great opportunities.

      so, I am saying be patient and ease your funds into the market as great opportunities come up. Don’t be afraid to over weight a great opportunity. But, look to take 18 months or a year to get fully invested. In the meantime, KMI or LNCO or T or Horus Mann are good value stocks with solid income that you can park cash in for now (IMO).

      cheers (you have a great problem to have)
      t

  31. Phil says

    Great article! I usually try to pick stocks that have a yield over 3.5%. I had never thought to consider stocks with lower yields that have stronger dividend growth rates. In fact, I hadn’t given growth rates serious thought before, except when researching dividend aristocrats, but they seem to be just as important as current yield. How do you research dividend growth rates? Where is that information usually listed for stocks?

  32. Greek says

    Lol, I bought Visa the day it IPO’d and sold it a week later for around $1000 profit. Big mistake. If I held it still I’d be up around $15k plus dividends. Buy great companies, monitor them, sell occasionally, and collect dividends. End of story.

    Keep spreading the word Jason.

    • says

      You hit it on the head. Too often we are tempted by quick gains not realizing we are holding incredible companies especially ones that pay dividends. I had a similar experience years ago with UPS. I bought it around the mid $40′s and sold not too long after that in the mid $60s. A nice gain for sure, but a few more years would see me holding UPS around $100.

    • says

      Greek,

      Oh, man. Sorry to hear that. You made a very nice quick profit there, but it’s a shame you don’t still own shares. That company has been retiring shares at a very robust rate, which obviously makes the shares you would have held much more valuable.

      We live and learn, though. It makes us more experienced (and hopefully better) investors! :)

      Thanks for the support. I definitely plan to keep spreading the message.

      Best wishes!

  33. says

    Very interesting breakdown Jason.

    I have stocks in all three stages and I love when I receive big dividend from stage 1; however, in reality stage 2 and stage 3 stocks rewarded me really welll in dividend growths and capital gains.

    best regards,

    • says

      Finance Journey,

      I’ve generally experienced the same. Many of the stocks I own that have fairly low yields have appreciated the most. That’s not always the case, as Raytheon had a healthy yield of around 4% or so when I bought and it’s about doubled. But for them most part the stocks I own that have higher yields haven’t appreciated in share price as much. However, I knew that was likely going to be the case going in. You’re receiving a greater portion of the profits in cash, and the company doesn’t have as much to reinvest. So you’re getting more of your return in cash money, which serves a purpose.

      Best regards!

  34. says

    Hey DM,

    Great article. I feel like most of my stocks are in stage 1 as I started only a year ago and wanted some inital dividend inflow. This article was great for an example of longer perspective outcomes with regards to high dividend growth rates. In the future I will be looking for more future growth rather than high current yeild’s.

    Thanks again for an inspireing blogg! Keep up the good job!

    • says

      Ruter,

      Thanks for stopping by! Glad you found some value in the post. :)

      And I do recommend diversifying between the stages as it makes sense for you. I think too often we dividend growth investors ignore the Stage 3 stocks, and that is possibly to our detriment. Of course, those stocks typically come with greater risk, so tread carefully.

      Stay in touch.

      Take care!

  35. says

    well done. I like your analogy. I recently tried to show someone some math on a portfolio that is comprised of what you call Stage 1 and Stage 2 stocks. Although I found the math persuasive, they just got glassy eyed… do you ever run into folks who just don’t have a plan for their future? I am continually surprised by how many high earners I know don’t invest or invest dangerously (can you say buying lottery tickets?!?!). Full ride on HEMP and they just think double down. :*0 oh well, glad to get it and glad to be reading a blog that gets it. Good luck!

    • says

      Tuliptown,

      I’ve run into many, many people who basically have no plan for the future, or are just now getting around to planning for retirement when they’re already in their late 50s. I feel bad for those people, and I also identify with them. Because if I didn’t have an epiphany a few years ago I could have just as easily continued down the path of financial illiteracy and ended up just like that. It’s a shame.

      But I feel a duty to spread the message, and I’m glad to have a small platform that allows me the opportunity to do so. :)

      Thanks for stopping by!

      Cheers.

  36. Ian Stewart says

    I was hoping to get your perspective on railroad stocks such as UNP, NSC, CSX… They seem to fit the stage 3 category, 1.8 to low 2% yield, but with eye-popping dividend growth rates of 20% or more. At the same time, railroads are vital, long-standing infrastructure that I want to own a piece of at some point. Perhaps the least risky of the Stage 3 category?

    At the same time, it’s probably going to be a while before I bite off a chunk of those companies. My current income situation means I will probably be stuck paying a discount brokerage like Scottrade or TradeKing 1% or so if I want to invest on a monthly basis… And I definitely feel that that monthly buy will help me build momentum and discipline, even if it means I’m stuck on stage 1 stocks for a while. A local money manager I know from the farmers’ market has strongly suggested T as a good first pick for my portfolio. Got any advice for me? :-) Thanks for your perspective!

    • says

      Ian Stewart,

      So you’re just starting off? Very exciting stuff! I wish you the best of luck with your new journey. The investor class is wonderful, but the transition takes a while. Stick with it. :)

      I like railroads. The competitive advantages are obvious. I only own NSC, and it’s my favorite on the east coast. However, I’d love to own a chunk of UNP at some point as well. That’s just a monster. I don’t know if any of them are real compelling buys right now, however, with UNP being arguably a bit expensive right now. I think these are great companies to invest in, but I don’t know if the time is right here.

      If I were just starting out I’d probably look at PM right now. The valuation makes sense, and you’re getting both high yield and solid growth. You’re getting the tangible effect of real dividend income right off the bat, with which you can reinvest as you feel fit. Plus, that income will very likely continue to organically grow with no further effort on your part. If that doesn’t suit you, a good first stock buy right now might be O. Everyone is concerned about interest rates, but I think that’s shortsighted. The yield and growth is pretty solid, and it’s one of the bluest of blue chip REITs. That could start your portfolio off with a bang.

      Best wishes!

  37. says

    Hi DM, love the analogy here! Feel its is very close to the truth, at least it is true for me. I have just recently started my adventure and am currently heavily invested in “stage 1″ companies. Because of this I start receiving a pretty decent income stream with a limited amount of capital invested. This works very motivating! This “starting dividend” I now use to start my positions in “stage 2″ companies. And maybe once I have a diversified enough portfolio, I will make the step into “stage 3″

    Best,

    DW

    • says

      DW,

      You nailed it there. A big yield right off the bat may not be the best for an entire portfolio for the long-term, but it provides tangible benefits right off the bat and keeps you motivated to keep going. Then you can take that big income and reinvest it into better long-term plays like KO, PEP, JNJ, and the like. The income builds, which gets reinvested, which builds it more. The snowball starts to roll downhill. And the rest is history. :)

      Thanks for stopping by!

      Cheers.

    • says

      R2R,

      That’s a cool visual model! That gives you a pretty nice perspective of what your mix of yield and growth is. Of course, the issue is that stocks move to and fro all the time. For instance, WMT shocked everyone with a 2% raise this year which certainly affects one’s future expectations. Disruptions like that are exactly why it’s difficult to mathematically model a dividend growth portfolio. In the end, it’s just about owning the best companies you can at the best price possible, and reinvesting the dividend income appropriately. :)

      Best regards!

  38. SR says

    Somehow I managed to insert this question way at the top of the thread. Sorry about that. This should work better …

    Hi. I was just wondering if you could tell me what the total amount is that you have invested out-of-pocket as of the June 1st portfolio spreadsheet. Don’t include dividends. I’m just wondering what you’ve put in to date. I tried to find the info myself but if it’s there I’m missing it.

    Really enjoy the blog.
    Thanks.

    • says

      SR,

      I just ran my YTD deposit report at Scottrade, and from Jan 1 to June 1 I’ve deposited $7,100 into my account. That’s considerably lower than my historical fresh cash contribution rate, due to the changes at work as I took a big pay cut and eventually left, the increases in my expenses (healthcare and a car), and my lifestyle change as I’m now writing. I think $7,100 in six months is still solid, especially considering what’s been going on. I think if I can keep that kind of rate up while solely writing I’ll be very happy. It would be far below where I was at before (~$12k every six months), but I would still be investing fairly heavily while doing something I really enjoy. That’s a win-win. :)

      Best wishes.

  39. says

    Great post, Jason. As you know, I’m still a beginner, so it would be somewhat dishonest to say I’ve formed a solid strategy at this point, but stage 2 seems to be where I’m at. I’ve saved 40-50% of my pay for the first six month of this year, so I’m going to try my best to keep that momentum going.

    • says

      Addison,

      Hey, we all have to start somewhere! :)

      And great job with the savings rate. A 50% savings rate is really, really awesome. I view 50% as the crossover from serious to extreme. That kind of savings rate should get you to financial independence in around 12-15 years, if you’re able to keep it up.

      Thanks for stopping by!

      Best wishes.

  40. William says

    Hi Jason,

    Been following ur blog for a while… im on a low salary being a taxidriver..
    Getting arround 1500 euro’s a month and able to save 950-1000 euro a month as i’m not the only one living in this house with a 100.000 euro mortgage which is payed off in exactly 30 years.
    My age at the moment is 25 now.
    When would I be FI going the same path like u do with stage 2 stocks, if i just kept this rate up the next decade
    or so?

    Thanks for reading and i really like ur blog by the way!

    Greetings from Holland

    • says

      William,

      Thanks for following along! I appreciate it. I hope you find some value in the content here. :)

      Congrats on maintaining such a high savings rate! That’s very impressive.

      Assuming you can keep the expenses relatively static and you’re able to keep up that savings rate, you should be financially independent in about a decade or so. The key is obviously rolling that excess capital into assets that produce reliable and rising income. But I can’t see why you won’t become financially independent well before 40, and that’s assuming you’re not able to raise your income over time, which is probably unlikely if you’re enterprising.

      Keep up the great work over there. And thanks for stopping by all the way from Holland!

      Best wishes.

  41. William says

    Thanks for the info.. well average rent in this town is about 700- 800 euro’s a month. My expenses are about 900 a month excluding groceries of 300 as buying is cheaper then renting for the appartment.

    Got my wife and kid and a paying roommate so im happy that i can save so much 75%on this salary.

  42. says

    Hey Jason,
    Great article once again! It got me thinking about my portfolio and I definitely recognize it from your classification. Most of my stocks are currently from stage 1, but I have been slowly increasing the weight of stage 2 stocks. I still have a small portfolio so I have been chasing a bit higher yield. Now that the portfolio is generating some kind of cash flow, I feel more comfortable increasing the weight of stocks with lower yield, but faster growth.

    Regards,
    TDW

    • says

      The Dividend Way,

      Sounds like you’re in a great position there! Your portfolio is generating some decent cash flow now, and you’re slowly increasing the quality and growth prospects. You’re well on your way, my friend. :)

      Thanks for stopping by!

      Cheers.

  43. says

    Hi DM,
    I enjoyed reading your post and liked the analogy, thank you for writing it. I have T, KO and PG today and while I have a couple of stage 3 stocks, I’ve recently decided to stop buying more so it’s stage 2 for me for now. I just hope I can find stage 2 engines with good fuel economy!

    When you mention about inflation and its effect on future purchasing power, is there a particular inflation rate e.g. 2% that you take into account as a target to beat?

    To Infinity and Beyond!

    • says

      Dividend Life,

      To infinity and beyond, indeed! :)

      As far as inflation goes, the numbers I’ve seen show it’s been under 3% for the last few decades. And the Federal Reserve appears poised to keep it under that level for the foreseeable future. As such, I try to look for at least that level of dividend growth from any company I’m interested in or currently invested in. Right now, the only company that isn’t really up to par is AT&T, but that could change in the future. It’s on probation right now.

      This all being said, I don’t mind a year or two of under 3% growth as long as my entire portfolio in aggregate is well above this number. However, recurring dividend raises under inflation means I’m losing purchasing power and I’ll likely look elsewhere for better growth. Generally speaking, most of the companies I invest in average dividend growth well above inflation, and as long as my overall purchasing power is going in an upward direction then I should be okay.

      I hope this helps!

      Best regards.

  44. MarciaB says

    Wow, this is your best post yet! And that’s saying something because your blog is an absolute goldmine. Thanks for sharing all your good work with us.

    Do you have thoughts on WIN? Or PPL?

    • says

      MarciaB,

      Thanks for the very kind words. Glad you enjoyed this article. :)

      It’s funny you mention WIN. Another reader just asked the same question maybe yesterday or the day before. I looked at the company a long time ago and didn’t see anything I really liked. The business model isn’t great as landline telephones are going away, the balance sheet was horrible, the dividend growth had stopped, and the payout ratio was well above 100%. I took a peek at it the other day before responding back to the other reader and nothing has changed. The dividend hasn’t grown, the balance sheet looks even worse, and the payout ratio is horrendous. The dividend is currently covered by FCF, but not by much. The high yield is attractive, but this doesn’t appear to be a very good investment for the next 5-10 years or beyond. It could perhaps make a nice current income generator, but you’d have to be ready to dump the second even bigger trouble appears. And sometimes you don’t see that warning coming. To me, the risk is too great.

      Best regards.

  45. says

    Great article and equally great discussion thread. What a great community this is. This was a topic that you don’t normally see in most DGI blogs and thats what I like about yours.

    I find it interesting that, in the back of my mind, this has been my strategy. I thought I was a bit of a rogue using this approach, so I was happy to see that this is actually a pretty common way of approaching the various stages of investing in divi stocks.

    Keep up the good work. I wish you had moved to Idaho…..I would seriously enjoy buying you a beer and discussing stocks.

    • says

      Tom,

      Thanks so much. I’m glad you enjoyed the post and the blog. I really take pride in the content here and I always try to put together interesting and thought-provoking articles.

      Wish I could meet up in Idaho! I’ve met a number of readers now and it’s always fun to sit down and discuss investing for an hour or two. I could ramble all day long, so it’s good to get some of that out of my system every once in a while. :)

      Thanks for stopping by.

      Best wishes!

  46. says

    As always…great post! Very interesting way to look at dividend stock investing. Using this information, I guess we are slowly moving from Stage 1 into Stage 2 and 3.

    I share your sentiments and will likely put most of our portfolio in Stage 2 stocks. Overall, stocks in stage 2 appear to give you the most bang for your buck in terms of overall potential growth. Not to discount Stage 3 stocks, because I believe everyone needs stocks in this category as a foundation or moat.

    Thanks for sharing this discussion…best wishes! AFFJ

    • says

      AFFJ,

      Glad you enjoyed the post! I appreciate the kind words. :)

      I’m with you. I think many of the blue-chip stocks you’ll find with a ~3% yield and ~7% or so growth offer the best risk-adjusted returns. You get both a good sized bird in the hand and a bird in the bush as well. And the quality is typically very high. But I also keep in mind that many of these stocks started off with very low yields and the high growth rate over time combined with a maturing of the business moved them from Stage 3 to Stage 2. Those who bought them when they were still Stage 3 did very well, for the most part.

      Thanks for stopping by!

      Best regards.

  47. Cristiano says

    Hello

    Interesting Blog. Will follow you from now on…
    Opinion about GE, DIS and AAPL for my first stock.

    Thanks

    • says

      Cristiano,

      I appreciate the readership!

      As far as your first stock, that’s tough. It all depends on what company you feel suits your needs best. Personally, I’m a fan of GE and have been buying up shares over the last year or so. But I think AAPL should do well over the long haul. DIS is a great company, but I think the valuation is a bit high, and the yield leaves a bit to be desired.

      Best of luck deciding. :)

      Take care!

    • says

      Hi Cristiano,

      I just happened to pick up some GE this month and think it’s a great core holding as far as dividend growth portfolios go. There is no one size fits all with dividend growth investing. It’s all about time horizon and amount of risk you are willing to take. I will say that the blogging community is very open and willing to share and educate. I think that the transparency is amazing and you can actually follow real life dividend investors and their successes and failures.

  48. says

    Hey DM,

    First time commenter, I was wondering what trade platform do you use to reinvest your dividends in? I currently use TradeKing and they only allow reinvestment of dividends into the original stock. Maybe you could do a breakdown of the different trade platforms that you use or know of for your next piece. Thanks!

  49. Ron L. says

    Jason, what about the re-entry stage or Golden Parachute stage where growth is not needed but high income is. So the likes of utilities and preferred stocks might be on the menu.. Or do you figure that growth is always necessary to stay ahead of inflation?

    • says

      Ron L.,

      Well, this really depends on a lot of factors. If you’re starting out really late in life and you don’t think you’re going to be alive much longer then I would think it would be preferable to target the highest possible yield you can find. Otherwise, if you target current income only and live much longer than you thought you would you’ll eventually lose ground to inflation. But, again, really depends. It depends on your age, your investment income, your expenses, how long you think you’ll live, etc.

      I would always prefer to err on the side of caution, but I can see one slowly tilting toward Stage 1 stocks as they get older if the spread between dividend income and expenses is tight. Ideally, you’d want to start this strategy a bit younger and allow the rocket to take off. But one can adjust on the fly.

      I hope this helps!

      Best wishes.

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