In these hard days of covid mess it is difficult to be a true dividend growth investor. Even high quality companies like Helmerich and Payne (HP) which was increasing their dividend for 47 consecutive years decided to cut the dividend.

As a dividend investor I was relying on the dividend aristocrat list and always defended the idea that if a company increases dividends for 50 years or more then it is very unlikely that it would cut the dividend. Although, I admitted that it can happen, I actually didn’t believe it much. Now, that it happened, the question is what to do next?

I was building my position in HP lately adding shares to reach 100 shares in this stock. The dividend was nice and all numbers looked OK to me. I am not an overly expert in evaluating dividend stocks, so I may have missed some warnings but I still felt confident that this stock would be safe.

Then the Covid crash came and the stock plummeted. Then the oil crisis added on top of it and the stock plummeted even more. It went from $45 a share to $12 a share at some point.

And, on top of all that the company announced the dividend cut. The dividend growth investor is supposed to liquidate such position and move to a different, better company. At least, that is the theory. But if I liquidate at today’s price, I would be realizing huge loss. And I am not willing to do that.

One reason is that the metrics of the company are still good and the dividend cut is not a result of reckless leadership but to preserve cash in the difficult times like today. It can actually be perceived as a good approach from the board.

This had me to reevaluate my dividend investing strategy and line it up with my recent approach to treat my stock holdings as true asset, like a rental property I decided to buy, hold forever, and monetize it.

And that is the response to the question “what to do?”

I will keep the stocks and keep accumulating my positions despite the dividend cut, and deploy options to generate cash in lieu of the dividends. It is basically an approach described by Samir Elias in his book “Generate Thousands in Cash on your Stocks Before Buying or Selling Them” where you keep selling puts until you buy 100 shares of a stock and once you buy 100 shares you keep selling covered calls until you sell the stock. Then repeat the process.

So, instead of selling a stock, I will keep it. I will keep accumulating until I reach 100 shares and then start selling covered calls. I will also track my cost basis and may reevaluate my holdings once the cost basis drops below the current stock price. Then I may decide to liquidate the position and move elsewhere or keep it. Time will show.

This depends on your plan and goal. If you plan on building a portfolio over long haul which will one day generate nice income you can use to pay your bills and live off of your investments, then you should invest in any and all market environments. Ignore all noise, rumors, and fears of others telling you that the market is overvalued, at all time high, the longest bull market ever, prone to an imminent crash, etc. There is a very high chance, that those people saying this have no idea what they are talking about.

To illustrate my point, if you are going to invest for the next 20 years, here is a chart of my stock, 20 year chart. It is a high quality dividend growth stock, paying dividends for the last 100 years and increasing them for the last 57 consecutive years. If you invested in that stock 20 years ago, your dividend yield on that original investment would be 12.83% today and you would make 700% gain on the stock itself.

I removed the name of the stock and hid the X,Y axis. Can you identify the 2008 recession on that chart?
 

If you held through those blips called recession and hardly identifiable in the long run, reinvested the dividends you would be able to live comfortably from your dividends. If you listened to rumors and got scared anytime a market dips or panic, you would blow up your account.

People over estimate their abilities short term but grossly under estimate their ability to invest long term. There will be dips, panics, corrections, and recessions, but if you look at history of the markets, bulls can last 20 years, while bears only about 2 to 3 years. Yes, bears can be severe, but they are short. You will also have periods of difficult markets. Some people will rush to tell you that if you invested in 1932 or in 2000 the market got nowhere for 20 years. Well, yes, overall market was stagnant, but even if you look at the chart, it was not a single drop which took 20 years. It was a drop, which took 3 years, then several years of recovery, then another 3 years drop, and several years recovery, and eventually a breakout from this pattern. If you kept reinvesting the dividends and buying more shares during these panics, you would be buying cheaper and cheaper and every time, during the recoveries, you would be ahead the market. For example, I was purchasing JNJ stock during 2008 recession. My average cost basis is $44 a share today and the stock trades at $150. Even if the market crashes today and loses 70% of its value, this stock would go down to $45 a share (70% loss). I will still be above my cost basis with no loss at all. And on top of that, I still will be getting my nice fat 12% yield dividend.

And that is the beauty of dividend investing. With dividends you do not care what your stocks are doing, whether there is an end of the world out there or a bright sunshine. As long as your stock keeps paying you nice dividend and increases that dividend every year, you do not need to worry about the current price of the stock itself (unlike the growth investors who need to sell a portion of their holdings to generate cash).

If you want to speculate with dividend stock, then you need to identify the market environment correctly and be buying in bullish market and selling short in bearish market. But you would have to be really good at it otherwise say goodbye to your account…

Yes and no. Dividends themselves will not protect your principal investment. If there is a recession or a panic selling, your stocks will lose value. There is no protection except going 100% cash. But that is tricky because no one will ever know when the recession started until we are in one deep to our eyeballs. And going full cash at that moment is usually too late already. So the best way is to stay invested during recessions and if possible keep buying more shares.

What the dividends can however do for you (unlike the growth stocks) is to guarantee your income. So there is a difference between buying growth stocks and dividend stocks and that difference is the reason why I use dividend stocks over growth stocks.

And the difference is that even during recessions, your dividend stock will keep paying you your dividends. And if you build a portfolio over time made of dividend stocks paying you enough every year so you will never have to sell a single share of your stocks, then you do not have to worry about the value of your stocks. If you never have to sell, who cares if your portfolio loses 50% or even 70% of your value?

There are two strategies how people can save for retirement – a 4% rule (peddled by current financial advisers) and a sole dividend income.
The 4% rule means, that every year you sell 4% of your portfolio and use the cash for your daily expenses. So if you have a portfolio of, let’s say $1 million you will be selling $40,000 annually for your retirement (and if you need more than that, let’s say $60,000 every year, you need to save more) and hope that during the next year your stocks grow more and make up for your next year withdrawal (because after your first year withdrawal, you will only have $960,000 in your account).
But let’s say the very second year a recession hits the market and your portfolio drops 60%. Now your $960,000 portfolio is worth only $384,000. And since recessions and bear markets usually last 1.5 to 2 years (sometimes a bit longer) at the end of the second year you will be taking $40,000 out of your $384,000 leaving you with $344,000 to start a year three. Ouch. That is pretty much an end of the game and a sure ticket to go back to work.

On the other hand a dividend growth stocks can provide you a protection of your income; not your portfolio, but your income.

If you start building up your portfolio when you are 20 years old and save $1,000,000 then your YOC (yield on cost) on your stocks will be around 15% to 20% (depending on the stock selection and dividend growth). But let’s stay conservative and say that your YOC will be only 6%. And 6% annually from your $1 million stock holdings will be $60,000. Yes you will receive $60,000 every year no matter what is happening. If a recession hits and your portfolio shrinks down to $384,000 you still will receive your $60,000 annually and you do not have to sell a single share. And 6% is a very achievable rate. As I mentioned above, over 25 or 30 years, your actual yield will be a lot higher due to the dividend growth as every company increases the dividend every year. For example, Johnson & Johnson (JNJ) paid dividend for the last 100 years and increased the dividend for the last 50 consecutive years, Coca Cola (KO) increased dividends for the last 57 consecutive years, McDonalds for 44 consecutive years, etc. There is currently 138 high quality dividend growth stocks (aristocrats) which were paying dividends for more than 50 years and increased them every year for more than 50 years. Even during 2008 recession these companies increased their dividends.

And these are the stocks you want in your portfolio because they will protect your income. They will not protect your portfolio value (to some extend) but with these stock, you can let your portfolio drop by 50% or even 70% and you wouldn’t have to move a finger and you would be comfortable waiting the storm out and in two to three years your portfolio recovers.

There is another aspect to the dividend stocks. They tend to grow at the same rate as their dividend. So if a company increases the dividend 3% every year, you may expect the stock price to increase by 3% that year too. For example, I was buying JNJ stock when everyone was selling it during the panic. My average cost basis is $48 a share. Today, the stock is trading at $147 a share. Even if it loses 70% of its value during the next recession, it will be trading at $44 a share. I will be pretty much break even on the value of my holding but on top of that, I will still keep receiving my nice fat dividend (currently my YOC is 20%). And guess what I will be doing if this stock loses 70% of its value? You guess it, I will be buying like crazy!

And that is the big difference between growth stocks and dividend stocks and how dividend stocks can protect you and help you to weather out recessions.
Of course, there is another important aspect to dividend investing – you must pick high quality dividend growth stocks. On my blog, I have a list of the dividend aristocrats (champions) updated every month (note: the list was originally created by David Fish and now when he passed away the list is maintained by one of his followers Justin Law). Here is a link: Dividend Growth Stocks CCC list.

If you keep buying shares from that list (and sell when they are removed from the list) your portfolio will be well invested and your income well protected.