The KISS investment strategy is based on applying DDM to
dividend stocks and aiming for meeting or even beating the market performance
with lower risk and volatility than is associated with index investing. The
strategy follows the following rules:
1. Total dividend return greater than projected return for
SP500
Stock market valuation predicts the future returns with
great accuracy. Beating the total market with safe dividend stock may be a
challenge; however, it is possible to obtain market matching performance with
lower risk and volatility than associated with index investing.
Based on current (04/2012) stock market valuation, the
annualized return over the next ten years for SP500 is 7.5%. We use this as our
minimum discount target for DDM. For example, for a single stage DDM analysis,
we want the total return (dividend yield + growth rate) to be greater than r = 7.5%. Currently, large telecoms can
be expect to deliver this performance: ATT has yield Y = 6% and the expected
growth rate is g = 2%. The total return r
= Y + g = 6%+2% should therefore exceed the SP500 over the next ten
years.
In summary, the KISS strategy
invests stocks where the long dividend return alone will meat or beat the projected
return for SP500.
2. Diversification
Invest in at least 10
stocks and in different sectors to reduce risk from a single company. Ideally,
the KISS portfolio should include at least 20 different stocks.
3. Size
Large companies have more predictable dividends than small
companies whose earnings can vary widely. The
KISS strategy invests in companies with the market cap of at least $2B and
ideally over $10B.
4. Payout ratio
The payout ratio is generally defined ratio of dividend to
earnings. The common recommendation is that the payout ratio should be less
than 50% meaning that the company earns $2 for each $1 that it pays out. The
theory is that low payout ratio offers “buffer” against earnings drop and
leaves the company with money to grow the earnings in the future. This criteria,
however, is too restrictive as it excludes some of the best dividend payers.
To see the fallacy, we need to realize that profit is not
the same as cash flow: due to tax reasons, even money making companies can
report loss. For example, telecommunication companies may write down the assets
resulting in paper loss while still bringing in more money than they are paying
out.
The KISS strategy
seeks to buy stocks where the dividend is supported by the long term cash flow.
5. Debt
From KISS perspective, debt is always bad. High dept means
that the company may have trouble raising money when it needs it the most. The most
useful ratio for analyzing the company debt is the debt-to-equity ratio. The ratio
can be compared to mortgage: If persons assets are essentially a mortgaged
house and the debt is 90% of the house, the debt to equity ratio is 90%. Should
the housing value drop by 10%, the person would essentially have no equity left
and it would be very difficult to obtain additional financing from banks that
demand collateral.
Debt-to-equity ratio less that 50% means that the company equity
is 2x the debt. For very stable sectors (=utilities and telecommunication), the
debt to equity can be larger but it should always be less than 100%.
The KISS strategy invests
in stocks where the debt-to-equity is less than 50% (less than 100% for
utilities).
6. Minimum dividend yield
Higher dividend yield is better that low. Ideally, most of
the return should come from the current dividend yield as it is risky to rely
on decades of dividend growth.
The KISS strategy invests
in stocks the dividend yield is at least 2x the market yield. Currently,
the yield for SP500 is 1.9%. Hence, the yield for dividend stocks should be at
least 3.8%.
7. Dividend growth
The dividend growth is not as important as the dividend
yield but some growth is always desirable. A company that has not been able to
grow dividend in the past may be in trouble and could potentially cut dividend
in the future. The KISS strategy invests
in stocks the dividend growth rate greater than zero. Zero growth rate may
be acceptable if the increased risk is compensated by high yield that leaves
room for dividend cuts.
8. Sell criteria
The dividend stock investment is for a long duration and ideally
there should be no reason to sell a KISS stock; however, there are two
exceptions when the stock should be sold:
a) The dividend is cut unexpectedly. This is always bad news
and will most likely result in price decline lasting several weeks. The sooner
the stock is sold, the better.
b) The price increases so much that the future return from dividends
is no longer attractive. For example, if the stock that yielded 4% at the time
of purchase doubles its price decreasing the yield to 2%, it is time to take
the profits and find another investment.