Building A Dividend Portfolio

A great time to build a dividend portfolio is when the stock market is suffering from the after effects of a crash.

A significant stock price decline will hurt and potentially kill off many small firms. It is the nature of life and the world that after abundance comes scarcity. After a huge market climb over many years, there will come a period of decline.

These times of decline often prove to be poor times to own stock in small companies who are either not very well established as businesses or are only just profitable. During a recession, these businesses will be put under significant pressure and may fail.

Those that bought their stock near the top of the market will very likely suffer massive financial losses if they hold their stake long-term. History shows that prolonged periods of stock market decline can be brutal to both stock and bond holders - if they bought at the wrong time and held on for better days.

However, at the same time, many of the larger companies in the market will be trading at prices that offer significant value and provide the opportunity to an investor to build a successful dividend portfolio.

An example might assist...

In 2001, your author purchased shares in Lloyds Tsb, one of the largest banking companies in the UK. During the 'tech boom', the share price had been bid up to around £11. As prices fell across the entire market, banking stocks were also impacted. Your author purchased some shares at around £4.50 each.

However, the company was still paying a dividend that related to an £11 share price. In fact, the dividend payout was not reduced by the firm until around 2008.

The price continued to fall to the region of £2.60 per share. Alas, your author was not that insightful! But the holding still paid out a dividend of around 8% of the amount invested. Considering that the period 2000 to 2005 saw some of the lowest interest rates in history, an 8% yield has proved to be impressive.

Added to this, the market and UK banking stocks then rose and for a time the shares traded at well over £5 each and have been as high as £6.50. In short, at poor times in the market, it is an ideal time to buy big and established companies and build a dividend portfolio.

Of course, the financial and banking crisis of 2008 onwards was not nice to the sector globally. The bank had been run quite conservatively until a government led merger with another major UK player, HBOS, brought the company to it's knees. At their lowest, the shares traded at around 25 pence each in 2011. What a downfall.

Hopefully, that tale of woe will not put you off from looking from bargains with a high dividend yield in times of stress in the markets.

In short, it is possible, if you purchase at the right point in the economic cycle, to build a very high paying and relatively low risk stock portfolio. Self restraint is one of the major requirements.

How Does Dividend Policy Alter A Company Stock Price?

To an investor looking for high and fast capital gains, a company that makes a dividend payment is a low priority. However, for long term investors, research shows that such a payment is an important part of the overall return on investment.

Many of the biggest quoted companies have been paying an annual dividend every year for years. Part of the appeal of their shares as an investment, and part of the valuation in the price is this dividend policy and reliability.

As a general rule, the largest companies also make the largest and most secure dividend payment. Of course, this can never be true of every situation, but the bigger and more established businesses have the security and often the profits to cover a payment comfortably.

It may not be the most rewarding of actions for a company which has a track record of creating a high return on investment to pay funds out to shareholders. Unfortunately, there are too few businesses of this nature. Company management also recognise that by paying an annual dividend their company can potentially be called an income stock.

Income stocks are not necessarily viewed as 'sexy' in the market, but there is a wide array of mutual type funds that specifically invest in such companies. This of course opens the way to much larger institutional investment in a firm which in turn will help to underpin the price in the market.

As big funds buy big holdings, the number of shares floating in the market will usually be reduced. By lowering liquidity, the share price will generally be assisted.

There are, of course, many investors that will purchase company stock and are specifically attracted by the payment of a dividend. These investors will use the payment to subsidise their income and as such, value stability.

Pension funds, for example, generally have a very good idea about their future liabilities - when and how much they will need to pay out and for how long. Therefore, it is in their interests to create a portfolio that include lots of assets that will pay an income that approximately matches the required outgoings.

It is for this reason that once company management has started paying an annual dividend, they will be fearful of ceasing payment. Should the income or pension funds be forced to sell their holdings, the market price will almost certainly suffer. The bonuses and stock options of management are usually tied to this market price!

A private investor will almost certainly be required to pay income tax on any or all dividend income received. In many countries, some of this tax is deducted at source so that the dividend payment is reduced and the company sends money to the tax authorities on behalf of investors.

For more pages:

To An Investor, A Dividend Is A Valuable Thing!

The Definition Of A Dividend

Dividend Policy And Dividend Cover

Understanding And Calculating A Dividend Yield

How High Is A High Dividend Yield?

How Does A Scrip Dividend Work And What Is A Scrip Issue?