How to Build a Dividend Portfolio

So you want to create a Dividend Investment Portfolio. First off, what are Dividends?

According to an article by Motley Fool:

Dividends are money that a company pays its shareholders, typically every month, quarter, or year. Because many established companies earn more money than they can reinvest back into their business, they choose to return some of the extra cash to shareholders rather than stuff it under the mattress or plow it into unprofitable research and development.

Dividends typically come in two types:

  1. Regular dividends: A company pays a regular dividend because it expects to continue to pay the same amount, or increase it, over time. Most dividends paid are regular dividends, which are funded with a company's earnings.

  2. Special dividends: These are dividends that are paid sporadically. A company might pay a special dividend in a year when it is especially profitable, after selling a business unit, or to take advantage of changing tax policy (many companies paid large special dividends in 2012 because dividend tax rates were set to increase in 2013). Special dividends are considered one-time events. 

So now that we know what Dividends are, why invest in dividend-paying stocks?

There are many reasons to love dividend-paying stocks, but one of the most compelling reasons is because stock dividends have historically been more stable than stock prices.

In 2008, for instance, the S&P 500 lost 37% of its value, as expectations for corporate earnings declined in light of the financial crisis. Despite the plunge in stock prices, dividends paid out by S&P 500 companies actually increased from 2007 to 2008.

It wasn't until 2009 that S&P 500 companies decreased their dividends in light of the deep recession, but dividends only declined by about 20%. By the next year, dividends paid by S&P 500 companies started increasing again, and by 2011, they reached a new record high. Stock prices, however, didn't reach a new high until a year later.

Building a DIY dividend portfolio

The Dividend Aristocrats Index (See the full list here), which is maintained by S&P Indices, is a great place to start. This is a collection of several companies that have increased their dividends for at least 25 consecutive years. That means that every company in the index successfully gave investors raises not just during the good times in the market, but also during more volatile downturns, such as the dot-com crash of the early 2000s, the financial crisis of 2008-2009, and the COVID-19 pandemic so far. They may be a safer investment than the average dividend-paying stock.

Here are five great companies from that index to start your search, listed in no particular order, followed by details about each company:

Procter & Gamble (NYSE:PG): Consumer products manufacturer Procter & Gamble has increased its dividend for an astonishing 63 consecutive years. It owns an impressive portfolio of consumer product brands, including Pampers, Downy, Tide, Charmin, Gillette, Head & Shoulders, and Crest, just to name a few. Not only do these brands give Procter & Gamble pricing power over rivals, but most of their products are items people need no matter what the economy is doing.

AT&T (NYSE:T): Telecom giant AT&T has increased its dividend every year for almost four decades, and receives utility-like steady income from its core wireless phone and high-speed internet customers. And the company's aggressive moves into entertainment could provide long-tailed growth potential.

Realty Income (NYSE:O): This is a real estate investment trust, or REIT, that primarily invests in single-tenant retail properties. Most of the tenants operate recession-resistant businesses like drugstores, dollar stores, and convenience stores, and they all sign long-term leases with gradual rent increases built in. Realty Income is one of the newest members of the Dividend Aristocrats, having joined the index in January 2020 after reaching 25 consecutive years of dividend increases. Note that the company hasn't missed a monthly distribution to investors in 50 years.

Johnson & Johnson (NYSE:JNJ): Like Procter & Gamble, Johnson & Johnson owns a portfolio of excellent brands that make products people need -- specifically healthcare items. In addition to its Band-Aid, Neutrogena, Tylenol, Zyrtec, Benadryl, and Johnson's brands (among others), Johnson & Johnson has massive and steadily profitable operations in pharmaceuticals and medical devices, the combination of which has allowed the company to increase its dividend for nearly 60 years in a row.

Target (NYSE:TGT): You may be noticing a common theme here -- Target sells products people need. It has done an excellent job of growing its online and omnichannel sales (such as by offering curbside pickup), and while sales in some of its departments -- such as electronics -- may suffer in recessions, it is generally a well-insulated business in tough times, which is why it has given investors 52 years of consecutive dividend raises.

Four more of the best dividend stocks to buy

The Dividend Aristocrats aren't the only place to look. Many excellent companies simply haven't been paying dividends (or haven't been publicly traded) for long enough to be included in the index, although they can still make excellent long-term dividend investments.

Here is a list of dividend-paying stocks with characteristics such as excellent brands, loyal customer bases, and favorable demographic trends that are also worth putting on your radar. Below, see details about each company.

Verizon (NYSE:VZ): Like AT&T, Verizon enjoys utility-like income from its wireless communications and high-speed internet customers, and the fact that Verizon has significantly less debt is appealing to many investors. Unlike AT&T, Verizon is more focused on its core business and should be one of the biggest beneficiaries of the upcoming transition to 5G mobile technology.

Microsoft (NASDAQ:MSFT): As one of the largest companies in the world, Microsoft has steadily increased its sales, and an especially attractive feature for dividend investors is its focus on recurring, or subscription-based, revenue sources. The company has a solid balance sheet with more cash than debt and a very low payout ratio that leaves tons of room to grow the dividend. Given its 18-year streak of dividend increases, we wouldn't be surprised if Microsoft joins the Dividend Aristocrats club soon.

Apple (NASDAQ:AAPL): Tech giant Apple has been paying dividends for only a few years now, which is understandable given the rapid growth it experienced in the early years of the iPhone and iPad. Companies tend to choose to reinvest profits into the business while in "growth mode." Even so, Apple has an incredibly loyal customer base, and since its devices are designed to work well with each other, the company has a nice tech ecosystem that should keep its revenue strong. And Apple's rapidly growing subscription services business is providing a growing source of recurring revenue.

Welltower (NYSE:WELL): A real estate investment trust (REIT) focused on healthcare properties (particularly senior housing), Welltower should benefit from a long-tailed demographic trend as the older age groups of the American population gradually get much larger over the next few decades.

Sources: Motley Fool - How to Build a Dividend Portfolio

Motley Fool - Dividend Stocks

Wallet Hacks - How I Built a Dividend Growth Investment Portfolio

The Dividend Investing Resource Center - Dividend Champions Excel Spreadsheet

Sure Dividend - 2020 Dividend Kings List | See All 30 Now | 50+ Years Of Rising Dividends