Sunday, October 27, 2013

Dividends & Income - Should you buy Dividend Machines or a low cost ETF?

A Comparison of two dividend strategies: 2013 Dividend Machine Strategy and low cost ETF Strategy. 

I started writing about my income investing theory and experience in late 2010 after I retired as an investment advisor.   One way to invest for income is to buy stocks that pay dividends. Many investors use dividend income and dividend growth strategies.  Others like John Bogle and Ben Stein support the thesis that a low cost ETF is a better and easier strategy

The purpose of this article to report on how my 2013 Dividend Machine Portfolio performed as compared with a low cost dividend ETF. 


I use four criteria to determine which dividend stocks qualify as Dividend Machines.   I created a portfolio of 52 stocks in 2011 and 48 stocks in 2012 using these criteria.   These portfolios have done well.    In 2013 I refined my four criteria a touch and have selected seventeen stocks year to date using the same four criteria I used in 2011 and 2012 but with a little more precision.

These four dividend machine criteria are:  (1) earnings per share must be greater than the dividend paid out in the most recent four quarter rather than just one quarter,  (2) dividend yield has to be at least three percent; in 2013 I wanted stocks with a dividend yield closer to four percent, (3) dividend has to have increased every year for at least five years, in 2013 I wanted at least seven years, and finally (4) debt to equity ratio (D/E) is 1 or less or equal to industry standards; no change from the previous years.


In order to compare my Dividend Machine Strategy with a passive strategy using a low cost ETF, I decided to use the SDY.    This ETF is designed to closely match the returns of the S&P high yield dividend aristocrats.  The expense ratio is .35%.

Each time I picked a 2013 Dividend Machine, I used the same cost basis to buy SDY shares.   I used the low price of the day as the cost basis.   


Seventeen Stocks selected over 2013 using my Dividend Machine Strategy are listed below as well as the number of shares of SDY purchased. 

As of 11:50 AM on 10/25/2013, in the aggregate, the 2013 Dividend Machines are up 10.85%.   Based on annual yields, this portfolio pays 3.77% on the basis and 3.40% on the current value.  

The SDY portfolio accumulated a total of 1,189.14 shares.  In the aggregate, these shares are up 8.93%.  Based on the SDY website, the yield is 2.45%.


If we hold these portfolios for a full twelve months from our last buy, the yields of 3.40% from Dividend Machines and 2.45% from SDY are accurate.  However, you have to own the stock or the SDY shares on the ex-dividend date in order to receive the dividend.   Stocks are not like bonds; bonds pay interest every day you own them.  Stocks pay only on the dividend pay date to shareholders of records on the ex-dividend date.

I live in the real world and I wanted to know which strategy actually delivered more dividend income year to date.

The tables below present the results of this comparison.  

Dividend Machines paid a total of $1,579 year to date for a yield on basis of 2.01% and yield on current value of 1.82%.   SDY paid a total of $931 year to date for a yield on basis of 1.18% and yield on current value of 1.09%.


I have never liked mutual funds.  I do not like not knowing what I own.  I don’t like not being able to sell covered calls on my positions.   I don’t like layers of management and expenses.   ETF’s are lower cost versions of mutual funds and I must admit that I have used ETF’s when I want to exposure to markets where it is difficult for the ordinary investor to trade such as in Asia or South America or India.  But for my money, I prefer owning individual stocks. 

I read John Bogle’s articles and Ben Stein’s books and respect their expertise greatly.  However, my personal gut reaction as an investor and as a former financial advisor is that owning individual, well selected stocks does work well for income investors.  In this comparison the Dividend Machine Strategy delivered better results than the ETF Strategy.

A capital gain of 10.85% versus 8.93% is significant.   An annual yield of 3.40% versus 2.45% is equally significant.   Actual income received of $1,579 versus $931 makes a difference in the income investor’s cash flow.  

Comparing my Dividend Machine Strategy with the SDY ETF Strategy convinces me that a disciplined approach to income investing using my four criteria is a very effective technique for income investors.

The Money Madam