The 10-11-12 System
The three important criteria in picking dividend stocks in the 10-11-12 system are:
Do not chase yield, never buy a stock just because the yield is attractive.
The historical average dividend growth of the S&P 500 is 5.5% per year.
Payout ratio is all about safety of the dividend.
Remember, look for payout ratios based on the free cash flow of 75% or less. Unless the stock is a BDC, REIT, or MLP in which case they can be as high as 100%. In those cases the margin of safety is much lower.
These numbers are meant to be a guide, they are not set in stone. These figures are based on the following assumptions:
1.Unless otherwise stated, over the next 10 years the stock will appreciate 7.84% per year. This figure is equal to the historical average of the stock market since 1961.
2.The average stock performance and growth are consistent. Obviously this will not be the case in real life.
There are online calculators available to calculate dividend returns. The author recommends the Wealthy Retirement Dividend Calculator which is the website for his retirement newsletter.
How to Setup Your Own 10-11-12 Portfolio:
Example company: Kimberly-Clark Corporation (NYSE: KMB) has raised dividends for 48 consecutive years.
Three guidelines for setting up your portfolio:
1.Payout ratio 75% or lower
2.Starting yield of 4.7% or higher
3.Dividend growth of 10% or higher
Of all the guidelines, payout ratio is the one you’ll want to stick to the closest.
Payout ratio of 75% or lower not including BDC, REIT, or MLP in which case they can be as high as 100%.
In this entire strategy, the reliability of the dividend is the most important factor.
Keep an eye on the free cash flow and if management has publicly stated a payout ratio goal.
Yield of 4.7% or Higher
A 4.7% yield on a stable company is pretty solid.
A stock with a 4% yield that grows by 10% per year will yield double digits by year 11 and will yield 20% by year 18.
Dividend Growth of 10% or Higher
It is not recommended to buy a stock with a 13% yield with a dividend that is unsustainable.
When to Sell:
At least once a year look at your stocks to see if any of the following has occurred:
- Increased payout ratio
- Decline in cash flow, earnings, or sales
- Change in dividend policy
Any major changes in these three areas may indicate that it is time to sell.