Investing is different for everyone because we all have different goals. To invest successfully, you must first define what you want.
One investor may be happy with a 5% yield and 2% price appreciation for a 7% approximate long-term total return. Another investor might target 10% total returns, not caring at all about the income generated from the investments.
A focus on income makes your life easier because dividends are more reliable than share-price appreciation if you choose companies with stable businesses that perform relatively well in all sorts of markets and business cycles.
Set your goals
The first thing an investor should do is to set a portfolio goal, which consists of the income and price appreciation components of the total return.
Assuming you’re starting a new portfolio today, let’s say that your goal consists of a 4% minimum yield and 3% growth that targets long-term returns of 7%.
Pick quality stocks that fit the goals
The stocks you pick don’t all need to fit the criteria of a 4% minimum yield and 3% growth as long as the portfolio’s average yield and growth fit. For example, Canadian National Railway Company (TSX:CNR)(NYSE:CNI) only yields 1.9%, but for 10 years it has increased its dividend by 17.5% on average per year.
We can simply use dividend-growth estimates from the respective companies we’re interested in. So, choose companies with trustworthy management that has a track record of solid execution, sharing profits with shareholders via growing dividend payments, and perhaps share buybacks.
Brookfield Infrastructure Partners L.P. (TSX:BIP.UN)(NYSE:BIP) owns long-life infrastructure assets around the world that generate stable cash flows. Its assets include ports, toll roads, and rail operations.
It has increased its distribution for eight consecutive years. Its last distribution increase was 7.5%, which aligns with its distribution-growth guidance of 5-9% per year. At $50.10 per unit, it yields 5.7% using a foreign exchange of US$1 to CAD$1.25.
Brookfield Property Partners LP (TSX:BPY.UN)(NYSE:BPY) primarily owns quality office and retail real estate properties around the world that generate stable cash flows. Its last distribution increase was 5.7%, which aligns with its distribution-growth guidance of 5-8% per year. At $28.40 per unit, it yields 4.9% using a foreign exchange of US$1 to CAD$1.25.
Using the midpoints of the company distribution-growth estimates, we forecast Brookfield Infrastructure’s distribution to grow 7% per year going forward and Brookfield Property’s distribution to grow 6.5% per year going forward.
If a quality company does not provide dividend-growth forecasts, you can see how much its dividend has grown in the past year. For example, in the past year Royal Bank of Canada’s (TSX:RY)(NYSE:RY) dividend increased 5.2%. So, we can predict its dividend will grow 5% next year. At $70.10 per share, Royal Bank yields 4.6%.
We set a portfolio goal of a 4% minimum yield and 3% growth, targeting long-term total returns of 7%. Brookfield Infrastructure, Brookfield Property, and Royal Bank all fit this goal. If you invest the same amount in the three companies today, the portfolio will have an average yield of 5% and is forecasted to grow the income by 6.1% per year, implying long-term total returns of 11.1%.
If we throw Canadian National Railway into the mix, the portfolio will have an average yield of 4.3% and is forecasted to grow income by 8.4%, implying long-term total returns of 12.7%. In essence, by adding a low-yield, high-growth company such as Canadian National Railway, we lowered the portfolio yield in hopes of higher total return via growth.
Of course, it’s even better to buy when shares are mispriced because you would get more value for your money. And it goes without saying that periodically (perhaps every quarter or every year), you should monitor how the businesses are doing and see if they continue to fit your goals. Make changes to your goals or your holdings as needed.