How do you get your dividend portfolio to be ready for retirement? Investors should pick stocks wisely for capital preservation and dividend safety and maintain a diversified portfolio.
Pick dividend stocks wisely for capital preservation
A big part of picking dividend stocks wisely for capital preservation is not overpaying. This requires investing skills on the investor’s part. In fact, you should aim to buy stocks at meaningful discounts. However, it’s easier said than done. Usually, when stocks go on sale, there are headwinds. Investors could consider investing if they determine the headwind is temporary and the underlying business is solid and has staying power.
Investors can turn to the analyst consensus 12-month price target as a gauge for a stock’s valuation. For example, you can search the ticker for the dividend stock you’re interested in on Yahoo Finance. Keep in mind that this target changes as things change. That is, the price target can rise or fall depending if there’s good or bad news.
The underlying business that drives the long-term direction of the stock may be indicative of the (un)certainty of the price target. For example, quality utility stocks tend to have fairly stable price targets, while the opposite may be true for small-cap or cyclical stocks.
The macro environment can also lead to big changes in the price target. For instance, rising interest rates triggered a downward re-rating of stock prices. The general rule of thumb is that the greater the uncertainty you expect in a business, the bigger of a discount you should seek in its stock.
For a quality utility stock like Fortis (TSX:FTS), I’d seek a minimum discount of 10% for purchase consideration. Its 12-month price target on Yahoo Finance is currently $60.71. So, my maximum buy target would be about $54.64.
Dividend safety
Dividends should be sustainably covered by earnings or cash flow. Fortis’s 2023 payout ratio is estimated to be about 76% of adjusted earnings, which is sustainable for the regulated utility. It also has a strong dividend history, having increased its dividend for close to half a century! Its business is so predictable that management has already guided dividend growth of 4-6% per year through 2027. This provides great clarity for retired investors. Durable earnings or cash flow growth also improves the safety of dividends.
Retirees who want higher growth can explore stocks with lower dividend yields but higher dividend growth, often supported by above-average growth in earnings or cash flow. This can make up a certain percentage of your retirement portfolio, depending on how much higher growth you need. Some higher dividend-growth suspects you can investigate are goeasy, Canadian Natural Resources, and Alimentation Couche-Tard. For your reference, their 15-year dividend-growth rates are 18.6%, 21.4%, and 23.1%, respectively.
Portfolio diversification
One last point to make your portfolio retirement ready is portfolio diversification. You don’t want to concentrate your portfolio in specific sectors or industries to protect your capital and keep your dividend income stream safe and growing. Businesses in the same sectors or industries have similar headwinds and tailwinds. So, they tend to move in tandem, and it makes sense to buy top companies in the respective sector or industry.
You want holdings that move in different directions for the purpose of diversification. This is why other than stocks, retirement portfolios tend to have a meaningful weighting in bonds that may come in the form of bond exchange-traded funds.
