Friday, April 18, 2014

Dividend ETF’s Are Bad for Investors: Here is Why

The Exchange Traded Funds (ETF) industry has ballooned since 1993, when the first ETF on S&P 500 was introduced. Currently, there are hundreds of ETF’s covering many investment strategies present. One strategy which is also being covered with dividend etf’s includes dividend paying stocks. In this article I would discuss the positives and negatives of dividend ETF’s, and explain why they are bad for income investors.


Some of the positives of owning dividend ETFs include instant diversification, ability to invest passively and the ability to gain exposure if you do not have a lot of money.

1) Instant diversification,

The biggest allure of dividend ETF’s is the fact that investors can easily purchase a basket of shares with just one trade. This basket of shares would be representative of different industries included in the index, and would reduce the risk that our investor overcommits to a certain sector if they are prone to chasing yield for example. Plus, you get to pay one commission to purchase a whole basket of stocks, or some companies might let you purchase ETF's commission free.

2) Ability to invest passively

Another appeal of dividend ETF’s is that it lets investors purchase a basket of stocks, and then not have to worry about analyzing stocks, monitoring 30 - 40 companies in detail. This is the job of the investment manager in charge of the ETF, who reads annual reports, keeps up with current environment, calls companies and does all the leg work so that the investor does not have to do it. Reading annual reports could sometimes be an intimidating or very boring task for some investors. The dividend ETF is ideal for investors who want to set the investment, and forget it.

3) Good for beginning investors who are still learning and have less than $10,000

The investment in a dividend ETF or dividend mutual fund is probably best for beginning investors who have less than $10,000 to start with. It offers them instant diversification and passive investment at the fraction of the cost of a do-it-yourself portfolio using an online broker. Dividend ETF’s also make it very easy for investors to put additional funds to work, while maintaining sector diversification in the index and without worrying which of the 30 - 40 securities is the best one to buy.


1) Annual costs

While Dividend ETF’s provide investors with instant diversification and the ability to let someone else to worry about the mundane details, the Ivy League investment manager comes at a price. In addition, most companies that offer dividend ETF’s also want to earn a fair profit on this product. As a result, investors in some of the largest dividend ETF’s like SPDR S&P Dividend (SDY) and iShares Dow Jones Select Dividend Index (DVY) pay 0.35% – 0.40% per year in management costs. If the stock portfolios in those ETF's yield 3% on average, this means that 12%-13% of your dividend income will be paid out as an investment tax. If our investor is also in the top bracket, and pays 23.80% federal tax on the income, they would end up with only two-thirds of their desired dividend income. While placing your stocks in a tax-deferred account such as a Roth IRA can eliminate taxation issues, placing your investments in ETF’s would result in recurring annual charges. In fact, investment companies end up charging their fees on a daily basis. This compounding of fees could cost investors large amounts of money over a normal 20 - 30 year investment period. While many ETF’s are now commission free at various brokerage houses, investors would need to pay a commission for most of the dividend ETF’s out there.

2) Investors have no say about which stocks the ETF holds

Another negative of dividend ETF’s is that investors have no say on how these baskets of stocks should be invested. Sometimes, a dividend ETF might hold shares that do not fit in its strategy for months. For example, back in 2008 and 2009, the SPDR S&P Dividend ETF (SDY) held on to shares of companies that cut or eliminated distributions for several months after the fact. As a result, a portion of the capital of this ETF was not properly invested and was not generating much in dividend income for investors. In addition, many dividend ETF’s are placing higher weights on higher yielding stocks, which could increase risk for income investors. This increases exposure to companies with accidental high yields which are large because the dividend is in danger. In addition, some of these ETF’s also tend to focus mostly on higher yielding sectors like utilities and financials, which could increase risk as the portfolios would not be properly diversified.

3) Investors fail to learn about investing

The most successful investors make their own investments, after a careful analysis. If investors simply purchase an ETF, they might not truly get an understanding of what they are buying and could pay a high price over time. Educating yourself on how companies make money, how the economy works and understanding how to value a security would be beneficial to investors who follow stocks, bonds, commodities or real estate. If they blindly buy ETF’s or mutual funds without fully understanding what they are getting into, they might be much more likely to lose money by selling out during bear markets or by getting overly excited about the wrong investments at the most inopportune times.

4) If not enough money is attracted, the ETF could be closed

Another less known risk about dividend ETF’s is that if the fund fails to attract enough investors, it could end up closing and returning money to investors. If our investor is passive and only checks their portfolio once or twice/year, this could mean that they can potentially miss on potential upside by not being invested in the markets. A small ETF size typically also translates into higher bid/ask spreads and higher annual costs.

5) Too much turnover

I am a pretty passive dividend investor, who makes sell transactions very rarely. In fact, I have realized that one of my largest mistakes I have committed in the past few years was selling fine companies in order to get something that I thought is better. The end result of this mistake is that I have ended up with more paperwork, and transaction costs, without really achieving a better benefit. Talk about reinvestment risk. Therefore, I am not a fan of ETFs or Mutual funds that have turnover, which produces capital gains that investors have to foot the bill for, without really getting anything extra. The issue with dividend ETFs is that they contain quite a lot of turnover, and unfortunately the investor does not have any say about it. Honestly, if a company I own froze dividends for a few years, it would not be a strong enough sell signal for me. I also don't want to sell a company when it splits into two after raising dividends for 40 years, despite the fact that the new companies lack a record of dividend increases. This happened with Altria (MO) after it spun-off Kraft (KRFT) and Phillip Morris International (PM) in 2007 and 2008.

For my personal portfolio, I tend to invest in stocks directly, and build my exposure to different sectors from the ground up. I have a direct say on portfolio weights, and selecting only companies whose stocks are attractively priced at the moment. My only cost is the commission to buy or sell securities. If commissions were $5/trade, an investors purchased shares in $1000 increments, then this comes out to a 0.50% one-time cost. This is a much better cost than paying 0.35% – 0.40% every year. During a 20 - 30 year period the costs are going to reduce income over time. In addition, I have flexibility to exit stocks that do not make sense right away, and reinvesting the funds into another security that makes sense. Plus, if you achieve a certain net worth, your investment costs might be close to nill with some brokerage houses.

Full Disclosure: Long MO, PM, MDLZ, KRFT,

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Wednesday, April 16, 2014

When to sell your dividend stocks?

Ideally, your holding period should be forever. Investors who purchase shares in prominent dividend paying companies with the intent of flipping them within a few months are likely to make a lot of mistakes. This is because by frequently buying and selling stocks, investors incur costs such as taxes and commissions, which drain their capital. Studies have shown that the investors who make the most trades per year tend to earn mediocre returns at best. This is because a successful investment would likely pay in rising dividends over many decades to come. A lousy investment would be one where dividends are cut or eliminated as earnings per share decline. Even the best businesses can experience such adverse situations a few times during their lives. A patient investor should let the company work its problems out, especially given the fact that they are in it for the long haul, as long as dividends are at least maintained. You have already delegated your investment in the hands of company management indirectly, who work to increase earnings and pay you the dividends. Thus, micromanaging business conditions does not strike as particularly rewarding. Many times companies fall onto hard times, and keep a dividend frozen, only to resume increases in a few quarters or years. Just think of General Mills (GIS), which has paid dividends for over 115 years, and has never cut it. There have been times where it achieved a streak of 30+ years of consecutive dividend increases, followed by a few years where dividends were frozen.

An impatient investor who sells after dividend freezes might increase portfolio turnover dramatically, increase their investment costs, and sell securities which have experienced temporary turbulence. For example, in 2009, Hershey (HSY) froze dividends, thus ending a 30 year streak of dividend increases. Selling would have been a mistake, as the company resumed increases a year after it kept distributions unchanged. The dividend has since increased by over 60%, which is not too bad for a five year holding period.

When a dividend is cut or eliminated however, this is management’s way of saying that things are indeed bad. Dividends are a sacred cow, which might be frozen from time to time, but very rarely cut or eliminated. As a result, a dividend cut shows that this business is likely in trouble. As a dividend investor, this is when I decide to sell my position automatically. This safeguards the capital left, and provides a fresh perspective after the sale is done. The reason for this automatic sale is to prevent me from being overly emotionally attached to a stock, and rationalize my holding until it is too late. For example, dividend investors in Bank of America (BAC) enjoyed a rising dividend for 30 years in a row, before the dividend was cut two times between 2008 – 2009. This took the quarterly dividend from 64 cents/share to 1 cent/share If you sold right after the first announcement, you could have managed to get out around $29 - $30/share. If you held BAC stock for the past 20 years however, and you rationalized that the bank would eventually bounce back, you suffered from no dividend income on this portion of your portfolio for 5 - 6 years in a row. Sometimes, admitting mistakes is difficult, but costly if nothing is done about it.

If the dividend cut is reversed and the company initiates or increases dividends, you can get back in. In a typical dividend growth portfolio consisting of 30 – 40 securities, I would expect a dividend cut to occur at least once per year. On the bright side, if 39 portfolio holding raise distributions by at least 2.50%, and one completely eliminated distributions, your income will stay flat. Chances are however that the 39 companies will increase dividends by 6%/year, and the capital you deploy from the dividend cutter will generate some return when invested elsewhere.

Full Disclosure: Long GIS

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Monday, April 14, 2014

How to monitor your dividend investments

Once an investment is purchased, it has to be monitored frequently. While monitoring is important, it is also important to avoid too much action with your investments. The hardest part of dividend investing is sitting and doing nothing for years if not decades. The good businesses will usually take care of themselves, while the bad businesses may produce some dividend payments for you for a few quarters before cutting them or eliminating them completely.

The way I monitor investments is by focusing on annual reports and maybe quarterly reports and press releases. I usually update my stock analysis about once every 12 – 18 months as well. I do this mostly to aide me when deciding to buy a stock or not. I discuss the conditions that would cause me to sell in the next chapter. An investor should apply extreme caution to dealing with information that is noise, and does not really present you with material information about the business you own. Examples include analyst opinions on stocks, news articles from mainstream media sources or TV commentary from the likes of CNBC. You should apply your judgment in determining whether you would benefit by listening to this noise.

In the analysis, I look for rising earnings per share, dividend per share, sustainability of distributions and how the business is doing. If you have spent a lot of initial time learning about the company, there would not be much to learn from year to year. For a period of several years however, you might learn about new acquisitions, divestitures, and plans on how to grow the business. You should be careful if management focuses too much on growth at any price, as this could result in poor performance in the fundamentals that matter to you as a dividend investor. For example, if a utility company you own is trying to revolutionize energy market by trading energy, electricity and internet bandwidth, without focusing its attention to actual profits, this could be a red flag. This is Enron of course, which was a sleepy company until management got crazy in the 1990’s and eventually bankrupted shareholders and left thousands of employees without a job.

Investors might also monitor investment for extreme overvaluation. For example, a business that is ridiculously overvalued might be better off sold, although this could be evaluated in light of the steep tax liabilities it could produce. Sometimes it might make sense to hold on to a temporarily overvalued business, merely because the investor expects the improving fundamentals will “bail them out” eventually. For example, Coca-Cola (KO) and Wal-Mart (WMT) were terribly overvalued in 1999 – 2000. However, the improved fundamentals eventually bailed investors out. Of course, the capital invested in Coca-Cola and Wal-Mart didn’t deliver much in terms of dividend income, and could have been invested somewhere else. However, if significant unrealized profits were generated, selling and buying something cheaper could have been an exercise in wealth destruction. This is because there are no guarantees that the undervalued security in an overheated market is not a value trap. Therefore, investor would have been better off simply holding off, and reinvesting dividends elsewhere.

One should also monitor positions that go above a certain pre-set threshold. For example, if you hold 40 individual securities in your portfolio, each position would account for 2.50% in an equally weighted portfolio at the start. Over time however, it would not be unreasonable to have a position or two which turn out to be outstanding winners, and prove to be multi-baggers ( they increase in price several times above your purchase price). If such a position now accounts for 10% of portfolio value and dividend income, it produces a larger strain on portfolio income for diversification purposes. If you are in the accumulation stage, you can simply add new funds and dividend payments received and apply them to other attractively priced securities. As a result, the overall weigh of the multi-bagger would decrease. In the retirement phase, you can simply reallocate dividends towards other securities. The main idea is to try to let your winners run for as much as possible, and not tinker with your portfolio too much, unless there is extreme overvaluation, dividend cut or a fundamental shift in fundamentals. The only reason why I would always sell is included in the next chapter.

Full Disclosure: Long WMT, KO

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Saturday, April 12, 2014

Nine Reasons I Read Dividend Mantra Every Day

There are several sites I read daily, as part of my routine to check what other investors are doing with their money. Many of those include dividend investing sites, but I also look at sites covering general investment and investor psychology. One sites I have been following religiously since 2011 is Dividend Mantra, written by Jason Fieber. There are several reasons why I personally start my day with his site.

1) His stock analyses

He thoroughly analyses companies he buys, including qualitative and quantitative factors. I enjoy the fact that he tells readers about the story behind each company, and reasons why he purchased it. It is very interesting how different dividend investors with somewhat different approaches to analyzing companies end up with a very high overlap of quality dividend paying companies in their portfolios.

2) He earns a middle class salary,

This makes his efforts relevant to a large base of investors. This is a very powerful lesson, which shows that everyone can make it in investing, as long as they find the right strategy, save high portions of income consistently, and keep being persistent for long periods of time. Even if you start with a few hundred dollars a month using a no-cost broker like Loyal3, you can still amass a sizeable collection of dividend paying stocks over time.

3) He is frugal with money.

Jason writes about his monthly income and expenses, which include things as mundane as delivery pizza he ordered to buying and selling a scooter. I think that one of the largest contributors behind his accumulation of a six figure portfolio is due to his high savings rate. I am lucky to also have a very high savings rate as well, which is a definite plus, because it allows be to find enough capital to deploy every month, and kick start my dividend growth compounding. It is a site where frugality meets dividend growth investing.

4) He plans to retire early.

Jason tries to retire at the age of 40, which is a pretty lofty goal. He started his journey at the age of 28 – 29, which means that he expects to be financially free within a decade of saving and investing. Given the fact that he has shown the stamina to keep putting money in dividend paying companies on a consistent monthly schedule, I am more than confident that he will achieve his goal. As I had mentioned earlier, in order to determine whether you can retire early, you need to determine how much you are spending. The next step is determining how much you will spend in retirement, and work backwards to achieve this goal. The key inputs in your financial independence calculation include money you are putting every month to work, investment returns and time you allow your capital to compound.

5) We have very similar personalities and strategies

The one thing that I like about Jason is that we have a lot of things in common. I am fairly frugal, and I put money in dividend paying stocks, because I think this is the best strategy for someone like me who wants to live off an investment portfolio. I also plan on achieving financial independence early in life, in order to achieve something else with my life, other than enduring a 50 – 60 hour weekly grind at my job.

6) He is able to motivate himself and readers to keep the good fight

One of the reasons I like reading his site is the dose of motivation that puts things in perspective. I think that few people really stop to think about the true cost of buying a new car or a new TV every few years. Jason discusses why those might not be important for your true happiness, and how you only live life once. Therefore, you need to spend it in the way that is best for you, not how others are telling you to spend it. He is able to visualize his ideal retirement, and how it would free up his time from having to exchange his time for money.

7) He had all odds stacked against him, yet he still persevered through hard work to get where he is today

Actually, he has had it much more difficult than I have ever had it. Some of his stories are really scary for me to read, although it does make it even more telling how far ahead he has come. It is great how he had his awakening moment in his late 20s, that has truly provided the spark that will lead him to greatness. I guess it is at the moments of despair that the seeds of future success are planted.

8) His dream is built in real time

He is a dividend growth investor who is building his dream in real time. Unlike most other stories of persons who retired early a long time ago where you hear about them only after they have retired, you get to see Jason save and invest his money in quality dividend stocks every single month in almost real-time.

9) He is a celebrity

Jason has been interviewed by the USA Today, CNBC etc. He is a role model for many people who want to be able to live life on their own terms. I see him as a positive role model, whose story should be more widely followed than the other celebrity gossip people usually waste their time on. I would much rather read about his monthly income and expenses on the cover of People magazine or on E!, than anything about the Kardashians. I don’t read those magazines, but I know a lot of people do, and their views are shaped by these publications.

When I started my own site in 2008, I planned on posting my monthly income and expense, as well as how much I earn in dividend income, but I decided against it. I didn’t feel safe revealing everything about myself to the world, and still don’t. Kudos to him for doing what he is doing, and motivating people to take ownership of their financial lives.

Friday, April 11, 2014

How to deal with new cash from dividend payments

As a dividend investor, you have the luxury of receiving regular cash infusions into your portfolio on a regular basis. During the accumulation stage, you will also have extra cash that you would need to deploy on a regular basis. Even once you become retired however, you might still find a trickle of excess cash finding its way to your bank accounts, that you might decide to put to work in your dividend portfolio. You then have the opportunity to deploy this cash in one of two ways that you believe are the most optimal for your portfolio. The two options are to reinvest automatically (DRIP), or reinvest manually. Another option could be to mix and match both strategies.

Each of those strategies has its pros and cons. The major negative about DRIPing is that investors risk reinvesting distributions into shares without regards to valuation or opportunity cost. It could be very costly in the long run, if you mindlessly allocate dividends received into the overvalued companies that generated them, particularly if more attractive places for this cash are available. This is one of the reasons why I usually combine new cash with dividends received every month, and then make a purchase in my best ideas at the time.

One of the positives of DRIPs is that you are taking immediate advantage of the power of compounding, by putting cash dividends received into more shares right away. That way, you are not wasting time trying to accumulate enough cash so that it is cost effective to make an investment. Plus, you can set it and forget it, and take a more passive approach to compounding your wealth and passive income.

Another advantage of automatic dividend reinvestment is that you are not charged a commission when putting money back into the same stock that distributed cash for you. I do not advise anyone to pay more than a 0.50% in commissions before investing in dividend paying stocks. If you lose a portion of dividend income to excessive brokerage fees, you are shooting your compounding process in the foot. This is why automatic dividend reinvestment is ideal for situations where your dividend income is low, or you cannot add money to this account, in order to justify waiting for a set amount of capital to accumulate in cash.

I only reinvest dividends automatically for my Roth IRA account, which I started in 2013. This is because I can only put $5,500 per year in it, and the amount of dividend income generated per year is a couple hundred dollars. Therefore, it is not cost effective to wait for cash to accumulate and pay an exorbitant commission of over 2%, which would stump the turbocharging effect of growing dividends that are being reinvested. It is much better to reinvest dividends back into the company that paid them for free, rather than taking the time and paying a steep fee in order to reinvest elsewhere. Manual dividend reinvestment is quite inefficient for smaller portfolios with no new additions of capital. For my taxable portfolios, which are the lions share of everything however, dividends are reinvested selectively.

Full Disclosure: None

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Wednesday, April 9, 2014

How to Manage Your Dividend Portfolio

The hardest part about investing is sitting down, and not doing anything. Just monitoring your portfolio even when its quoted value drops by 50% in a given year, is something that only a very small number of investors can achieve. Studies have shown that the most investors usually perform very poorly when making investments. Those that buy and hold on, are a very rare breed. However, these are the types that save a ton in commissions, taxes and have the best chances of generating the most bang for their investment bucks.

Wall Street makes its money if you actively buy and sell stocks. It nickels and dimes you in commissions, bid/ask spreads, annual fees etc. The hedge fund managers and high speed computers are all operating at a day to day or minute to minute time frame. They see orders from small investors as prey. However, as dividend investor, you should not care whether you paid $37 or $37.01/share for Coca-Cola. Your edge lies in the fact that you would hold the stock for as long as it maintains and raises its dividend. This is where your edge against the Wall Street types comes from.

Your other edge as a long-term investor comes from deferring taxes paid to the IRS. If you bought Coca-Cola in 1988 for a split-adjusted $3/share, you are now sitting on an unrealized capital gain of $35 - $36. At 15% in taxes, this is more than what you paid for the stock. Those who buy and sell securities frequently, end up paying a ton to the tax man. Of course, if they are really bad at investing, they can generate a lot of tax deductions for themselves to use for years against taxable incomes.

Your other edge comes from the fact that you should not care how you are doing against a benchmark like S&P 500. Many mutual fund manager are evaluated based on how they did against a benchmark within a 3 month period. This is non-sensical – as quotations in the short run are just noise. You can’t judge the performance of an investment strategy based on short-term period of less than one year. You also have a much better chance of succeeding, if you have a strategy that fits your investment goals and objectives ( see first article in the series). If your goal is to generate a rising stream of income, that would pay for your expenses in retirement, you should not worry that the quoted value of your dividend stocks is down by 50%, as long as the underlying fundamentals are still intact.

What I am trying to show with those examples above is that your portfolio management should be very passive in nature. You should sit tight, and watch your dividends deposited in your accounts.

I usually sell only after a dividend cut. I have modified my criterion of selling if I thought stock was severely overvalued, but so far my results are pretty mixed with that. In retrospect, I would have been slightly worse off sticking with the original investment I sold. Therefore, you should be very careful about selling securities. This is because a factor that might influence you to sell could seem important at the time of sale, but in reality could be just noise in the data. With long term buy and hold investing, you stand the greatest chances of earning the most in dividends and capital gains. The best results are probably still ahead for you. If you think about it, if you focus on strong franchises such as Coca-Cola (KO), Wal- Mart Stores (WMT) and McDonald’s (MCD), chances are that 20 years from now, your investment would likely be worth several times your initial capital outlay. If history is any guide, you can likely expect an annual dividend income stream which is equivalent to approximately 20% yield on cost. Therefore, while your amount at risk is fixed, your upside is virtually unlimited.

There are a few more traps that suck investors into selling their stock prematurely, and therefore not participating fully in any dividend upsides:

- Do not sell simply because you have a huge gain

- Do not sell if your stock trades at a P/E of 23 and replace with a stock with a P/E of 20

- Do not sell because of dividend freeze

- Do not sell because of spin-offs

The most important thing about investing is to be patient. It is true that you won’t make money on all of your stock selections. A portion of the businesses you purchase today would likely be obsolete in 20 -30 years, thus cutting or eliminating distributions, while another portion would likely be mediocre dividend growers. The dividend growth from the remaining winners however would likely more than compensate for the lost dividend income from the losers.

As a result, it is wise to accumulate dividends in cash, and use it to buy the most attractive securities at the time. If a position accounts for more than 5%, do not add to it. Unfortunately, if it becomes 10%, determine if new cash added over next year to other positions can lower positions weight in portfolio. Otherwise, you might need to trim it.

Full Disclosure: Long KO, WMT, MCD,

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Monday, April 7, 2014

How to analyze investment opportunities?

I have discussed before my criteria for screening dividend stocks. The screen narrows down the list of companies to look into more detail, to a more manageable level. In addition, it makes you focus on a set of companies with minimum set of earnings and dividend growth characteristics which are cheaper. Therefore, you would avoid looking at Automatic Data Processing (ADP) at 26 times earnings that yields 2.50%, and instead focus on researching the likes of Chevron (CVX) at 10.70 times earnings that yield 3.40%.

However, it is very important to avoid being short-sighted in regards to stock screens. This is due to the fact that data could not be fed correctly, or it might be misrepresented in the database you are using. For example, some companies usually record one-time adjustments to earnings. Any astute dividend investor should know to exclude these one-time items from the calculation of price earnings ratios. Back in 2010, Coca-Cola had to record a one-time gain on the acquisition of Coca Cola Enterprises North American Bottling Operations. As a result, the stock appeared as a much better bargain in comparison to PepsiCo (PEP). However, this was an illusion, made possible by the one time gain discussed earlier.

The opposite also happens, where a onetime adjustment could push earnings so low, that the P/E ratio and dividend payout ratios scream avoid. In reality, if a one-time adjustment should be taken out, it would usually show that the stock might be a good opportunity.

This is why simply relying on a stock screen to find ideas is not sufficient. This is also why astute dividend investors should research every prospective buy candidate one at a time.

For every company I look at, I focus on several quantitative factors to begin with:

1) Rising earnings per share over the past decade
2) Rising dividends per share over the past decade
3) A stable and sustainable dividend payout ratio
4) Returns on Equity that are stable over time

I also try to read the annual report, and quarterly press releases from the company. There is usually a lot of information, but not all of it can be actionable. I usually try to understand the company’s business while reading reports. However, the thing I am most interested in is trying to determine if there are catalysts for growth in earnings. Only a company that manages to grow earnings per share over time, will be able to afford to increase distributions for its loyal shareholders.

Companies can grow earnings by selling more products, creating new products and services, expanding in new markets, increasing prices, cutting costs, squeezing out inefficiencies, buying back stock, acquiring competitors to name just a few ways. Sometimes, companies can manage to grow earnings per share through a combination of all of the above. For example, Coca-Cola (KO) can earn much more per share, if it manages to convince the average consumer in China and India to drink as many servings of its product as the average US consumer. The average US customer consumes 401 servings of Coca-Cola product every year, compared to 39 in China and 14 in India.

I usually like to see companies which offer a product or service which is unique, and results in repeatable sales to consumers. I also look for companies that have strong brand names for products or services, which are pursued by a fan base of loyal customers. If the customers really like your product or service, and cannot get it anywhere else due to various reasons, you can have very good pricing power. This could be extremely profitable, if there is a limited amount of government regulation. This is referred to as the business having a moat, or strong competitive advantages.

For example, consumers who like Coca-Cola, would be much less likely to buy a Pepsi (PEP). Therefore, if a store does not offer Coke, customers are likely to go to another store to purchase their daily fix. The same is true for other branded products like Hershey (HSY) bars for example.

Full Disclosure: Long KO, PEP, CVX, ADP

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Friday, April 4, 2014

When to buy dividend paying stocks?

Dividend investors should not view every stock they purchase as a price that fluctuates on a computer screen however. On the contrary, they should view each stock purchased as a share in a business. Therefore, the most important thing to focus on is the underlying strength of the business you are investing in, and not day to day fluctuations in security prices.

Once an investor has a list of quality businesses, he needs to be able to decide at what prices to purchase them.

Fluctuations in security prices should be utilized by the enterprising dividend investor to his or her own advantage. In order to be rational and allocate their money in the most efficient manner, the intelligent dividend investor should have devised a system for buying. This system would allow the investor to acquire shares of quality companies at a reasonable price.

The intelligent dividend investor should know that even the best company in the world, is not worth purchasing at any price. Therefore, they should realize the value of being patient, and only buy securities when they are available at attractive valuations. The number of quality companies selling at cheap prices would vary depending on the conditions on the stock market. During times of Irrational Exuberance, it would be almost impossible to find securities, whose prices are not bid up in the frenzied environment. The opposite happens during stock market panics, when doom and gloom circles the common psyche of scared investors, who rush to unload their holdings at rock bottom prices. During these panics, the number of bargains could typically be overwhelming.

However, these environments on both ends of the spectrum of extreme circumstances are relatively rare in occurrence. An investor is much more likely to experience an environment which is somewhere in the middle, with quality securities being available from some sectors, but not in others. Again, having the entry system and the patience to wait for those opportunities is of utmost importance.

For example, I usually run a screen at least two times per month on the list of dividend champions. I use the following parameters:

1) A company raising dividends every year for at least a decade
2) A price to earnings ratio of less than 20.
3) Annual dividend growth exceeding twice the annual rate of inflation
4) A dividend yield that exceeds 2.50%, which is slightly higher than the yield on S&P 500
5) A dividend payout ratio below 60%, in order to ensure sustainability of distributions

Note: For REITs and MLPs, I look for FFO and DCF information, rather than earnings. As those as more advanced securities, they are not the point of this article.

The output of this screen only provides with a quantitative view of a list of businesses. It should not be an automatic signal to buy, especially if the investor knows nothing about the businesses that are produced by that screen. If the investor has analyzed the companies that are on the screen already, he or she can put their money to work by acquiring shares in these enterprises.

It is important to also take into account existing portfolio weights and holdings, after screening for attractively valued quality dividend growth stocks. When presented with the results of the screen, investors should first always initiate positions in quality companies that are rarely undervalued. Then, they should add to existing positions, as long as they are not taking a prohibitively high portfolio weight. Again, this paragraph assumes that the investor already has knowledge of the company they are buying, and finds it to be a quality company.

It is very common for the investor to see the same companies on the screen for months or even years to come. Therefore, it could be wise to be on the lookout for candidates that are new to the screen results. In addition, it might also be important to get into the habit of monitoring companies you are interested in for steep drops on negative news, which could also present an opportunity to buy a quality company at a bargain price. Unfortunately, these usually do not come out with a consistency that a twice monthly regular screen would produce. Therefore, keeping an open view could prove to be profitable.

In addition, I also like it when the companies I am investing in have a plan to grow earnings per share. Examples include IBM’s (IBM) strategy to grow earnings per share to $20 by 2015.

Full Disclosure: Long IBM

Relevant Articles:

How to be a successful dividend investor
How to identify your dividend investment goals
Where to search for investment opportunities?
Diversified Dividend Portfolios – Don’t forget about quality
Not all P/E ratios are created equal

Wednesday, April 2, 2014

Where to search for investment opportunities?

There are thousands of companies in the world, who have chosen to list their shares on a stock exchange. It would take a lifelong journey, in order to learn everything there is about every one about these publicly traded companies. Fortunately, out of that large universe of investments, less than 300 represent that investment universe of dividend growth investors.

As a dividend growth investor, your goal is to select investments that can afford to increase distributions every single year. The three lists I focus my attention on include:

Dividend champions: This list is maintained by David Fish. It includes all companies which have managed to increase dividends for at least 25 years in a row. In addition, David's list also includes Dividend Contenders, which are companies that have managed to increase dividends for at least ten years in a row. The champions and contender lists are superior to the dividend aristocrats and dividend achievers lists, because they are not excluding companies based on superficial criteria such as market capitalization or average trading volume. Therefore, they provide a more complete population of potential investment ideas for the enterprising dividend investor.

International Dividend Achievers: This list includes companies which are domiciled outside of the US, which have managed to increase dividends for at least five consecutive years. It is generally helpful to be aware of international companies which have achieved a track record of consistent dividend increases, since those are not followed by many income seeking investors. However, you should also be aware of the pros and cons of investing in international dividend stocks.

I require at least 10 years of consecutive dividend increases, in order to weed out companies that simply got lucky in a positive economic trend. I do not believe in a business model that has not gone through the average of two economic cycles, which the decade is equivalent to. I want high odds that the business earnings power will be immune to shocks during the next recession, in order to ensure uninterrupted and growing distribution payments to shareholders.

You should learn as much as possible about these companies, even if they are always overvalued. If you can track all 300 of them, you would have the knowledge necessary to act, should the right but brief opportunity arrives.If you gain that knowledge, you would be able to specialize in a strategy you know very well, and earn good returns on your capital. Over time, this knowledge will accumulate like compound interest, and lead to better outcomes for your portfolio.

Full Disclosure: None

Relevant Articles:

International Dividend Stocks – Pros and Cons
S&P Dividend Aristocrats Index – An Incomplete List for Dividend Investors
Dividend Champions - The Best List for Dividend Investors
The case for dividend investing in retirement
The World’s Best Dividend Portfolio

Monday, March 31, 2014

How to identify your dividend investment goals

You have saved up some money after working hard for many years, and now you have decided to put it to work. You see hundreds of articles on investing online, and hundreds of strategies that promise you everything. You are getting information overload. How should you select your strategy?

The first goal when selecting your strategy is to determine what your desired end result should be. For most investors who want a strategy that would help them in accumulating a certain level of target monthly income, dividend investing might be the best solution. The goal should be very specific, and should incorporate as much information as possible to fit the objectives of the investor.

As a result, the goal of earning $1000/month in dividend income is more specific as accumulating a nest egg of $300,000. This is because accumulating a nest egg of $300,000 does not automatically translate into the desired target monthly income to meet expenses, and does not discuss how to pensionize this asset.

For example, my goal is to generate a sustainable level of dividend income, which maintains its purchasing power over time, at the minimum. This would be achieved by creating a diversified dividend portfolio, consisting of quality dividend growth stocks that I try to acquire at attractive valuations over time.

Your dividend investing goals should take into account things like amount you can put to work every month, the time until you retire, as well as make reasonable assumptions about investment returns (initial yield, earnings and dividend growth).

For example, if you put $1000/month in a portfolio of dividend paying stocks that yield 4% and grow distributions at 6% per year, you can expect to earn $1000 in monthly dividends in 12.5 years. If you increase your contributions to $2000/month, you will be able to generate $1000 in monthly dividend income in only eight years.

The types of dividend paying stocks, which could be part of such a portfolio could include:

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products.The company has managed to boost distributions from 46 cents/share in 2008 to 94 cents/share presently. Currently, the stock yields a very reasonable 4.60%. Check my analysis of Philip Morris International.

Unilever PLC (UL) operates as a fast-moving consumer goods company in Asia, Africa, the Middle East, Turkey, Russia, Ukraine, Belarus, Europe, and the Americas. The company has increased dividends for at least 15 years in a row. The stock yields 3.65%. Check my analysis of Unilever.

Kinder Morgan, Inc. (KMI) operates as a midstream and energy company in North America. The company has managed to boost distributions from 30 cents/share in 2011 to 41 cents/share presently. Currently, the stock yields 5.30%.

In addition, that investment plan should discuss more issues, such as where to start your search for investment opportunities, how to analyze them, when to buy, how to manage your portfolio and when to sell. Over the next few weeks, I would discuss each one of these bullet points, and walk you through the complete dividend plan, from beginning to end.

Full Disclosure: Long PM, UL, KMI

Relevant Articles:

My Dividend Goals for 2014 and after
Why do I keep talking about the same companies all the time
How to retire in 10 years with dividend stocks
How to accumulate your nest egg
Warren Buffett’s Dividend Stock Strategy

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