Wednesday, April 1, 2015

Taxable versus Tax-Deferred Accounts for Dividend Investing

Dividend investing is a great strategy for accumulating income producing securities, which pay their owners cash on a regular basis. These cash distributions are viewed as taxable incomes in the eyes of the Internal Revenue Service (IRS). Depending on the taxpayers adjusted gross income, they could end up paying as much as 20% on the dividends they received. Compared to the top marginal rates on ordinary income such as salaries or bond interest however, dividend income has much lower tax rates. In retirement, qualified dividend income will not be subject to federal taxes for married couples earning $95,000/year (assuming no other sources of income). Unfortunately, it would take the average dividend investor years of accumulating assets, before they reach their dividend crossover point. This will result in them paying taxes throughout their accumulation phase. Many investors have the choice to shelter some or most of their investments in tax-sheltered accounts which could either postpone or eliminate the need to pay taxes on their investment incomes. By reducing or eliminating tax waste in the accumulation phase, dividend investors could reach the dividend crossover point much sooner than by doing it with taxable accounts alone.

There are several tax deferred account options for US investors who are still earning a paycheck. These include regular and Roth IRA’s in addition to 401 (k) plans. Each of these accounts has its pros and cons.

Traditional IRA’s provide investors with a tax benefit today, and allow them to compound their gains for years to come but have to take required minimum distributions at the age of 70 ½ years. Distributions are taxed as ordinary income. However there are strict eligibility rules that do not allow high income households to get the deductibility of contributions. Other negatives include the low contribution limit of just $5,500/year. There is a catch-up contribution limit increase of $1,000 for persons who are above the age of 50. The largest negative includes a 10% early distributions penalty that the IRA imposes if someone withdraws funds prior to the age of 59 ½ years. However, you can pretty much invest in almost anything with your IRA.

Roth IRA’s do not provide any tax benefit to investors today, but allow for tax free compounding of capital and tax free distributions from the account at the age of 59 ½ years. Direct contributions can be withdrawn tax-free at any time, although investors need to wait until they are 59 ½ years old, before they can withdraw gains from the account without a penalty. Investors cannot put more than $5,500/year in a Roth IRA, and there are strict income eligibility requirements to open an account as well. There is a catch-up contribution limit increase of $1,000 for persons who are above the age of 50. Another advantage of a Roth IRA is that there are no required minimum distributions requirements. With my Roth IRA’s, I can pretty much purchase any US Dividend Growth Stock I choose, and I like this flexibility. Tax payers are taking a gamble with Roth IRA’s however, as cash strapped Congress could decide to tax distributions in the future. Of course, it is also likely that tax rates on qualified dividend income will increase before Congress doing anything about limiting or taxing Roth IRA's for middle-class consumers.

The 401 (k) plan is the company sponsored defined contribution plan, that millions of Americans are eligible for. The annual contribution limit is $18,000/year for those under the age of 50. If you are over the age of 50, you can contribute up to $24,000/year to your 401 (k). The majority of 401 (k) plans allow participants to put pre-tax contributions today, and enjoy tax-free compounding of capital. They do have required minimum distributions starting at the age of 70 1/2 years old. This is when you will have to pay ordinary income taxes on any money you withdraw from the 401 (k). An increasing number of employers are now also offering Roth 401 (k) contributions, with the same limits as the traditional 401 (k). The nice thing is that contributions are after-tax, the money compounds tax-free, and there are no taxes to pay on investment earnings. The drawback of most 401 (k) plans for many investors is the limitation on the types of investments to choose. A good 401 (k) plan will offer low cost mutual funds to investors. A really good 401 (k) plan will also offer a Brokerage Link window, that would allow investors to pick their own investments. A really bad 401 (k) plan will include high-fee mutual funds with sales loads. If the fund you are purchasing charges an annual management fee of 1%/year, chances are this is part of the offering of a bad 401 (k) plan.

One disadvantage of both accounts (IRA and 401 (k)) is that you cannot deduct investment losses, or offset them against investment gains. In addition, foreign dividends are subject to witholding taxes at the point of origin despite the fact that they are in a tax-sheltered account. Unlike taxable accounts, investors cannot get a tax credit for these foreign tax withholdings. Dividends in tax-sheltered accounts of US investors which are derived from Canadian or UK companies are not subject to tax withholdings.

Despite popular beliefs however, Master Limited Partnerships can be held in tax deferred accounts, as the UBTI which scares investors off is mostly a non-event ( and has been in my few years as an MLP investor, although things might change). In the years that I have owned ONEOK Partners (OKS) and Enterprise Product Partners (EPD), I have never had positive UBTI.

In addition, investors need to choose whether to open a Roth or a Traditional IRA with their $5,500 in a given year, but cannot open both. Investors can still have an IRA and a 401(k) plan however. Given the lack of investment options in 401 (k) plans, they are of limited value to the self-directed dividend growth investor. 401 (k) plans are helpful as a tool to minimize taxes and get the company match, and buy a few index funds, which is why they work for mostly passive investors. The nice thing about 401(k) plans that I utilized in 2013 is that if you quit your job, you can rollover the money into an IRA. After that, you can pretty much invest in anything you want, including creating your own dividend stock portfolio.

In my investing portfolio, I keep most of my holdings in taxable accounts.The taxable accounts give me a lot of flexibility in my investments, and I can add or withdraw as much as I want at a moment’s notice. I do pay taxes on my investment income, but I also get to do tax loss harvesting on my investments.

I expect that by the end of 2015, I would have approximately 10 - 15% in tax-deferred accounts such as 401 (k), IRA, Roth IRA, SEP IRA and Health Savings Accounts (HSA). This is mostly because I used to believe that there are too many restrictions on withdrawing principle and accumulated gains from these tax-advantaged accounts. As a result, I used to contribute only the bare minimum to my 401 (k) in order to get the company match.  As I researched further, I realized that it is possible to withdraw money out of an IRA before the age of 59 and a half penalty free. With Roth IRA's, contributions can be withdrawn penalty-free at almost any time. With 401 (k) plans, investors can start withdrawals penalty free if they have separated from service, and they are 55 years of age or older. Or, just like with IRA's, investors can use Substantially Equal Period Payments (SEPP) and withdraw money to live off at any age. The only catch is that if you start withdrawing money using SEPP, you need to continue doing it for the next 5 years or until you turn 59 1/2 years - whichever is longer.

The part I don't like about taxable accounts is that I was paying too much in taxes on salary and investment income. Taxes are the largest expense item on my personal income statement. Therefore, I have been maxing out all tax-deferred investment vehicles like crazy since early 2013 (luckily for some I was able to contribute for 2012 as well). I have saved tens of thousands of dollars in Federal and State taxes in the process. Prior to that epiphany, I had only contributed slightly more than the employer match I received. If I had to do it all over again, I would have been much smarter about the tax-efficiency of my investments. If my accumulation phase lasts for one decade, this means I would have to pay taxes on the money I want to invest in a taxable account, and then pay taxes on distributions I receive for that entire decade. It is little consolation that when I become FI, my dividend income will be tax-free. When you have too much waste in the accumulation phase of investing for retirement/FI, you end up with less money to invest, since you are paying so much in taxes.

Full Disclosure: None

Relevant Articles:

How to Retire Early With Tax-Advantaged Accounts
My Retirement Strategy for Tax-Free Income
Dividends Provide a Tax-Efficient Form of Income
My Dividend Goals for 2015 and after
How to accumulate your nest egg

Monday, March 30, 2015

Comparing your results to S&P 500 could be dangerous for dividend investors





As a dividend growth investor, I tend to create diversified portfolios full of companies that regularly raise dividends. I try not to overpay for shares in these companies, when I put my money to work. Dividends are more stable than capital gains, which is what makes them ideal for those who want to live off their nest eggs. The end goal for me is to generate as much in dividends to pay for my regular expenses every month. I expect the forward dividend income generated in my taxable accounts to reach the dividend crossover point at some point around 2018. The stable nature of dividend income makes it easier provides much more confidence in projecting future dividend income at a certain point. On the other hand, I cannot tell you whether the value of the portfolio will be twice as much as today's or half as much.

However, I regularly receive some feedback from new readers, because they might have overheard about the importance of benchmarking against a common benchmark, such as the S&P 500. While I have tracked results versus S&P 500, I think that this is not a value added activity for my strategy and my goals. I believe that tracking my total return performance relative to S&P 500 is not going to add any actionable insights, that would help to me achieving my goals. My goals including reaching a certain target annual dividend income within a certain time period. Whether I do better or worse relative to some random benchmark is irrelevant to my long term goals and objectives.

I monitor the annual operating performance of the businesses I have invested in, as I review them at least once every 12 - 18 months. I also review press releases regarding quarterly results, dividend increases announcements, mergers and acquisitions. I track the organic dividend growth rate for my portfolio. I also track dividend income received, and try to understand whether growth came from organic dividend growth, dividend reinvestment and new cash contributions. As you can see, it doesn't matter for my goals and objectives, if over the next 5 - 10 - 15- 20 years the total return on my portfolio is better or worse than the S&P 500. Not only is relative performance versus a benchmark lacking actionable insights for me, but it could be downright dangerous for dividend investors like me.

The biggest danger in comparing my performance to that of the index, is reaching dangerous conclusions. For example, stock prices do not go up or down in a straight fashion. They move depending on a variety of factors, that few can predict in advance. Sometimes, even quality companies might be under appreciated by market participants, and their stock prices might stagnate for extended periods of time. At the same time stock prices can be increasing, as evidenced by stock indexes. However, if the fundamentals of the underlying businesses are doing well and improving, then holding on to those businesses might still make sense. This is because while their price is doing worse relative to the stock market index, they are getting more valuable, despite being underappreciated by the stock market. It might take the quoted price some time before investors realize this discrepancy and bid up the price. If I sold undervalued shares, to buy something that has done well in price, I would be selling low and buying high. I believe that this is not smart investment behavior. Please remember that the stock market is there to serve you, not to instruct you. The time to sell a business is when it no longer performs to expectations, not because the stock prices a group of other businesses have done better in the past 3 - 6 months.

For example, back in 1999 - 2000, many shares of tobacco companies, financials, utilities and REITs were punished by investors who wanted new economy technology companies. The popular indexes such as S&P 500 and Dow Jones Industrial's Average added technology companies in 1999 - 2000. The performance of those companies was great for a while, as everyone gobbled up those shares in speculative frenzy. The old economy boring companies were not viewed as attractive enough. If a dividend investor had sold their tried and true investments because they underperformed for a short period of time, they would have made a terrible mistake.

If I am impatient however, I would feel like I am missing out by comparing my “slow moving” stocks to the index and chances are I would sell as a result of the exercise. This is usually at the same time that the index would likely start dragging its feet, while the shares of the former “slow mover” finally get appreciation by buyers. I see this happen again and again. This is why most individual investors never make any money in stocks – they go from one strategy to the next, chasing hot strategies and looking for something that magically works all the time. If they stick to a slow and steady strategy like dividend growth investing, they would do very well for themselves over time. This is because rising earnings per share, leads to rising dividends per share, which ultimately makes stock prices more valuable. Plus, the fact that most dividend investors are truly passive, they can compound their capital for decades investing in what they know. Studies have shown that the more passive the investor, the higher the chances for satisfactory long-term performance.

My goal should be to have a portfolio that produces slow and steady returns that I can live off of. If I get scared because my portfolio underperforms for a few years, and I end up switching at the worst possible time, I would likely never make any money investing in stocks. The real lesson here is to have a solid understanding behind my strategy, and then to have the patience to stick to it through thick and thin. If I sold my dividend portfolio holdings today and I invest everything in an S&P 500 fund, my dividend income will drop by 45 - 50%. This will be caused by the fact that I will have to pay capital gains taxes on unrealized capital gains and I will have to accept a lower current yield. This change would actually require me to spend more time working at a job that I might or might not enjoy. Since I am not a robot, I have a limited number of years on this earth that I can spend working, rather than enjoying life. In addition, index funds contain a lot of companies that do not pay dividends. And as we know, relying on capital gains works great during a bull market and prices move up. However, if prices are flat, as they were between 1929 - 1953 or 1966 - 1982 or 2000 - 2012, my portfolio will not last for long if it doesn't yield anything. Selling off stocks in your portfolio results in less stocks available over time. If prices do not grow fast enough, you will deplete your portfolio. Selling off chunks of my portfolio to live off is similar to cutting the tree branch you are sitting on. Why not just pick the fruit from the tree, and let it grow uninterrupted?

When someone tells me they are going to sell securities from their portfolio, they are essentially telling you that they blindly believe the stock market will only go up during their retirement. This flawed thinking ignores past history, and sequence of return risks in the portfolio distribution phase. It also resembles the flawed belief by some homeowners between 2000 - 2008 that they can tap equity from their appreciating homes and spend the proceeds. Treating your house like a piggy bank, and relying on increases in house prices to live off turned out to be a poor choice. Spending too much time comparing yourself to the Joneses, is another folly people do. To me, comparing total returns of my portfolio relative to that of someone else's is a perfect example of keeping up with the Joneses. This can only lead to folly behavior.

I am not a big fan of dividend funds or dividend ETF's either. Even dividend growth funds tend to do bizarre things such as keep companies that have cut dividends for almost an year, as was the case of Citigroup in 2008. Another bizarre thing I have seen is when some companies are not included, or others are taken out, as was the case of Altria (MO) being dropped from the S&P Dividend Aristocrats index in 2007. A third example includes my purchase of Higham Institution for Savings (HIFS) in 2010, which was not covered anywhere else except on the list provided by David Fish.  As you can see, indexing does not work for my goals and objectives. However, it could still work for anyone else. Because I am the only one who truly cares about reaching my own goals and objectives, I create my own portfolios by picking individual stocks.

To reiterate the biggest danger in comparing to index funds is that any under or over performance produces no actionable insight for my portfolio management. On the contrary, it can cause me to abandon my strategy at the worst time possible, simply because I “underperformed” the index. With dividend growth investing, I would likely at least match total returns of S&P 500 over long periods of time like 20 years for example. This could include variations in under or over performance over periods of time of varying lengths. However, just because I underperformed for 3 years, it doesn’t mean I would underperform for next 3 years. Because of reversion to the mean, the 3rd year of underperformance might mean that dividend stocks are cheaper than the stock market as a whole. Therefore, they could provide much better returns for the next few years, relative to a market index such as the S&P 500. As usual, past performance is not a predictor of future performance.

The real reason why everyone encourages individual investors to buy index funds in the first place is because some individual investors are horrible at making investment decisions. Not only are they terrible at investing, but they are overconfident and overtrade, fail to stick to a single strategy because they are afraid of missing out on the next big thing. The common fallacy among inexperienced investors is that you need to find the next Microsoft to make money in stocks. Unfortunately, few ever find the next Microsoft, but many lose a lot of money in the process. In fact, these investors would have been better off simply buying and holding on to the original Microsoft in the first place.

(The conclusion that individual investors are terrible at investing is based on data I have analyzed from DALBAR. While I am sure DALBAR is a reputable organization, I have learned to always take information with a grain salt and some healthy dose of skepticism. This is because the information is used by financial providers, advisers and mutual fund companies in order to get clients. Since Dalbar's clients are financial services companies, DALBAR has an incentive to show how bad individual investors do on their own.  If you prove to investors that they need help from the financial industry, they are more likely to come and earn money for your company. There is an incentive for DALBAR to not compare apples to apples, in order to make a case against individual investors. So, as Charlie Munger says, "Never ask a barber if you need a haircut" )

The truth is that if you build a diversified income producing portfolio with companies that are purchased at fair prices, and you do little activity every year, you stand a chance to do pretty well over time.

I reached these conclusions after studying the performance of the original 500 stocks in S&P 500 in 1957 versus index, as well as the ING Corporate Leaders fund for the past 50 years. Did you know that S&P 500 index replaces approximately 4% of components every year? Did you also know that if you had purchased the original 500 components of the index in 1957, and held on for the next 50 years without doing anything other than reinvesting your dividends, you would have outperformed the index? Did you also know that S&P 500 frequently makes changes to its index methodology, which would have reduced past performance numbers?

In addition, if you study the history of the ING Corporate Leaders fund, you can gain a glimpse of the potential in a truly passive buy and hold portfolio. The trust was formed in 1935 with a list of 30 blue chip dividend paying stocks. Given the mergers, acquisitions, dividend eliminations, the list is now down to 22 companies. Over the past 50 years, the fund has managed to return 10.20%/year, versus 9.80% for the S&P 500. The trust sells when a company eliminates dividends or stock price falls below $1.

To summarize, it looks as if the only way to achieve my goals and objectives is by constructing portfolio myself, by purchasing companies with sustainable advantages at fair prices, and then holding passively for the long run. Being passive should be the goal, as selling is usually one of the biggest mistakes investors make. It is a mistake because few can just sit tight and enjoy the ride while ignoring the noise out there. Frequent churn could be costly. Cutting investment costs to the bone is also very very important. If you have a $1 million portfolio invested in index funds, you are likely paying $500 - $1000 every year. You can easily purchase stakes in 30 – 40 of the largest dividend paying blue chips listed in America, and just hold them for eternity. Some of those will fail in the next 40 - 50 years, others will merge or be acquired or spin off countless subsidiaries. A third group would likely still be around 40 – 50 years later, showering you and your descendants with more dividend income than you ever imagined in your wildest dreams.

Full Disclosure: Long MO, HIFS

Relevant Articles:

Dividends versus Homemade Dividends
Why I am a dividend growth investor?
Dividend Portfolios – concentrate or diversify?
Are performance comparisons to S&P 500 necessary for Dividend Growth Investors?
How to be a successful dividend investor

Friday, March 27, 2015

W.W. Grainger (GWW) Dividend Stock Analysis

W.W. Grainger, Inc. (GWW) operates as a distributor of maintenance, repair, and operating (MRO) supplies; and other related products and services that are used by businesses and institutions primarily in the United States and Canada. W.W. Grainger, Inc.is a dividend champion, which has raised dividends for 43 years in a row.

The most recent dividend increase was in April 2014, when the Board of Directors approved a 16.10% increase in the quarterly dividend to $1.08/share.

The company’s largest competitors include Fastenal (FAST), Wesco International (WCC) and Applied Industrial Technologies (AIT).

Over the past decade this dividend growth stock has delivered an annualized total return of 16.30% to its shareholders. Future returns will be dependent on growth in earnings and starting dividend yields obtained by shareholders.


The company has managed to deliver a 13.80% average increase in annual EPS over the past decade. W.W. Grainger is expected to earn $13.01 per share in 2015 and $14.41 per share in 2016. In comparison, the company earned $11.45/share in 2014.

Earnings per share have also been aided by share buybacks. The number of shares outstanding has decreased from 92 million in 2005 to 69 million by 2015. For the past 30 years, the number of outstanding shares has been reduced by approximately one half.

W.W. Grainger is a leading distributor of maintenance, repair and operations products. The North American market is highly fragmented, and is characterized by annual revenues of approximately $150 billion. Grainger accounts for approximately 6% of it. The company can grow earnings through acquisitions, international expansion, gaining market share. The company has years of growth ahead of it. Some of that growth could be generated by going after small and medium sized customers. Currently, the company has a much better presence with larger customers. The company’s online platform could also generate higher sales growth, and lower costs for itself and customers. W.W. Grainger generates close to one third of its revenues from this online channel.

Approximately 88% of revenues are derived from North America (US and Canada). There is the opportunity to grow revenues by expanding internationally. Currently, W.W. Grainger has operations in Canada, Japan, Mexico, India, China, Panama and in Europe.

W.W. Grainger has scale and relationships with suppliers and customers (SME). Its size provides cost advantage relative to fragmented peers. The company also has strong relationships with manufacturers, which provides rebates and helps in maintaining a cost advantage.

In addition, W.W. Grainger is more efficient than its biggest competitor Fastenal. It manages to generate more revenue with less employees and less physical locations. However, those locations are generally larger, and have much more SKU’s and items per store.

The annual dividend payment has increased by 18.10% per year over the past decade, which is much higher than the growth in EPS. Future growth in dividends will be much lower than that however, and will be limited by the growth in earnings per share.

An 18% growth in distributions translates into the dividend payment doubling every four years on average. If we check the dividend history, going as far back as 1977, we could see that W.W. Grainger has managed to double dividends almost every six years on average.

In the past decade, the dividend payout ratio has increased from 24.30% in 2005 to 36.40% by 2014. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

W.W. Grainger has also managed to grow return on equity from a low of 15.90% in 2005 to 24.50% in 2014. I generally like seeing a high return on equity, which is also relatively stable over time.

Currently, W.W. Grainger is selling for 18 times forward earnings and yields 1.80%. Despite the fact that I typically require a higher initial yield, I like the growth story and the growth prospects behind this company. As a result, I recently initiated a half position in W.W. Grainger. I would consider adding to my position if current yields exceed 2%. I would really consider load up on this company if yields exceed 2.50%.

Full Disclosure: Long GWW

Relevant Articles:

Dividend Champions - The Best List for Dividend Investors
39 Dividend Champions for Further Research
Pure Dividend Growth Stocks I wish I owned
Dividend Investors – Do not forget about total returns
Warren Buffett’s Dividend Stock Strategy

Wednesday, March 25, 2015

Dividend Stocks Provide Protection in Any Market

Dividends provide a positive return on investment in any market environment. Unlike capital gains, which can disappear in an instant unless the stock is sold, dividends represent a return which is realized by the investor and cannot be taken away from them. The dividend is always a positive return on investment, as evidenced by the cash deposited in investor’s brokerage account. It is also more stable than capital gains.

A cash dividend provides investors with a positive reinforcement during market declines. Bear markets as well as market volatility can make even the best investors worried about their nest eggs. Seeing the value of your portfolio fluctuate by the amount of a typical person’s annual salary every day, could be devastating to a retiree and make them question their judgment. Rash decisions such as selling your stocks, and purchasing bonds in order to limit the pain are thus much more likely especially if investors do not receive any dividends to soften the blow of stock price depreciation.

In order to reduce the psychological factors when dealing with adversity in dividend investing, there are several things that investors need to consider.

The first one is to have a strategy that fits the investor’s personality. Selecting dividend stocks provides both exposure to equities and a regular stream of income in the form of cash dividends. I can confidently predict the amount of dividend income I expect to receive in a given year - the same cannot be said about the price changes in the underlying value of my stock holdings.

The second one is that income investors should focus on analyzing companies they are purchasing in detail, and try to asses if they can continue growing. This would involve looking at ten year trends in earnings, dividends, revenues, returns on assets or equity, as well as reading a few annual reports and articles on the company in question. Having a solid understanding of the company’s business and how it generates cash flow will make it easier to stick to your guns if stock prices go down. You might even decide to add it to your portfolio if the valuation is right.

Sometimes however, no matter how well we understand the business, things outside of our control do happen. There could be change in the environment, business model or the economy, which could throw away even the best researched investment plans. In order to mitigate those risks, one needs to have a diversified portfolio of stocks. I am always amazed by the arrogance of investors who believe that a portfolio of 10 – 15 individual stocks is sufficient. They cite quotes by Buffett where he discusses how diversification is for the ignorant. I have looked at the portfolios of several traders/investors which have lost it all, and the common factor was lack of diversification. The risk that just one or two bad picks can permanently postpone your retirement is simply an unacceptable outcome in portfolio construction. Smart dividend growth investors would much rather have well-diversified portfolios with sleep well at night investments, than swing for the fences in a concentrated 10 – 15 stock portfolio. You are already retired ( or very close to that goal), so why would you even attempt to show how great of a money manager are you? It makes no sense to risk what you do need, in order to get something you might want to have but really don't need.

Another risk mitigating factor is having some firm exit rules. For example, I automatically sell an investment that cuts or eliminates dividends. I might sell at a loss, but this rule eliminates the risk of losing 100% of my investment value. While some companies increase several times after cutting dividends, others lose 95-100% of their value. If you lose 95% of your portfolio on bad investments for example, you would need to find an investment that goes up by 2000% simply to break even after that. Most investors who purchase these stocks are pure gamblers. The goal of my portfolio is to provide a dependable cash stream of dividends that grows over time, not to get rich quick overnight.

Stocks that pay dividends cushioned the losses for investors during the financial crisis. In fact, there were many companies which even boosted distributions to their shareholders:

Johnson & Johnson (JNJ), which researches and develops, manufactures, and sells various products in the health care field worldwide. It operates in three segments: Consumer, Pharmaceutical, and Medical Devices. The company paid quarterly dividend of 41.50 cents/share in 2007, raised it to 46 cents/share in 2008, and has continued increasing it all the way up to 70 cents/share in 2014. This dividend king has raised distributions for 52 years in a row. The company is attractively priced at 16.50 times forward earnings, and yields 2.70%. Check my analysis of Johnson & Johnson for more details.

Exxon Mobil Corporation (XOM), which explores for and produces crude oil and natural gas in the United States, Canada/South America, Europe, Africa, Asia, and Australia/Oceania. The company paid quarterly dividend of 35 cents/share in 2007, raised it to 40 cents/share in 2008, and has continued increasing it all the way up to 69 cents/share in 2014. This dividend champion has raised distributions for 32 years in a row. The company is overvalued at 22.40 times forward earnings, and yields 3.30%. Check my analysis of Exxon Mobil for more details.

PepsiCo, Inc. (PEP) operates as a food and beverage company worldwide. The company paid quarterly dividend of 37.50 cents/share in 2007, raised it to 42.50 cents/share in 2008, and has continued increasing it all the way up to 65.50 cents/share in 2014. This dividend champion has raised distributions for 43 years in a row. The company is slightly overvalued at 20.40 times forward earnings, and yields 2.70%. Check my analysis of PepsiCo for more details.

Altria Group, Inc. (MO), which manufactures and sells cigarettes, smokeless products, and wine in the United States and internationally. The company paid a quarterly dividends of 29 cents/share in 2008, which was raised to 32 cents/share later in the year, and has been increased all the way up to 52 cents/share by 2014.  This dividend champion has raised distributions for 45 years in a row. The company is attractively priced at 18.40 times forward earnings, and yields 4%. Check my analysis of Altria for more details on the company.

The reason why I do not track the dividend aristocrats list is because they kicked Altria out in 2008. The reason for kicking out Altria was dumb -  the company split itself in three parts, which reduced the dividend for the resulting legacy domestic US tobacco company. However, the investor in the original Altria did not really suffer in terms of total dividend income - rather they received shares in Altria, Phillip Morris International and Kraft, which together are paying much more in total dividend income than in 2007 or 2008. I am constantly surprised at the writers on Seeking Alpha who tout the dividend aristocrats index and pray that they are not really risking real money behind their work, since they obviously do not do thorough research to begin with. I have said it before, and I will say it again - the list of Dividend Champions maintained by David Fish is the most complete list of US dividend growth stocks available. The dividend aristocrats index is an incomplete list of dividend growth stocks at best.

Full Disclosure: Long all companies listed above

Related Articles:

Dividend Investing During the Financial Crisis
Where are the original Dividend Aristocrats now?
Historical changes of the S&P Dividend Aristocrats Index
The Dividend Investment Journey
S&P Dividend Aristocrats Index – An Incomplete List for Dividend Investors

Tuesday, March 24, 2015

Why Stock Charts Are Misleading for Dividend Investors?


As a dividend investor, I do not really look at stock price charts. The things I look for are trends in earnings and dividends, catalysts for further earnings growth, and whether the security is cheap relative to the other investment opportunities within my opportunity set. In other words, if I expect PepsiCo (PEP) to deliver the same growth as Johnson & Johnson (JNJ), but Johnson & Johnson is available at a cheaper valuation, I would buy Johnson & Johnson (JNJ). It won’t matter whether Johnson & Johnson is selling at a 52 week high, or 52 week low.

However, I know that for a lot of investors, they look at stock price charts for whatever reason. I believe that focusing only on stock price history is misleading, because it doesn’t show you everything you need to know about a security.

The missing link of course are dividends. One of the biggest lies told to investors is that stocks , as measured by S&P 500 or Dow Jones Industrial Average, went nowhere between 1929 – 1954 and 1966 - 1982. It might be true that stock prices were volatile but mostly flat, however dividends provided for a handsome return to those patiently reinvesting them through thick or thin.

For example, if let's look at the annual price performance of the S&P 500 between 1929 and 1954. The price in 1929 was 24.86 points, which was not reached again until some time in 1953. Based on looking at price alone, someone could incorrectly assume that stocks did not provide any returns to shareholders for a quarter of a century.

However, if you add in dividends, and reinvest them, you can see that someone who put money in 1929 broke even by sometime in 1937. This is a very interesting finding, because it shows that even during a period where unemployment was at 25%, industrial and agricultural production fell, GDP fell stocks in the US did well for the long-term shareholder who was not afraid.  In fact, during that 25 year period, the whole return on US equities came from reinvested dividends. Over that period from 1929 to 1953, a $1000 investment quadrupled in value.


Let's also look at the 1966 - 1982 period for US stock prices. Again, I used historical annual data for the S&P 500. You can see that between 1966 and 1982, the S&P 500 increased from $93.32 to $117.28. If you look at reinvested dividends however, you can see that a $1000 investment at the end of 1966 pretty much doubled in value during that period.



Dividends usually accounted for 40% of average annual total returns. They are always positive, and more stable than capital gains, which makes them as a reliable source of income in retirement. Interestingly enough, prior to 1994, the yield on US Stocks was averaging around 4%. Incidentally, a researcher found that it is “safe” to "withdraw" 4% of your portfolio in retirement. I say incidentally, because it is clear that this researcher inadvertently makes the case that the safe 4% average annual spending comes entirely from dividends and the high interest income that was prevalent at the times. For those in the accumulation stage, the thing to remember is that reinvested dividends have accounted for 97% of stock market gains since 1871.

The shortcoming of stock charts is also evident when looking at individual companies returns over time.  Another thing stock price charts miss is spin-offs. Altria (MO) is a prime example of this, if you look at historical charts on Yahoo Finance. To anyone who only looks at the chart, and ignores everything else, it looks like Altria has done pretty badly since 2007. In reality, the chart fails to account for the fact that Altria (MO) spin-off Kraft in 2007 and Phillip Morris International in 2008.


Those two spin-offs actually have confused a lot of institutions. For example, despite the fact that Altria had a record of consistently increasing dividends for over a quarter of a century, it was booted off the S&P Dividend Aristocrats index in 2007. Anyone who blindly followed the index, likely also sold their shares. In reality, Altria (MO) never cut dividends. Anyone who purchased Altria in early 2007, has been receiving growing annual dividends ever since. The only issue is that those dividends were generated from shares of Altria (MO), Phillip Morris International (PM) and Kraft Foods (KRFT) ( and later Mondelez (MDLZ) as well). This is why I am very skeptical about blindly following indexes - there could be lapses of judgment that stem from mechanical application of rules, without really giving much thought to the reality and facts involved.  This is also why I think it is important to analyze every company I own, or expect to own in detail. Luckily, when Abbott split in two in 2013, the mighty S&P Dividend Aristocrats committee decided to keep both Abbott (ABT) and Abbvie (ABBV) in the index. Either way, I focus on the dividend champions index, which is the most complete list of US dividend growth stocks I know of.

The spin-off situation at Altria also confused a lot of "chartists" that appear on CNBC. You might want to check this article - it blatantly ignores the fact that the split from 2007 and 2008 ever happened.

To summarize, stock price charts only show one part of return that investors would have received. However, without taking into accounts dividends, and the power of dividend reinvestment, you cannot understand what the total returns on an investment really are. It pays to research every investment in detail, before putting hard earned money to work there. In addition, it pays to own investments that regularly shower their investors with cash, in order to reduce the risk of outliving money in retirement. As we was above, stock prices can remain flat for extended periods of time - anywhere from 16 to 25 years. If you only rely of capital gains to bail you out, you might be in for some nasty surprises if you happen to invest during one of those periods. An investor who expects to live off the dividend stream generated from their portfolio can afford to ignore stock price fluctuations, and enjoy the retirement that they have worked so hard to achieve. An investor who wants to sell of portions of their portfolio will be in real trouble if that portfolio doesn't pay dividends and share prices fail to increase.

Full Disclosure:

Relevant Articles:

Altria Group (MO): A Smoking Hot Dividend Champion
S&P Dividend Aristocrats Index – An Incomplete List for Dividend Investors
S&P 8000 – The power of reinvested dividends in action
Dow 370,000
The case for dividend investing in retirement

Monday, March 23, 2015

The Perfect Dividend Portfolio

A few years ago, when I was starting my website, I featured research from Jeremy Siegel on the performance of the original companies in the S&P 500 index between 1957 and 2003. You can find the link in my article titled The Ultimate Passive Investment Strategy. Prof Siegel describes how an investment in the original 500 companies in the S&P 500 would have fared over that 46 year period. My favorite part was about the Total Descendants Portfolio, which assumed a total passive approach, where an investor reinvests dividends, holds on to shares of spin-offs, doesn’t do any rebalancing.

The lessons are very eye opening:

1) Having a totally passive approach has worked great for long-term investors

This is because spin-offs were held, transaction costs and taxes were minimized. It was quite interesting to learn how a totally passive investment ended up outperforming the S&P 500 over that 46 year period.


It is also interesting that only 30 companies failed outright, while 92 were merged and 74 were taken private.

2) The best performers were consumer staples and pharmaceutical companies.

The reason behind this strong performance is because many consumer staples and pharma companies have moats, reinforced by strong brands used regularly by consumers, customer loyalty and pricing power. The combination of competitive advantages, pricing power, brand loyalty which have resulted in above average returns for investors



3) Valuation is important

The most interesting thing is that investors in the so called slow growth companies for which investors have low expectations tend to outperform glamorous companies in new and exciting industries. This is because their valuation is usually low, and because investors in hot industries tend to bid up the valuations in pursuit of growth to the point of low expected returns. If you overpay for future growth, you might not earn a satisfactory return on investment even if your expectations are eventually met.

4) S&P 500 of today is not a passive index

Over the past six – seven years that I have been focusing on dividend growth stocks, I am hearing more and more people talking about index funds like some sort of a magic panacea for all investors. The truth is that S&P 500 is an actively managed portfolio, with frequent turnover, where new companies are frequently added when their valuations are often pretty steep. In addition, index funds have to sell due to adjustments due to buybacks, spin-offs, float adjustments, and other reorganizations. When a new company is added, investors bid up the price before it is added to the index as well, which also causes worse performance. Furthermore, the rules of the index get changes too often and investors who are passive by nature do not probably take the time to learn about them. Needless to say, if you are a terrible investor who makes poor choices, you will not be saved by index investing because it is the lack of education and emotional strength to hold on when things are tough. Plus, if the investor has to select this international index or that other index they heard about on the internet, they are essentially still picking stocks. Only this time the process of picking securities has a fancy named as it is called asset allocation. I have done better than the S&P 500 index since 2007. Of course, if I were a true indexer, I would have also had to own international indexes, which have not done too well. So I have done much better than most indexers out there.  And my goal is not even to beat some index either.

However, if I were a busy professional with a family, and no free time or desire to learn about investments, I would invest only in index funds in my 401k/IRA. That describes most individuals out there (roughly 80% - 90%). Therefore, chances are these people are not reading my site. This situation also doesn't describe most of the people reading this site either.

5) Some Industries are built to last

Many investors are afraid of missing the next hot industry. As a result they chase those new industries, because they believe that they would make their big break in investing this way. They seem to forget that just because an industry makes people’s lives better, that doesn’t guarantee profits for investors. As a result, everyone piles in, pays high prices, but doesn’t make high returns. At the end of the day, the slow growth, boring stocks keep producing consistent results to their long-term investors. The important thing, as we mentioned before, is to avoid overpaying.

6) Some companies are built to last

After reading the research again, and also reading about the Corporate Leaders Fund, I am convinced that investing in blue chip dividend stocks for the long term is the best strategy for my portfolio. It is true that investing in 500 stocks today, and doing nothing, could result in a much different portfolio due to mergers and acquisitions, spin-offs, a few failures. However, from the 500 companies from 1957, there were not that many complete failures. This could change in the future, but nevertheless confirms my belief that doing nothing with a portfolio could actually produce the best results in the long-term. For example, one of my biggest mistakes has been selling a company and thinking that I can do better with something else. In 9 out of 10 such circumstances, I would have been better off I had been busy working instead and not fiddle with the portfolio. A portfolio is like a bar of soap - the more you fiddle with it, the smaller it gets.

7) The most important lesson is to be a long-term investor

The best lesson is that success in investing lies down to choosing an investment at an attractive valuation, building a diversified portfolio of those investments, holding through thick and thin, and only reinvesting dividends selectively. The S&P 500 index which constantly added new companies, was very active and failed to do better than a totally passive index. Investors who believe they can outguess the direction of companies and choose to frequently churn portfolios end up doing pretty bad in the future. That’s why it is important to sit on my portfolio for the long term, and do almost nothing. Time in the market is more important than timing the market. Time in the market is important, because it allows your capital to compound quietly. It is important to keep your winners, and not succumb to rebalancing or too much in other activity. It is quite possible that a few of your companies will end up going more than 1000%, which is why selling early because no one went broke booking a small profit is a foolish mistake to make.

Relevant Articles:

Buying Quality Companies at a Reasonable Price is Important
The ultimate passive investment strategy
Should dividend investors invest in index funds?
Dividend Investing Knowledge Accumulates Like Compound Interest
How to never run out of money in retirement

Friday, March 20, 2015

Eaton Vance (EV) Dividend Stock Analysis

Eaton Vance Corp. (EV), through its subsidiaries, engages in the creation, marketing, and management of investment funds in the United States. It also provides investment management and counseling services to institutions and individuals. Eaton Vance is a dividend champion which has paid uninterrupted dividends on its common stock since 1976 and increased payments to common shareholders every year for 34 years.

The most recent dividend increase was in October 2014, when the Board of Directors approved a 13.60% increase in the quarterly dividend to 25 cents/share. Eaton Vance’s largest competitors include Franklin Resources (NYSE:BEN), T. Rowe Price Group (NASDAQ:TROW) and Blackrock (NYSE:BLK). In a previous article I mentioned that I am bullish on asset managers for the long run.

Over the past decade this dividend growth stock has delivered an annualized total return of 7.20% to its shareholders.


The company has managed to deliver a 9.30% annual increase in EPS since 2004. Analysts expect Eaton Vance to earn $2.49 per share in 2015 and $2.83 per share in 2016. In comparison Eaton Vance earned $2.44 /share in 2014. The company has managed to consistently repurchase common stock outstanding over the past decade. As a result of these share buybacks, shares outstanding decreased from 142 million in 2005 to less than 119 million by 2014.

Overall I am bullish on asset managers in the long run, and Eaton Vance fits by default. The more assets under management they gather, the better the scale against competitors. Since investments grow in value over time, this makes it easier to simply generate higher fees without much additional insight. Switching costs to investors are high, since they would have to incur steep taxes and penalties as well as the uncertainty of finding an untested solution for their money. Therefore, a large portion of investors stick to the products they own.

Eaton Vance is a player that targets tax-sensitive investors in fixed income and securities. They are also a leader in closed-end funds. These assets are more sticky, and account for roughly half of assets under management. A company like Eaton Vance is worth a second look, since it has managed to attract and retain assets under management throughout different market cycles.

As we have millions of baby boomers retiring and needing financial advice, I expect them to use financial advice from certified planners, which would pre-sell open and closed-end funds and other financial products. Once a product has been sold to investors, it creates a recurring income stream to the provider of funds. The revenues that investment managers generate are realizable in cash almost instantaneously, which is a big plus. New product offerings could also contribute to growth, although at $298 billion in asset under management, it won’t be the main source of revenues for Eaton Vance. Eaton Vance has recently been cleared by the SEC to sell actively managed Exchange Traded Funds where holdings do not have to be disclosed daily.

Acquisitions to obtain advisers that target high-net worth individuals could be a big driver for future growth, as would be expansion internationally. Another positive is that as US stock prices keep increasing, this would eventually attract more investors to add in more money, which would create even higher profits for companies like Eaton Vance. Over time I expect Eaton Vance to get an even larger pile of assets under management due to all of the above mentioned reasons, which would lead to earnings and dividend growth.

One of the largest risks for Eaton Vance includes competition, which could result in net outflows for assets under management as well as decrease in fees charged to clients. Another risk includes prolonged declines in equity and fixed income markets, which could turn investors off stock market investing. A third risk includes underperformance relative to benchmarks, which could lead to outflows.

The company generates a very high return on equity, which has followed the ups and downs of the stock market over the past decade. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

The annual dividend payment has increased by 12.70% per year over the past decade, which is higher than the growth in EPS.

A 13% growth in distributions translates into the dividend payment doubling almost every five and a half years. If we look at historical data, going as far back as 1990, we see that Eaton Vance has actually managed to double its dividend almost every four years on average.

The dividend payout ratio has increased from 26.70% in 2005 to 58% in 2009, before falling down to 37% in 2014. The reason behind this increase was the fact that dividend growth exceeded earnings growth over the past decade. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.


Currently Eaton Vance is attractively valued at 17 times forward earnings, yields 2.30% and has a sustainable dividend payout. If the stock yields more than 2.50%, it would be attractively valued per my entry criteria. A 2.50% yield would be equivalent to a stock price dip below $40.

Disclosure: Long EV, TROW

Relevant Articles:

Dividend Macro trends: The Baby Boomer Retirement Investment
T. Rowe Price Group (TROW) Dividend Stock Analysis
Franklin Resources (BEN) Dividend Stock Analysis
Best Dividend Stocks for 2015
How to reach your dividend income goals?

Wednesday, March 18, 2015

39 Dividend Champions for Further Research


The list of dividend champions is the most complete list of US dividend stocks that have managed to boost dividends for 25 years in a row. David Fish painstakingly maintains this list, and spends many hours each month on this very useful tool for dividend growth investors. As a side bonus, his list also includes dividend contenders (those which have increased dividends for 10 to 24 years) and dividend challengers ( those which have increased dividends for 5 to 9 years in a row).

I did a quick screen on the list of dividend champions, where I isolated companies which have managed to grow dividends by 5%/year over the past 1, 3, 5 and 10 years. I believe that companies which have managed to grow dividends every year for over a quarter of century, deserve a second look for further analysis. I also believe that those companies that manage to grow those dividends at close to twice the rate of annual inflation deserve a second look. The reason is of course to find those companies which have the potential to keep delivering more dividend increases.

As I mentioned previously, the hidden power behind future dividend growth is earning growth. Without earnings growth, a company would be unable to grow dividends into the future. I am not interested in a company that merely grows dividends by expanding the dividend payout ratio. I am interested in a company that can grow earnings, and increase dividends as well. This combination also results in appreciation in the company’s value over time. You can see that dividend investors can have their cake (dividends) and eat it too ( capital gains as a bonus).

You all know my goal is to one day live off my dividends, when then exceed my annual expenses. I see the dividend income I will receive from companies I own as a salary substitute. I view capital gains as a bonus, which is dependent on a lot of extra factors I have little effect on. This is similar to my day job, where I know I can get a decent salary every 2 weeks. However, if my company does really well and I do my job really well, my total compensation could be much higher than the salary alone. This is how I view capital gains - as a nice bonus.

Using the output from the first screen, I went through the rate of earnings growth over the past decade for each company in the output. I tried to look for companies where earnings per share increased in the past decade. I was looking for a roughly doubling of earnings per share, and I ignored companies whose results seemed too volatile. The companies that I ended up with include:

NameSymbolIndustryYrs1-yr3-yr5-yr10-yr
3M CompanyMMMConglomerate5734.615.810.99Stock analysis
Air Products & Chem.APDChemical-Specialty32910.61111.2Stock analysis
Altria Group Inc.MOTobacco458.98.18.611.6Stock analysis
American States WaterAWRUtility-Water609.214.710.46.5
Automatic Data Proc.ADPBusiness Services4010.910.27.913.2
Becton Dickinson & Co.BDXMedical Instruments4310.110.911.114.1Stock analysis
Brown-Forman Class BBF-BBeverages-Alcoholic3111.810.6910Stock analysis
Chevron Corp.CVXOil & Gas277.910.99.610.7Stock analysis
Chubb Corp.CBInsurance3312.1879.8Stock analysis
Cintas Corp.CTASBusiness Services3210.416.312.611.4
Clarcor Inc.CLCAuto Parts3123.517.714.110.9
Colgate-Palmolive Co.CLPersonal Products526.87.810.511.5Stock analysis
Donaldson CompanyDCIIndustrial Equipment282729.922.518.9
Dover Corp.DOVMachinery592816.312.711.8
Eaton Vance Corp.EVFinancial Services34117.67.812.7Stock analysis
Franklin ResourcesBENFinancial Services3523.112.911.415.5Stock analysis
Genuine Parts Co.GPCAuto Parts5978.57.76.8Stock analysis
Gorman-Rupp CompanyGRCMachinery4212.19.37.47.4
Hormel Foods Corp.HRLFood Processing4917.616.216.113.5
Illinois Tool WorksITWMachinery4011.98.17.113.3
Johnson & JohnsonJNJDrugs/Consumer Prod.526.677.49.7Stock analysis
Lowe's CompaniesLOWRetail-Home Improv.5220.617.918.627.9
McCormick & Co.MKCFood Processing298.89.7910.2Stock analysis
McDonald's Corp.MCDRestaurants395.199.919.6Stock analysis
McGraw Hill Financial Inc.MHFIPublishing427.16.35.97.2
Medtronic plcMDTMedical Devices378.37.88.314.1Stock analysis
Nordson Corp.NDSNMachinery5121.220.316.89.9
Parker-Hannifin Corp.PHIndustrial Equipment5816.313.115.715.1
PepsiCo Inc.PEPBeverages/Snack Food4313.18.47.712.5Stock analysis
Raven IndustriesRAVNBusiness Equipment285.411.912.716.7
Sherwin-Williams Co.SHWPaints371014.69.212.5
Sigma-Aldrich Corp.SIALChemical-Specialty3878.59.710.5
Stepan CompanySCLCleaning Products476.29.28.96
T. Rowe Price GroupTROWFinancial Services2915.812.41216.6Stock analysis
UGI Corp.UGIUtility-Electric/Gas279.55.997.3
Valspar Corp.VALPaints3717.414.512.511.6
VF Corp.VFCApparel422119.313.315.5
W.W. Grainger Inc.GWWElectronics-Wholesale4316.218.318.618.2
Wal-Mart Stores Inc.WMTRetail-Discount425.71112.614.8Stock analysis

Long-time readers know that I look at valuation before putting my hard earned money to work in a dividend growth stock. For example, I generally avoid buying companies for more than 20 times earnings. If a company sells for more than that, I wait patiently and monitor the situation. I believe that overpaying for a stock can reduce future returns, and provide no margin of safety for my capital. I also try to generally look for a minimum dividend yield of 2.50%, but I am more willing to break that guideline if I really like everything else about the company.

More sophisticated readers might also employ strategies such as put selling, in order to effectively purchase a stock at 20 times earnings.

After going through the exercise described above, I added a few shares in McCormick (MKC), PepsiCo (PEP) and initiated small positions in W.W. Grainger (GWW) and Genuine Parts Company (GPC).

Full Disclosure: I own shares in MMM, APD, MO, ADP, BDX, BF-B, CVX, CB, CL, EV, GPC, JNJ, LOW, MKC, MCD, MDT, PEP, TROW, GWW, WMT,

Relevant Articles:

Dividend Champions - The Best List for Dividend Investors
S&P Dividend Aristocrats Index – An Incomplete List for Dividend Investors
Dividend Angels – a possible searching ground for investment opportunities
The Pareto Principle in dividend investing
How to read my stock analysis reports

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