Wednesday, May 19, 2010

Dividend Payback from six quality dividend stocks

When investors put their hard earned money to work, they are always hoping that they would receive a positive return on their investment. The profits could come either through capital gains, from dividends or from a combination of both. Dividends have traditionally been more stable than capital gain returns. Stock prices are volatile, and it would not be unheard of experiencing 40% losses in one year, which is then followed by 30% gains in the following year. That’s why many retirees these days are building their retirement income strategies exclusively off of dividend stocks.

The payback that these investors are targeting is mostly from the dividend income stream in order to estimate how long it might take to get their money back. Dividend payback is just that – how long it would take for the dividends from a stock investment to exceed the investment itself. Savers have two options – either go for a higher yielding but slower growing company or go for a stock with a lower current yield but has a huge dividend growth potential.

I compared the two strategies using a few stocks in my portfolio to illustrate my examples. In the first example I used electric utility Con Edison (ED). Right now the company is yielding 5.40%, which means that an investment in the company today could pay off for itself in 19 years. This estimate assumes limited dividend growth for the next two decades. I calculated it by dividing 100 by the current yield in order to come up with the number of years that it would take for the dividend checks to pay me back for the stock.

Based on this exercise, one might believe that in order for dividend checks to pay for the stock in the shortest amount of time possible, one should go for the high dividend stocks of the day. However even a small growth of 1% in the dividend payment however could shorten the time for the dividend payback to seventeen and a half years. If you are able to reinvest your dividends in the company, the payback would probably be even quicker.

That’s why I checked other stocks like Johnson & Johnson (JNJ) in order to estimate whether a low yield of 3% coupled with a dividend growth of 10% annually makes a difference. It seems that for an investment like that it would take fifteen and a half years in order to achieve a dividend payback. In fact if you had purchased Johnson & Johnson in 1994, the dividend income stream would have paid for the stock by 2009, without even reinvesting the dividends. The cost on your investment would have been returned to you, yet you would still maintain ownership.

Being a balanced investor I have highlighted six stocks which I believe would achieve a dividend payback of fifteen years. Some of the stocks mentioned below are high dividend stocks, while others are dividend growth stocks with good potential.

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates through three segments: Consumer, Pharmaceutical, Medical Devices and Diagnostics. Johnson & Johnson has consistently increased dividends for 46 years in a row. The stock yields 3.40%. The yield on cost on stock purchased at the end of 1989 is 29.10%. (analysis)

The Procter & Gamble Company (PG) engages in the manufacture and sale of consumer goods worldwide. The company operates in three global business units (GBUs): Beauty, Health and Well-Being, and Household Care. The company has rewarded stockholders with dividend increases for 53 consecutive years. Check my analysis of the stock.

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The world’s largest retailer has a 35 year record of annual dividend raises. I would be a buyer of WMT on dips. Check my analysis of the stock.

McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. The company's share of the US fast food market is several times larger than its closest competitors, Burger King (BKC) and Wendy's (WEN). McDonald’s is a major component of the S&P 500 and Dow Industrials indexes. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. (analysis)

Consolidated Edison (ED) provides electric, gas, and steam utility services in the United States. This dividend aristocrat has raised annual distributions for 36 years in a row. The stock spots a yield of 5.3%, which a good compensation if you seek current income for the next 5 - 10 years. Check my analysis of Consolidated Edison.

Kinder Morgan (KMP) owns and manages energy transportation and storage assets in North America. This dividend achiever has raised annual distributions for the past 14 years. The stock currently yields 6.50%. Check my analysis of Kinder Morgan.


Full Disclosure: Long ED, JNJ, KMP, MCD, PG, WMT

Relevant Articles:

- 2010’s Top Dividend Plays
- Six Dividend Stocks for current income
- Inflation Proof your income in retirement with Dividend Stocks
- Living off dividends in retirement

5 comments:

  1. Why wouldn't you use the "rule of 72" to calc your time to get your money back with dividends?

    If your div yield is 5.40%

    You should get your money back in 13.33 years not the 19 years you mention.

    ReplyDelete
  2. Wangooroo,

    I use 19 years because I do not assume dividend reinvestment. If we reinvest dividends at 5.40% for 13 years, then we will be able to get our capital back much faster. If the company raises dividends, that woudl speed up the process as well.

    ReplyDelete
  3. Of course I thought of that AFTER I posted my comment. :)

    I do wonder... what is the preferred method?

    Reinvest divs automatically? My brokerage at BoA Investments will set up commission free reinvestments of divs, even if a company does not have a defined DRIP.

    However... I am on the fence about this. I currently just take all the cash, and then when I have accumulated a pile, I will go buy a new stock, cef, or etf, or will buy more shares of something I already own.

    The downside for me, is I have to pay a $5 trade commission on my own trades. Whereas is I let the brokerage set up automatic reinvest, there is no commission.

    For me, I like the control, and the choice. Though I am not sure its really in my favor.

    Your thoughts?

    -chris aka Wangooroo


    PS - Really like your blog!

    ReplyDelete
  4. I typically accumulate the cash and then allocate it to investments. I only reinvest a few stocks automatically through sharebuilder. I do use Zecco, since I hate paying commissions. And 10 free trades/month is enough for a buy and hold investors.

    ReplyDelete
  5. My brokerage is BoA Investments, which is now "BoA Wealth Management" which is "powered by Merrill Lynch.

    They have cheap commissions. $5, $7, or $10 depending on your banking relationship status.

    $5 is what I pay, but I found out they do offer 30 free trades a month. The caveat is that you must have account balances of $25,000 in FDIC insured deposits (Checking, Savings, CDs, Money Market Savings) in order to get the free trades.

    30 is not so limiting. I am just not so sure I want to tie of $25K of cash in such low interest bearing accounts. I never trade to that level of frequency, so for me I would be saving only $5-50 a month in trading fees, not sure the trade off is worth it for me.

    ReplyDelete

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