Wednesday, January 22, 2014

Six Compounding Machines for Long Term Dividend Investors

One of the common misconceptions about dividend growth investing is that investors who follow the strategy are only focused on dividends. While a growing dividend over time is the ultimate goal, it is not the only factor to focus on. For example, I always look for companies which can deliver growth in earnings per share over time. The common characteristic of companies that are able to increase earnings per share include strong brands, some sort of competitive advantages, as well as products or services which have some pricing power. Of course, it doesn't hurt if the company is expected to benefit from a tailwind such as increased exposure to emerging market consumers, increase in number of locations, adding innovative new products to the marketplace, making strategic acquisitions, and increasing margins by focusing on cost containment and productivity. Another common characteristic of those companies also includes consistent share buybacks as well, in an effort to take out the holdings of weak hands.

Rising earnings per share are very likely to result in dividend growth, which provides the inflation protection to your passive portfolio income. Because dividends are always positive, and do not fluctuate too much, they are an ideal source of income for retired investors.

As a passive investor, my goal is to essentially purchase a stake in a quality business, and sit back while they quietly compound my capital. It is paramount to purchase these companies at attractive valuations, and avoid overpaying for future growth. In general, I am not going to pay over 20 times earnings ever for the best dividend companies such as Coca-Cola (KO) for example. I try to have some margin of safety, in the event that future is much different than the past.

For the purposes of this exercise, I have outlined a few compounders which I believe are attractively priced today, and will grow your wealth for several decades.

The Coca-Cola Company (KO), a beverage company, engages in the manufacture, marketing, and sale of nonalcoholic beverages worldwide. This dividend king has rewarded shareholders with a dividend increase for 51 years in a row. Over the past decade, earnings per share have increased by 12.30%/year, while dividends were raised by 9.80%/year. Currently, the stock is trading at 20.40 times earnings and yields a very sustainable 2.90%. Based on forward earnings of $2.09/share for 2013, the stock is fairly valued below $41.80/share. Check my analysis of Coca-Cola for more information.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend machine has rewarded shareholders with a dividend increase since being spun-offs from Altria Group (MO) in 2008. Earnings per share have doubled over the preceding 7 years to $5.17 in 2012. Quarterly dividends increased from 46 cents/share in 2008 to 94 cents/share by the end of 2013. Currently, the stock is trading at 15.80 times earnings and yields a very sustainable 4.50%. I find current valuation to be a steal for this security. Check my analysis of PMI for more information.

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion has rewarded shareholders with a dividend increase for 26 years in a row. Over the past decade, earnings per share have increased by 12.20%/year, while dividends were raised by 10.60%/year. Currently, the stock is trading at 9.80 times earnings and yields a very sustainable 3.40%. I find current valuation to be attractive. Check my analysis of Chevron for more information.

Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has rewarded shareholders with a dividend increase for 46 years in a row. Over the past decade, earnings per share have increased by 9%/year, while dividends were raised by 19.80%/year. Currently, the stock is trading at 16.10 times earnings and yields a very sustainable 2.90%. I am planning on dollar cost averaging my way into Target in 2014, by putting equal dollar amounts every month. Check my analysis of Target for more information.

McDonald'’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has rewarded shareholders with a dividend increase for 38 years in a row. Over the past decade, earnings per share have increased by 22.60%/year, while dividends were raised by 22.80%/year. Currently, the stock is trading at 17.10 times earnings and yields a very sustainable 3.40%. I find the current valuation to be attractive. Check my analysis of McDonald'’s for more information.

Exxon Mobil Corporation (XOM) engages in the exploration and production of crude oil and natural gas, and manufacture of petroleum products. This dividend champion has rewarded shareholders with a dividend increase for 31 years in a row. Over the past decade, earnings per share have increased by 19.70%/year, while dividends were raised by 9.60%/year. Currently, the stock is trading at 13 times earnings and yields a very sustainable 2.50%. I would be more excited about ExxonMobil if it dips below $90, as I find current valuation to be a stretch relative to peers due to Buffett's investment in the company. Check my analysis of Exxon Mobil for more information.

I did not use a quantitative screen to get to this list. This group of stock is a result of my following 200 – 300 dividend growth companies over the past six years, screening for value every couple of weeks, researching individual companies, and using my judgment to pick those that are compounders.

I believe that successful investing is all about protecting your downside first, and avoiding big mistakes, rather than trying to hit homeruns. If you take care of the downside, the upside will take care of itself for the long-term buy and hold investor. I expect to buy and hold dividend compounders for life, although I do monitor my positions regularly. Therefore, if one of my holdings fails to live up to my expectations and does something like cutting the dividend, I would be putting my hard earned money somewhere else. In addition, I try to dollar cost average my way into positions over time, and attempt to build out a diversified portfolio of income producing securities. In an equally weighted portfolio of 40 individual securities, my compounding won’t suffer if one or two companies fail.

Relevant Articles:

Buy and Hold means Buy and Monitor
How long does it take to manage a dividend portfolio?
How to define risk in dividend paying stocks?
The work required to have an opinion
Seven wide-moat dividends stocks to consider

5 comments:

  1. Nice article. I like the engines concept.

    There's some figures missing from the paragraph on Philip Morris.

    ReplyDelete
  2. Long term the future of retail is online and Target lacks the online experience in many ways. Brick and mortar stores will be closing and TGT will have a tough time adapting for the "long term investors". Just because they've increased dividends for 40+ years doesn't mean their business advantage (or lack there of) will permit them to do so in the future.

    ReplyDelete
  3. JB,

    I fixed it.

    Anon,

    You are correct, Target has a lot of potential online. Plus internationally too.

    And, just because online sales are low today, doesn't mean Target won't be able to make more online sales in the future.

    Of course, online retailing has been around for 17+ years, while retailers like TGT and WMT have increased sales during that period. That shows that probably not everything will be sold online, and all brick and mortar will fail. But let's see how the future unfolds!

    Thanks for stopping by.

    DGI

    ReplyDelete
  4. DGI, TGT has had recent lackluster growth and negative news does not bold well. This may be a value trap instead of a growing business....I am impressed with the dividend growth, but what about the prospects of the future...I think I will stay away, there are better quality companies out there...maybe WMT or my favorite COST going forward.

    Regards,
    Joe

    ReplyDelete
  5. JA,

    Many investors that I have talked to about TGT are subject to recency bias - they see bad news, and project them into the future to forecast the end of Target.

    Target is facing some short-term hurdles. However, are any of those going to affect long-term growth?

    Highly doubtful that they will. If price goes lower, I would keep buying monthly.


    ReplyDelete

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