Wednesday, August 27, 2014

Dividend Growth Stocks Are Still Great Acquisition Targets

Imagine that you are the CEO of a major corporation, which is sitting on a lot of cash. You are desperate to find some use for this cash, in order to justify a bigger bonus for yourself, and in order to grow the company you are managing. One of the things you can do is start a new division, invent a new product or try to expand organically. However, this is risky, since there is absolutely no guarantee that the expansion, or the new product will be a success. Another option is to acquire an existing business, which already has the products or services that customers want, is available at a good price, has a unique competitive position, and which also manages to earn a lot of profit s every year, while drowning shareholders in cash. It does seem like a lower risk proposition to acquire that business. Of course, if those managements have the discipline to pay a regular dividend to shareholders, they would have much less money for squandering, which would limit their focus to only the best ideas with the most potential for return on investment. But this is a topic of a whole other article.

The business to be acquired that I just described at a very high level is essentially what most dividend growth companies represent. A business that manages to grow dividends every year for a long time, indicates in many cases a business which manages to earn more profits over time. This is an attractive business to invest in, whether you are an acquirer or an ordinary mom and pop investor, provided valuation is not excessive. Thus, dividend growth stocks make great acquisitions.

In most cases however, shareholders would have been better off simply holding on to the companies they are owning and collecting a growing a stream of dividend checks with the passing of every single year. Unfortunately, many shareholders these days have an extremely short-term holding horizon, which is why they approve of those deals to earn a quick buck, while sacrificing future potential.

This is why I believe that even for long-term passive buy and hold dividend investors, it is highly unlikely that their portfolios will be static over a 20 – 30 year time period. A portfolio of dividend growth stocks selected in 2014 will likely look much different in 2044. Contrary to popular belief however, this is not because of a high failure rate in dividend growth stocks. The reason is because a large portion of dividend growth stocks are indeed attractive acquisition or merger partners. When you are the prettiest girl at the prom, odds are much higher that more than one person will ask you to dance with them. Same is true with those dividend growth stocks, which make excellent merger partners or great acquisitions to tap into. As for failure rates, based on historical research I have conducted, only a small portion of companies fail outright.

When I look at the dividend aristocrats list from 25 years ago, I notice that there are a lot of companies that are no longer here. As I mentioned in the earlier paragraph, this is because a large part of those companies either were acquired or merged. As a passive investor, I seldom sell. However, if the company that acquired my dividend holdings pays me cash for my stock, I will have to dispose of my shares. This is what happened with Anheuser Busch in 2008, when it was acquired for $70/share by InBev. This is also what happened to Rohm & Haas in 2009, when it was acquired by Dow Chemical (DOW). Nowadays, this is what is happening to Family Dollar Stores (FDO), which is being acquired by Dollar Tree for mostly in cash. Only a small portion of acquisition will be paid in stock, thus triggering a taxable event. Because I expected more in taxable income in 2015, that will potentially put me in a higher tax bracket, it made sense for me to sell today, as much as I don’t want to get any tax waste.

Based on my tax situation, it made more sense to sell my Family Dollar holdings in taxable accounts this year. For any tax-deferred accounts, I would simply hold on to the shares I receive, but reinvest the cash I receive in other quality companies selling at attractive valuations. Thus, I am saving on one commission, rather than sell all the stock, then buy another stock. In an essence I am holding in my retirement account, and then when the cash is paid, I can use it to buy other shares. At the same time I will probably keep the Dollar Tree shares, despite the fact that they won’t pay a dividend.

Of course, the issue with selling was that I missed out on the bidding war from Dollar General. The problem is that Dollar General’s offer, while a few dollars per share higher, was all in cash. Whoever acquires Family Dollar, will reward their shareholders tremendously, because they are paying for a great asset with cash that costs very little today. If you add in synergies expected, that deal will result in great returns for Dollar Tree or Dollar General shareholders, depending on who ends up owning Family Dollar stores.

Full Disclosure: Long FDO

Relevant Articles:

Dividend Stocks make great acquisitions
I bought this quality dividend paying stock last week
Dividend Stocks make great acquisitions
Where are the original Dividend Aristocrats now?
1991 Dividend Achievers additions- Where are they now?

8 comments:

  1. DGI,
    How much do you pay in commissions? I ask because you wrote that you are waiting for the cash from the sale and are "saving on one commission, rather than sell all the stock, then buy another stock." If the commission is low, you might be better off redeploying the capital earlier even if it mean paying a commission to sell. In other words, the purchased company's stock price might get close to the settlement price months in advance. If this happens, there may be other stocks that look attractive and you might want to just divest of the Family Dollar stock and put the money to work elsewhere.
    KeithX

    ReplyDelete
  2. Hi Keith,

    Thanks for stopping by. I am discussing only the FDO I hold in an IRA. The FDO I held in a taxable account was sold.. albeit $4- $5 earlier, before the DG news. I bought some WAG with the money.
    The commission on FDO in the IRA is $7.95/trade. But, there are several factors at stake. First, it is cheaper to pay $7.95 once, rather than pay $15.90. Every dollar today, at 10% per year turns into $117 in 50 years. So the amount of an extra $7.95 is more like $1000. I do not put new money in this account, and all dividends are reinvested automatically. Hence, a commission is sure to decrease amount I have in the account. The stock market is at all time highs.. There are values I see, but that doesn’t mean that by time deal for FDO is closed in 2015, we might not have lower prices or better deals available. Hence, this FDO investment is somewhat like a safe cash investment, which has the possibility for a decent return as well, provided the right circumstances emerge. I like having options, and this FDO provides me with them for potentially some time in 2015. When BUD or ROH were acquired in late 2008 and early 2009, shareholders received cash, the timing of which was excellent. Not saying we will get a 50% drop by 2015.. But if we did, I will be well positioned.

    The other factor is that I do not know what will happen to FDO. It might get acquired by someone, but we could get a bidding war between DLTR, DG or maybe WMT. Hence, the price could get higher from here. Who knows. It is also possible that the acquisition does not take place. Then, I can simply keep on holding to FDO, patiently reinvesting dividends. In most cases, a company like FDO would probably be more valuable 10 years down the road.

    The third factor is that I have cash in that IRA, which was from VOD, when it paid a huge cash dividend in early 2014. The amount was decent, but low enough that a $7.95 commission seemed too high. I bought some ETF commission free. But, I would be happy to sell that index fund, and combine the money with the distribution from sale of FDO.

    Overall, if FDO were acquired for stock in the acquirer, I would not have had all this maneuvering. Same is true for VOD. As a long-term holder, I want to hold stock, and not receive cash for it.

    ReplyDelete
    Replies
    1. DGI,
      Understood. Along with all of the variables you cited, if you really would rather hang on to the stock, then it makes sense to keep it. I agree that the market valuation is high right now, and I have sold off 10% of my portfolio since the beginning of August. Positions where the valuation was too high, where I think the prospects for the future have gotten worse than when I bought the shares, or where I just plain screwed up buying stocks for the wrong reasons. Luckily, the high prices mean that I can reverse some mistakes and still make money.
      Best of luck,
      KeithX

      Delete
  3. HI DGI,
    This up market is really hurting my dividend yield on KMB and KMP especially KMP. On a brighter note I increased my dividend yield on CBRL by 34% and HSY 24%. Well I had some help because the companies increased their dividend but I buy on every dip I find but it is getting harder and harder because each time I need to buy lower. Thank you for your website. Suzanne

    ReplyDelete
    Replies
    1. No, your overall dividend income is increasing - you are not hurting. That is what really matters. Markets go up and down, and the yields change with change in price. But as a long-term owner, the goal is how much income and gains can I generate in 15- 20 years, not how the yield changed this year.

      Delete
    2. DGI is right. The yield on your initial cost is important but after that the yield can do what ever it wants as long as the companies is increasing their dividends.

      Delete
  4. A correction. In 2009 Rohm & Haas was acquired by Dow Chemical, not by DuPont.

    ReplyDelete
    Replies
    1. Ha, thanks for info. I fixed it.

      Best Regards,

      DGI

      Delete

Questions or comments? You can reach out to me at my website address name at gmail dot com.

Popular Posts