Wednesday, August 13, 2014

Dividend Investing for Financial Independence

There are millions of Baby-Boomers in the US. Every day, thousands of them retire from the workforce. Most will rely on a mix of social security, company pensions and personal assets for income in their golden years. Fewer employers are offering traditional pensions these days however, and the future of the Social Security system is not as sound as it once was. Depending on who you listen to, Social Security system would either run out of money in 35 years or will be able to continue paying benefits, albeit at a deeply reduced rate. For many investors outside the Baby Boomer generation, the realization is that they would have to provide for their own retirement, and not rely on employers or the government.

The tools that there investors can leverage in order to reach their financial independence goals include time, compounding, capital and smart investing.

One investment strategy that can provide for your own investing is investing in dividend paying stocks. By creating a portfolio that consists of dividend paying stocks, an investor generates income that is paid to them at predictable intervals of time. Having a stream of income deposited in your brokerage account every month or every quarter makes budgeting much easier, and living off dividends a no brainer solution.

I view every dollar I can save as a dollar that can generate income for life. Let’s assume that this dollar is invested in a dividend stock that yields 4%, grows distributions and stock price by 6% annually. After ten years, this dollar will generate 7.16 cents in income, which will increase to 12.80 cents by year 20. In 30 years, this dollar will be generating almost 23 cents in annual income. If distributions are reinvested however, the dollar will be generating 10 cents, 26.70 cents and 71 cents in the next 10, 20 and 30 year periods. One cannot retire on a single dollar alone, but if you keep adding dollars to your investment portfolio and let them compound through dividend reinvestment, our investor can afford to generate enough income to retire.

These dollars need to be invested by designing and creating a diversified dividend portfolio that consists of at least 30 individual stocks. The portfolio should have representation from as many industries that make sense at the time of implementation. This portfolio should focus on dividend growth stocks, which are companies that have a history of regular dividend increases. A company that regularly increases dividends essentially provides investors with a stream of income that keeps its purchasing power over time. Compared to interest income, dividend income looks like a clear winner for preserving purchasing power from inflation.

The element of time is another crucial element in achieving financial independence with dividend paying stocks. Depending on the amount of capital invested initially, as well as the amount of capital added each month, a portfolio would require differing amounts of time to compound before a sustainable amount of income is generated. The portfolio would need more time to compound investment dollars in order to reach the target monthly dividend income if the amount of capital added is not high enough. However, if the amount of capital added to it is large enough, the time needed to reach the monthly income targets would be greatly reduced.

For example, let’s assume that an investor puts $1000/month in the stocks yielding 4% today and achieving a 6% annual dividend growth. If dividends are reinvested, the portfolio will generate over $7,900 in annual dividend income in ten years. However, if our investor put away $2000/month in income stocks with the same characteristics as above, they would be achieving $7,900 in annual dividend income only after 72 months.



Besides diversification and power of compounding, another crucially important factor to building a successful dividend portfolio is stock valuation. Just like a house is composed of many bricks, placed one by one, a portfolio is comprised of many individual stocks which are the building blocks that provide support behind the portfolio. If one or a few companies in a concentrated sector bet crumbles during a recession, it could potentially destroy the whole structure. Having a strong foundation would protect investors’ income portfolios in the event of dividend cuts or eliminations as a result of unfavorable business conditions. Each dividend stock in a portfolio should thus have to be carefully chosen, and should be purchased only at attractive valuations. Purchasing shares when they are cheap maximizes price gains and dividend income for shareholders over time. This further turbocharges the compounding in income stream growth over time. I typically look for companies that have raised dividends for over 10 years, that trade at less than 20 times earnings, have a dividend payout ratio of less than 60% and which yield at least 2.50%. For Master Limited Partnerships and Real Estate Investment Trusts however, the only differences related to how I calculate payout ratios and what minimum yield requirements I selected.

A few companies which are attractively valued today include:

SYMBOL
P/E
DPR
10 yr DG
YIELD
PRICE
DIV/SHARE
EPS

ADM
19.69
48%
12%
2.10%
49.04
0.96
2.01
AFL
9.35
23%
17%
2.30%
59.19
1.48
6.46
BMS
18.19
53%
6%
2.60%
39.84
1.08
2.05

CB
10.8
24%
9%
2.10%
88.34
2
8.36
CVX
12.21
42%
11%
3.20%
127.86
4.28
10.27
EFSI
11.76
37%
7%
3.60%
22.95
0.72
1.97

GPC
19.19
51%
6%
2.60%
84.24
2.3
4.49
HP
16.17
39%
23%
2.40%
103.23
2.75
7.09

JNJ
18.69
54%
11%
2.70%
101.08
2.8
5.23
MCD
16.94
59%
23%
3.20%
93.55
3.24
5.5
MMM
19.85
50%
7%
2.40%
140.85
3.42
6.9
ORI
8.98
36%
7%
4.30%
14.39
0.73
2.04

SRCE
12.68
32%
7%
2.30%
29.25
0.72
2.28

TMP
12.23
46%
6%
3.30%
44.36
1.6
3.51

TROW
18.08
43%
16%
2.10%
78.11
1.76
4.11

UGI
16.67
41%
7%
2.40%
49.02
1.18
2.85

WEYS
16.75
47%
15%
2.80%
27.08
0.76
1.61

WMT
15.42
40%
18%
2.50%
74.67
1.92
4.84
XOM
12.72
38%
10%
2.70%
99.74
2.76
7.34


Full Disclosure: Long ADM, AFL, CB, CVX, JNJ, MCD, MMM, WMT, XOM

Relevant Articles:

My dividend crossover point
Can everyone achieve financial independence with Dividend Paying Stocks?
Margin of Safety in Financial Independence
How to stay motivated on your road to financial independence
Achieve Financial Independence with Dividend Paying Stocks

11 comments:

  1. DGI,
    NIce analysis, but did you mean to start your table with a $1000 investment in the first month? It throws everything off so that you don't get the $7900 in dividends per year ($658.33 per month) after 72 months. Looks good otherwise.
    Thanks,
    Keith

    ReplyDelete
  2. Hi Keith,

    Thanks for stopping by. I updated the table so that it only shows $1000 initial investment and $1000 subsequent monthly investments, so that I don't fall in the apples to oranges comparisons..

    ReplyDelete
  3. So, according to your spreadsheet I should put in $1,000 every month for 156 months and the total under column 'shares' after 156 months is only $151,932.93? Seems obviously better to hang on to my $156,000 then. Something goes wrong with the calcs after month 12.

    ReplyDelete
    Replies
    1. Anonymous,

      Do not assume that just because you don't understand something it is automatically wrong. Instead of accusing the spreadsheet of being incorrect, take the time to read carefully what it shows.

      The column for shares does not show dollars, it shows shares. The column right next to it is titled share price. Now multiply the shares times share price at month 156.. What result do you get?

      Delete
    2. I did not assume. I came to the conclusion based on my understanding of the spreadsheet as it was presented. This is an important point not to be discarded. I think presentation is important so as not to confuse, and I think in this case it is especially important for those of us who are poor with our math skills (hard as I try). I like your more intuitive version (for me anyway) which you presented on your webpage as follows http://www.dividendgrowthinvestor.com/2012/05/how-to-generate-1000month-in-dividends.html. The way you show the share price column is still confusing to me as I read it now and I don't understand the way it is presented. I appreciate your site and always come back to see your postings.

      Delete
  4. Hmm, I am not sure why it is confusing. But for whatever reason I have seen others finding that table confusing ( I have posted it before)

    I guess it makes sense to me, since you have shares purchased per month ( which is $1000 divided by share price from column three) plus the shares already purchased in preceding row. The share price is adjusted in month 13, because a stock that raises dividends by 6% per year will likely have intrinsic value increase by 6% per year.

    ReplyDelete
    Replies
    1. I think the reason it is confusing is because most of us are considering the growth of dividends which most of us consider as cash, not shares. I think when the math turns toward growth of intrinsic price/value of the shares (which of course is different from the market price of shares) it becomes a little less clear. I understand your calculations now. Thank you for the replies you gave me.

      Delete
  5. This quick screen goes to show you there are plenty of good value companies out there to buy. Thanks DGI.

    ReplyDelete
  6. my only complaint - most companies (including the ones you listed in your chart above) pay out quarterly. I know that you wanted to make this a simple spreadsheet and make a point about monthly income, but if the companies pay out quarterly, wouldn't your total shares purchased be slightly less at the end?

    ReplyDelete
    Replies
    1. Well, but those companies do not all pay dividends in the same month. And most importantly, they are not recommendations or automatic buys.

      Best Regards,

      DGI

      Delete
  7. Nice analysis, shows how quickly the dividends add up if you continue adding capitals.

    ReplyDelete

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