Wednesday, July 23, 2014

Surprise: The real cost of inversions are paid by shareholders

There are several companies I own, which are trying to do a corporate inversion, in an effort to renounce their US corporate citizenship. This inversion is achieved when a US based company buys a foreign corporation, and as a result moves its legal domicile in the foreign country. As a result, the new combined company would be treated as a non-US company in the eyes of the US tax authorities. This is appealing to companies, because they would only owe US income taxes on income derived solely from US operations.

Under current laws and regulations, US companies that earn money abroad have to pay steep tax bills if they were to repatriate those funds to the homeland, in order to pay dividends, buy back stock or invest in the business. Once an inversion is complete however, these companies would not owe any taxes on income that is earned from foreign operations. As I discussed earlier, most of the companies that dividend investor tend to buy earn a very high percentage of revenues from abroad. This is the nice thing about owning a solid blue chip, which sells branded products and services around the globe, and earns more money to pay higher dividends to you over time.

There are some details that need to be met in order to do this inversion, such as the fact that at least 20% of shareholders of the new company need to be foreign, but this is not the point of this article. The important thing to remember is that inversions generally help reduce the tax rates of companies. From a tax perspective, if you are a US company and your top income tax rate is 35%, it does make sense to relocate to Ireland and pay a tax rate of 12.50%, if you can get away with it. This is essentially what an inversion does.

As a shareholder, less expenses translates into more earnings per share. In addition, cash that is locked abroad for so many US companies that do business internationally will now be easier to access for dividends, share buybacks, investment in the business. Furthermore, if the company relocated to a place like UK for example, dividend income is not subject to any withholding taxes to the US investor. Hence, those shares could still be held in tax-deferred accounts such as IRA’s. So at first glance, it seems like inversions are a good thing to shareholders of the acquirer, since they will result in higher earnings per share, and the possibility for higher dividends and share prices as a result.

As I dug deeper however, I learned that there is a tax that ordinary shareholders like you and me have to pay on inversions. When the tax inversion occurs, shareholders of the acquirer will be treated as if they sold their stock and then purchased the stock in the new, “inverted” company. This creates a taxable event, which means that investors would have to pay a tax on their gains. If the price at which investors acquired their shares was higher, then they might end up deducting losses. In the cases of Medtronic (MDT) and Abbvie (ABBV) however, I believe that most long-term investors are sitting at nice unrealized gains. The only consolation is that stock basis would be stepped up after this exercise. However, the forced tax leakage would be costly for long-term investors like me.

My cost basis in companies like Abbvie (ABBV), Medtronic (MDT) and Walgreens (WAG) is around 2 times lower than current prices ( I have been acquiring shares in each of the companies and their predecessors between 2008 and 2013). Only a small portion of my positions in each company is in tax-deferred accounts. For example, my basis in Abbvie is $29.43/share, while my basis in Medtronic is around $35/share.

I try to seldom sell, because I have to pay taxes. This reduces amount of money I have working for me. By not selling, I have a deferred tax liability to the IRS, which I hope to never pay. This is money I owe, but I don’t pay interest on. This is essentially float, that further helps me achieve financial freedom. It also means I have more money compounding for me. If I sell, I pay tax, and have less money to invest. The opportunity cost of a dollar paid in taxes, that grows by 10%/year for 50 years is $117. At a 3% yield, this is almost $3.50 in income in 50 years, for each dollar I put to work today. That is $1 less working for my descendants or my charitable causes.

These are not good news for any long-term holders like me, who have low tax bases. This is another reason I am trying to max out any tax-deferred accounts, in an effort to shield as much of my money from the crippling effect of annual taxes on my capital gains and dividends. Those friction costs do cost money, that means less money available for my dividend machine to use for its compounding purposes. Either way, over time, expansion of a business is good, since synergies are achieved, taxes are lowered, and this improves the earnings capability of the business. This increases the worth of the business, and the ability to pay higher dividends over time. The ability to pay dividends is further increased by the ability to access cash stored abroad at ease. So the net effect could be positive of course for the patient long-term holder. The effects would be really positive for the patient long-term holder, who placed their shares in a tax-deferred vehicle such as a Roth IRA.

I guess I am learning something new every day. Today is no exception. I thought this was a good deal for shareholders, since corporate taxes will decrease, which increases EPS, and allows companies to be able to access cash abroad for purposes of higher dividends and buybacks. However, this has to be weighed against the tax hit which many long-term investors are facing. What is really bad is the fact that most stock is owned through mutual funds, which do not care about many things such as corporate governance, taxes etc. For those who believe index funds are the way to go, you are one of the reasons why corporate managements think they can do what they want to do. When you have passive owners, who do not believe “active management” produces alpha, you are setting up really perverse incentives for management on executive compensation, corporate strategy, short-term thinking etc.

Hat tip to a reader in France, for alerting me to this topic.

Full Disclosure: Long ABBV, MDT, WAG

Relevant Articles:

My Retirement Strategy for Tax-Free Income
Dividends Provide a Tax-Efficient Form of Income
Roth IRA’s for Dividend Investors
Why should companies pay out dividends?
Dividends versus Share Buybacks/Stock repurchases

Monday, July 21, 2014

Five Dividend Machines With Growing Distributions

As part of my process of monitoring my proprietary list of dividend growth stocks, I monitor dividend increases regularly. This allows me to document any dividend increases for companies I own, by focusing on amount and frequency of the hike relative to past history and my expectations. This exercise also allows me to take note of any companies which have above average dividend growth potential. It is much easier to isolate companies that have certain behaviors such as high dividend growth, when they actually exemplify those behaviors, in comparison to a process where companies are screened for. Once a company with a certain set of characteristics is identified through the list of dividend increases, it is placed on the list for further research.

A few companies that raised dividends in the past week include:

Omega Healthcare Investors, Inc. (OHI) is a real estate investment firm. Omega Healthcare Investors increased quarterly dividend to 51 cents/share for an 8.50% increase over the distribution in the same time last year. This marked the 12th consecutive annual dividend increase for this dividend achiever. Omega Healthcare Investors has a five year dividend growth rate of 9.30%/year. This real estate investment trust (REIT) currently yields 5.40%. Check my analysis of Omega Healthcare Investors.

Kinder Morgan Energy Partners, L.P. (KMP) operates as a pipeline transportation and energy storage company in North America. Kinder Morgan Energy Partners increased quarterly distributions to $1.39/unit, for a 5.30% increase over the distribution in the same time last year. This master limited partnership has increased distributions to unitholders for 18 years in a row. Kinder Morgan Energy Partners has a ten year distribution growth rate of 7.40%/year. This MLP currently yields 6.70%.Check my analysis of Kinder Morgan.

Kinder Morgan, Inc. (KMI) operates as a midstream and energy company in North America, and is the general partner behind Kinder Morgan Energy Partners and El Paso Pipeline Partners. Kinder Morgan increased quarterly dividend to 43 cents/share. Kinder Morgan has managed to boost quarterly payouts by 43%, since going public in 2011. In comparison, the limited partnership has raised distributions by 20.90% over the same time period. I really like the fact that the owner of Kinder Morgan has almost all of his net worth in the company's stock, and limited partnership units. I enjoy being a part owner in enterprises, where management has skin in the game. The company currently yields 4.70%.

The J. M. Smucker Company (SJM) manufactures and markets branded food products worldwide. J. M. Smucker increased quarterly dividend by 10.30% to 64 cents/share. This marked the 17th consecutive annual dividend increase for this dividend achiever. Over the past decade, J.M. Smicker has managed to increase annual dividends by 9.50%/year. The company sells at 17.50 times forward earnings and yields 2.40%. I would consider initiating a position in the stock on dips below $102. Check my analysis of J.M. Smucker.

National Retail Properties, Inc. (NNN) is a publicly owned equity real estate investment trust. National Retail Properties increased quarterly dividend by 3.70% to 42 cents/share. This marked the 25th consecutive annual dividend increase for this dividend champion. National Retail Properties has a ten year dividend growth rate of only 2.30%/year. This REIT currently yields 4.50%.

Full Disclosure: Long OHI, KMR, KMI

Relevant Articles:

How to read my weekly dividend increase reports
Richard Kinder: The Warren Buffett of Energy
I admire Investors with Skin in the Game
Types of dividend growth stocks
Why am I obsessed with dividend growth stocks?

Friday, July 18, 2014

American Realty Capital Properties (ARCP) Dividend Stock Analysis

American Realty Capital Properties, Inc. (ARCP) owns and acquires single tenant, freestanding commercial real estate that is net leased on a medium-term basis, primarily to investment grade credit rated and other creditworthy tenants. Since going public in 2011, this Real Estate Investment Trust has managed to increase its monthly dividends from 7.3 cents/share to 8.3 cents/share.

However the company has expanded very quickly, which is why I believe that it is difficult to do any quantitative analysis of its financials. This is because FFO/share has had a very different composition in 2011, 2012, 2013 and 2014, due to the rapid growth in assets under this REIT umbrella. As a result, I am going to share mostly a qualitative opinion on the REIT. I purchased a position in this REIT in early 2013, after which I have not added to it. The only exception is that I have some shares in a Roth IRA, where dividends are set to reinvest automatically. I bought the stock because I viewed it as something that is similar to investing in Realty Income in the mid 1990s, before the company became an established REIT.

The rapid growth of acquisitions however makes me ask myself, "Are they doing this for the shareholders, or are they doing it for the executives?". It is good to see the scale of operations, which makes it easier to get high profile deals with major corporations. If you are Red Lobster, and you want to do lease-salebacks on 1,500 restaurant locations, you prefer to deal with one landlord that has the capacity to deal in the billions, rather than deal with hundreds of small landlords. The benefits of scale make it easier for that landlord to spread their costs over a larger pool of properties, which results in immediate gains to shareholders, if acquisitions are done properly. Acquisitions have been highly accretive to American Realty Capital Properties shareholders, which have resulted in increases in FFO/share and dividends per share.

American Realty Capital Properties currently yields approximately 7.90%. American Realty Capital Properties yields more than Realty Income (O) or National Retail Properties, Inc. (NNN) or W. P. Carey Inc. (WPC). These other REITs yield 4.90%, 5.50% and 4.30% respectively.  This is because investors view it as a higher risk play than the other triple-net REITs. Investors probably see a higher chance of a dividend cut from American Realty Capital Properties than say Realty Income (O) or National Retail Properties, Inc. (NNN) or W. P. Carey Inc. (WPC). On a side note, each one of those other REITs has managed to boost dividends for over a decade, placing them in the ranks of the dividend achievers list I regularly screen for ideas. ARCP on the other hand has only increased dividends for four years in a row, and therefore does not have a long track record.

The investment in American Realty Capital Properties is mostly an investment in management. I believe that the management is highly competent, and is working for the benefit of shareholders. Management has an extensive track record in dealing with real estate, as well as integrating companies that have been acquired. However, there is always the risk that management develops an ego, which could be disastrous for shareholders. It is one thing to get from $100 million in assets to 15 billion in assets. It is quite another thing to actually manage a portfolio of assets successfully and generate value for shareholders that way.

However, if there are issues in integrating new companies acquired, this could result in losses for shareholders. If you have high degrees in leverage, and no room for error, a botched acquisition could turn out to be very costly.

The other risk is that management is trying to get to be the largest triple-net REIT because they have huge egos, and because a huge size of assets under management could result in larger compensation for executives. For example, if you manage a REIT with $100 million in assets, you can probably command a salary in the hundreds of thousands of dollars per year. However, if you are now managing a REIT with $10 billion in assets, your compensation could be in the tens of millions of dollars, and having a smaller percentage impact on the organization than the lower compensation at $100 million in assets.

The risk with empire building and executive ego is that management ends up purchasing lower quality assets, accepts lower rates of return and gets in bidding wars that could result in unprofitable locations for the REIT portfolio. If you are an executive, you get much more respect if you manage a $10 billion dollar REIT than the executive that manages a $100 million dollar REIT.

I am not very happy about the proposed management compensation plan from a few months ago, which entitled the CEO to quite a handsome compensation package, provided that the shares return at least 7%/year. Given the fact that current yield is at 8%, this meant that the goal of management was to extract money from the business for their own gain, rather than work for the benefit of shareholders.

When I bought the shares in 2013, I believed that the company can develop to be the next Realty Income. It has so far developed a big scale, has managed to do a lot of deals in the process, and is very undervalued relative to competitors Realty Income (O), W. P. Carey Inc. (WPC), National Retail Properties, Inc. (NNN). However, it is yet to be seen if assets were integrated successfully in order for synergies to be generated. I want to see some clean financials, which would make it easier to do a quantitative analysis that would allow me to compare performance between quarters and years. I am also curious to see where management takes the REIT, after achieving such big scale so rapidly. While I would keep holding on to my shares for as long as the dividend is maintained, I am not sure about adding fresh money there. Of course, if shareholder fears are overblown, this REIT could deliver excellent performance going forward, given the fact that shares have been so beaten down.

Full Disclosure: Long ARCP and O

Relevant Articles:

Five Things to Look For in a Real Estate Investment Trust
Realty Income - A dependable dividend achiever for current income
Are we in a REIT bubble?
How to Generate an 11% Yield on Cost in 6 Years
Undervalued Dividend Stocks I purchased in the past week

Wednesday, July 16, 2014

Dividend Investors Will Make Money Even if the Stock Market Closed for Ten Years

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. Warren Buffett

Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. Warren Buffett

In 1914, the New York Stock Exchange closed for five months. In 2001, the NYSE, Nasdaq and AMEX were closed for a week. Active stock traders did not make any money during those periods. Dividend investors kept receiving their dividend checks, without interruption.

Investors can buy and sell their stock in an instant. This ability to quickly cash out makes stock investing a preferable option for many investors. Compare this to real estate or a private business, where it might take months in order to buy and sell an asset.

Sometimes however this could be a curse as well. While stocks are a very liquid investment, sometimes investors end up being too focused on short-term price fluctuations, while ignoring fundamentals. During bull markets, investors bid up share prices to unsustainable levels. During bear markets, investors who see their portfolio values collapsing panic and sell at the wrong times. Those investors become too emotional, which creates opportunities for the enterprising dividend investors. The emotional investors tend to forget that stocks are not some lottery tickets or numbers blinking on a computer screen, but ownership pieces of real businesses. In a perfectly rational world, the value of business depends on its current and future estimated earnings powers. This is why when entire businesses are sold to a private buyer, the price paid is usually close to the intrinsic value. However, due to the emotional state of Mr Market, the ownership pieces that are exchanged between stock market participants are frequently mispriced.

Dividend investors know that dividend stocks represent ownership stakes in real businesses. As a long-term investor, your success is dependent on the success of the business. If the business manages to grow earnings per share, it would be worth more and would also be able to distribute more in dividend income.

Dividend investors who embrace a buy and hold mentality have an inherently psychological advantage over the average investor. Dividend investors generate a return on investment every time they receive a dividend payment. As a result, many retirees who are living off dividends, concern themselves with the company’s ability to grow earnings to pay higher distributions, than the stock price of the stock. Astute dividend investors focus on fundamentals, understanding the company’s operations and valuing the business as if it were a privately owned corporation.

Dividend investors are in essence much different than the rest of participants, who rapidly exchange little pieces of ownership between each other, in an effort to outwit each other. Dividend investors see stocks as partial ownership pieces of real businesses. They understand that their ultimate success in investment is based on the price they paid and on the success of the business itself. If you own a restaurant along with 10 other partners, you care about making sure the business succeeds, and stays relevant for as long as possible. The goal is to make sure that repeat business is earned, customers are happy, and profit margins are healthy, while trying to constantly increase profits. The advantage of dividend investors is that they focus on the fundamentals of the business, how it earns money, and whether this business has the potential to earn more money in the future. Then they try to purchase that business at an attractive valuation, which takes into consideration a range of potential outcomes, and provide an entry price range which would generate a satisfactory return on investment. If you are the partial owner of a McDonald's franchise, you earn profits whether the stock market is open or closed. In fact, if you have found the right business at the right price, it is highly likely that you will hold this business forever.

This is how I view ownership of high quality companies such as Coca-Cola (KO), Johnson & Johnson (JNJ) and Kinder Morgan Inc (KMI). Those are real businesses, that provide real goods or services to clients, and which generate profits to be distributed to me as the partial share-owner. I expect to hold those businesses forever, and expect to earn ever increasing dividends over time from those ownership stakes. I see the rapid trading as pure madness, which actually doesn't really affect me. Whether I pay $37 for Coca-Cola shares or $37.10/share is irrelevant to me. Let the high-frequency computers make that money. The real money is made by identifying a quality company,  buying it at an attractive price, and then sitting on it for decades. In the meantime, the business will be earning more and more in profits almost every year, and pay you an amount of dividends that will likely exceed the purchase price paid by a factor of a few times the purchase price.  Time is the ally of the long-term, buy and hold dividend investor. The initial results are slow, but eventually, the compounding ends up snowballing into mind-boggling yields on cost and capital appreciation returns.

This is why I spend so much time screening the list of dividend champions and dividend achievers, and then researching companies one at a time. I am looking for companies with strong competitive advantages, strong brands, that would allow those companies to have the potential to be around in 20 years, and still earn more per share over time. For example, if you are a part owner of the local water utility, you know that this business will be around in the next 20 - 30 years, because it would be impossible for someone else to compete with you, due to regulation and cost to set-up and maintain the system. If you are a part owner in a company that provides a unique product or serves, which is largely unregulated, it essentially has a monopoly that could mint profits to the shareholder for decades. A prime example of that is Coca-Cola, which has a strong distribution network throughout the world, is associated in consumers' minds with positive emotions, has over 500 brands globally that quench the thirst of people in 200 countries to the tune of 1.9 billion servings per day. If you believe this business has the staying power to be around in 20 years, then you can make projections on earnings, revenues and dividends with a much larger degree of comfort. You want a business which will not change too rapidly. People will get thirsty 30 years from now. If you have the distribution scale that covers 200 countries, and a portfolio of 500 branded drinks, chances are that consumers will use your products. This is why Buffett invests in quality companies with durable competitive advantages, operated by honest and able managers, which have attractive returns on capital and which are available at attractive prices. If you find such a company, the goal of the dividend investor is to hold on to it for decades, and let the power of compounding do the heavy lifting for them.

In contrast, while I might know that Apple will be around in 20 years, I am not so sure how much profitable the enterprise will be, due to the rapid changes in technology. Sony was another great consumer technology franchise, which has not done so well as of the past decade. Will Apple follow the steps of Sony? I don't know, and chances are that few investors really have the necessary knowledge to make an educated bet today. This is why I am sticking to companies I understand, and focus on their fundamentals for the next 20 - 30 years. As a long term buy and hold dividend investor, my goal is to live off the dividends from my collection of quality enterprises. Therefore, my success will be determined on the success of the businesses I invest in, not on stock price fluctuations. The stock market is only helpful to me as a tool where I find sellers of quality businesses, not as a place to instruct me on how to make my investments.

Full Disclosure: Long KMI, JNJ, KO. One share of BRK.B

Relevant Articles:

Coca-Cola: A wide-moat dividend growth stock to buy and hold
Maintaining Moats in times of Technological Changes
Seven Sleep Well at Night Dividend Stocks
How to analyze investment opportunities?
Let dividends do the heavy lifting for your retirement

Tuesday, July 15, 2014

Seven Dividend Stocks I purchased for the long-term

In the past week, I acquired stakes in seven dividend growth companies. For three of the companies, I am adding to existing positions. For the rest of the companies, I initiated positions in companies which I believe will be around in 20 years, and stand a chance of earning more over time. The higher estimated level of earnings will hopefully lead to higher dividend payments to me as a shareholder. While the positions are small initially, I find it much better to monitor a company I am interested in by having some skin in the game. That way, if prices drop from here, I will be in a better position to take advantage of the situation, since I have done the prep work already and am monitoring the situation by being invested in the stock.

I am now increasingly favoring tax-deferred accounts, in an effort to minimize tax liabilities today, and enjoy uninterrupted tax-deferred growth of dividends and capital gains for the next 30 – 40 years. The 401 (k), Roth IRA and SEP IRA accounts are here to house the assets that will be generating my buffer dividend income. This is the income I don’t expect to ever need in retirement, but would have it just in case. I am also exploring ways to utilize a Health Savings Account, as another tool to cut down on taxes today, and have uninterrupted tax-deferred growth for decades on those funds. My only regret is that I didn’t max those out prior to 2012. If I had, I would have been much better off. Better late than never of course.

With those moves, my Roth IRA is maxed out for the year 2014. The companies I purchased there include:

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has managed to increase dividends for 32 years in a row. In the past decade, the company has managed to increase annual dividends per share by 9.60%/year. Currently, the stock is attractively valued at 13.30 times forward earnings and an yield of 2.70%. Check my analysis of Exxon Mobil.

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. This dividend achiever has managed to increase dividends for 19 years in a row. In the past decade, the company has managed to increase annual dividends per share by 19.40%/year. Currently, the stock is attractively valued at 10.50 times forward earnings and an yield of 2.40%. Check my analysis of IBM.

The Chubb Corporation (CB), through its subsidiaries, provides property and casualty insurance to businesses and individuals. This dividend champion has managed to increase dividends for 32 years in a row. In the past decade, the company has managed to increase annual dividends per share by 9.20%/year. Currently, the stock is attractively valued at 12.70 times forward earnings and an yield of 2.10%. Check my analysis of Chubb.

The Williams Companies, Inc. (WMB) operates as an energy infrastructure company. The company’s Williams Partners segment owns and operates natural gas pipeline system extending from Texas, Louisiana, Mississippi, and the offshore Gulf of Mexico through Alabama, Georgia, South Carolina, North Carolina, Virginia, Maryland, Delaware, Pennsylvania, and New Jersey to the New York City metropolitan area. The company has managed to boost dividends for 11 years in a row, and has a ten year dividend growth rate of 43.10%/year. I like the fact that the company owns the General Partner rights to Williams Partners, and has plans for further growth in dividend income through 2017. I have been monitoring the stock for 2 years, and just now initiated a position, which might not be at the best price of the moment. Of course, noone knows where prices will go next, which is why the best time to initiate a position is today. The yield is at 2.90%.

With the investment listed below, my SEP IRA is close to being maxed out for the year 2014 as well. I purchased the following investments there:

Baxter International Inc. (BAX) develops, manufactures, and markets products for people with hemophilia, immune disorders, infectious diseases, kidney diseases, trauma, and other chronic and acute medical conditions. The company has managed to increase dividends for 8 years in a row. In the past decade, the company has managed to increase annual dividends per share by 12.40%/year. Currently, the stock is attractively valued at 14.70 times forward earnings and an yield of 2.80%. Check my analysis of Baxter.

Deere & Company (DE), together with its subsidiaries, manufactures and distributes agriculture and turf, and construction and forestry equipment worldwide. The returns from this company are going to be lumpy from year to year, but the possibilities are high if world population increases, and more people in developing countries can afford to eat as much as those in the developed world. Deere is a dividend achiever, which has managed to increase dividends for 11 years in a row, and has a ten year dividend growth rate of 16.30%/year I believe the company will be around in 20 years, and given the low valuation today of 10.50 times forward earnings and yield of 2.60%, it offer a good opportunity for dividend growth and capital appreciation. Check my analysis of Deere.

Republic Services, Inc. (RSG), together with its subsidiaries, provides non-hazardous solid waste collection, transfer, and recycling and disposal services for commercial, industrial, municipal, and residential customers in the United States and Puerto Rico. The company is essentially part of an oligopoly, given the fact that waste storage locations need a lot of money, expertise to open and operate. I also like the recurring annuity like cash flow streams for the company. I believe that waste is going to increase over time in this country, and companies like Republic Services are going to benefit from this. I also like the fact that the company has managed to increase dividends for 11 years in a row, and had a five year dividend growth rate of 6.60%/year. The stock is close to being pricey at 19 times forward earnings and yields 2.80%. Check my analysis of Republic Services.

I consider myself incredibly lucky that I have been able to save money consistently, and put it to work towards my future. I have been very lucky that I kept adding money even throughout the 2008 – 2009 crash, and the subsequent recovery, when everyone was telling me that stocks are about to crash. Even if they do fall by 20%, 30%, 50% from here, as an investor in the accumulation stage, I am going to view this as an opportunity to get more stock for my buck. If you are building out your stock portfolio today, you should be praying for lower stock prices, which means better stock values and better dividend incomes. In addition, to paraphrase Charlie Munger, if you are not willing to sit through a 50% decline in stock prices, then you should not be in stocks.

What purchases have you recently been making to your dividend portfolios?

Full Disclosure: Long all companies listed above

Relevant Articles:

Deere & Co (DE) Dividend Stock Analysis
Can everyone achieve financial independence with Dividend Paying Stocks?
I purchased this dividend machine last week
Multi-Generational Dividend investing
My Retirement Strategy for Tax-Free Income

Monday, July 14, 2014

ConocoPhillips Rewards Long-Term Investors with consistent dividend increases

ConocoPhillips (COP) explores for, develops, and produces crude oil, bitumen, natural gas, liquefied natural gas, and natural gas liquids worldwide. Over the past week, the company’s board of directors approved a 5.80% increase in the quarterly dividend to 73 cents/share. After this increase, this dividend achiever has managed to boost cash payouts to its patient long-term investors for a cool 14 years in a row. This was the second dividend increase after the spin-off of Phillips66. The first increase was by 4.50%  to 69 cents/share in 2013.

When I last analyzed ConocoPhillips, I really liked what I saw. I have been adding to the stock for the past two years. I really like the fact that the company trying to deliver value to shareholders by focusing on projects with the best potential for return on capital, in order to deliver an annual growth in production between 3 – 5 % per year. As a result of the company’s ongoing portfolio optimization and effort to increase returns on capital, the company has been able to deliver results to shareholders. One of the company’s stated objectives of delivering a return to shareholders has been through regular dividend increases.

In fact, after the dividend increase was announced, the company’s CEO was quoted in the press release, stating that “A compelling dividend remains a top priority for our company and reflects our commitment to deliver competitive shareholder returns”.

One of the biggest misconceptions about ConocoPhillips is that the company didn't increase dividends in 2012. To the inexperienced investor, who doesn't dig deeper into the data, it looks like the company maintained the dividend at 66 cents/share between 2011 and 2013. The reality is that the dividend investor from early 2012 owned one share of COP that paid them 66 cents/share. This dividend investor received half a share of Phillips 66 (PSX) in the middle of 2012, after the company was spun off, that paid them 20 cents/share initially. In addition, they still held on to their original share of ConocoPhillips, which paid 66 cents/share. So as a result, the investor was left with a share of the new ConocoPhillips (COP), and the half share in Phillips 66 (PSX). The new ConocoPhillips company owned only the exploration and production portion of the old ConocoPhillips, but it still paid the same dividend amount as if it was the larger predecessor company. The first quarter after the spin-off, the shareholder received 66 cents from ConocoPhillips shares and 10 cents from their half share of Phillips 66. Subsequently, Phillips 66 dividend has been increased to 50 cents/share. Phillips 66 ended up with the Refining and Marketing assets from the original ConocoPhillips company from pre-2012. Those include Refineries in the US, as well as pipelines and terminals across the US. Contrary to popular opinion, the gas stations that you see in the US, that have the name ConocoPhillips or Phillips 66 are not owned by either company. Those have been sold out almost a decade ago, in an effort for the legacy ConocoPhillips to focus on its core competencies.

This is why you need to hold on to your spin-offs, and not sell them. Investors who fixate on having a certain number of companies in their portfolios might end up selling companies like Phillips 66, because they are arguing that they have too many companies in their portfolios to monitor. In my experience, selling a spin-off is usually a mistake. My experience includes Phillip Morris separating into Altria (MO), Phillip Morris International (PM) and Kraft, and the subsequent split of Kraft into Mondelez (MDLZ) and Kraft (KRFT). It also includes the split of Abbott into Abbott (ABT) and Abbvie (ABBV). I hold on to those positions, because the research I have read indicates that this has been the smart thing to do in the past. I initiated a position in ConocoPhillips after the spin-off however, which is why I don't own any Phillips 66.

I believe that this is a great company to buy and then hold on for many decades, while receiving higher dividends over time, that eventually surpass the cost basis of the stock.Unfortunately, I believe that shares have gone up quicker than I anticipated. Depending on other opportunities available for my capital, I would not be opposed to further building out my position in ConocoPhillips. It would be nice if I can add to my position at a starter yield of 4% or forward P/E of around 11.

What is your opinion on the company and the shares?

Full disclosure: Long COP, MO, PM, KRFT, MDLZ, ABBV, ABT

Relevant Articles:

Four Practical Dividend Ideas for my SEP IRA
ConocoPhillips (COP) Dividend Stock Analysis 2014
Why Investors Should Look Beyond Typical Dividend Growth Screens
How to Generate Energy Dividends Despite the Peak Oil Nonsense
Six Slow & Steady Dividend Achievers Boosting Distributions

Friday, July 11, 2014

Deere & Co (DE) Dividend Stock Analysis

Deere & Company (DE), together with its subsidiaries, manufactures and distributes agriculture and turf, and construction and forestry equipment worldwide. The company is a dividend achiever that has paid dividends since 1937 and managed to increase them for 11 years in a row. The company’s peer group includes CNH Industrial (CNHI), Caterpillar (CAT) and AGCO Corp (AGCO)

The company’s latest dividend increase was announced in May 2014 when the Board of Directors approved a 17.60% increase in the quarterly dividend to 60 cents /share. "Deere is well-positioned to benefit long-term from global trends that hold great promise for the company's customers and investors," said Samuel R. Allen, chairman and chief executive officer. "Our dividend increase reflects our confidence in Deere & Company's ability to generate strong cash flow throughout the cycle. We remain committed to our plans for profitable growth and for returning cash to shareholders."

Over the past decade this dividend growth stock has delivered an annualized total return of 12.10% to its shareholders.


The company has managed to deliver a 21.30% average increase in annual EPS over the past decade. Deere is expected to earn $8.55 per share in 2014 and $7.73 per share in 2015. In comparison, the company earned $9.09/share in 2013.


Deere also has an impressive record of consistent share repurchases. Between 2004 and 2014, the number of shares declined from 506 million to 379 million.

I have been biased against Deere, because it looks like a cyclical company, which managed to get lucky and ride a profitable trend over the past decade. As most of you are aware of, the past 10 – 15 years have been characterized by the rapid growth in emerging economies, which has lifted the boats of a lot of other companies. I am afraid that Deere might keep capitalizing on the those emerging markets, but at some point in time, it would have to go back to being a cyclical company with cyclical earnings. This could be a decade down the road, or could occur within the next few years. As a dividend growth investor, my goal is not only to find a cheap stock with a good dividend, but also a company that can grow earnings over time. If earnings per share are not increased over the next decade, most of dividend growth will come from increases in the dividend payout ratio, which is seldom a good sign for dividend income stability. I simply do not view Deere as the type of set it and forget it dividend growth stock that I can pass on to my heirs. That being said, it could still be a profitable investment for someone who buys today, given the low valuation, even if earnings do not increase by much. That would be true, as long as earnings per share do not decrease.

Long-term prospects could be brighter than I imagine however. An increasing world population should continue to exert pressure on food supplies, which in effect could raise the demand for new efficient farm machinery. However, if commodity pricing pressures farmer’s profits, demand for equipment could soften.

New products could be another boost for farming equipment, as is a cycle to upgrade old equipment over time, in an effort to boost productivity. The company has strong position in North America, with an established brand name and a 50% market share, which should provide it with a good scale of operations.
I also like the fact that management seems very shareholder friendly, as evidenced by their commitment to dividend growth over the past 20 years, the consistent share buybacks, and the fact that operations are run pretty well. For example, the finance division has pretty low loan losses, which is encouraging and shows that proper credit evaluation is being done before lending money to farmers.

I also like the fact that the largest shareholders is Cascade Investments LLC, which is the holding company that holds the investment portfolio of Bill Gates. I have been reading some about Bill Gates, and have found that his holding company is managed by Michael Larson, who is a very successful value investor.

The annual dividend payment has increased by 16.30% per year over the past decade, which is lower than the growth in EPS.

A 16% growth in distributions translates into the dividend payment doubling every seven years on average. If we check the dividend history, going as far back as 1989, we could see that Deere has actually managed to double dividends every eight years on average. What makes this analysis tricky however the fact that the company cut dividends in 1982 is, and the annual dividend didn’t exceed the 1982 highs till 1990. The annual dividend from 1982 didn’t really double until 2005.

Over the past decade, the dividend payout ratio has mostly remained low below 25%, with the exception of 2009. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Deere has managed to increase return on equity from 30.60% in 2004 to 41.30% in 2013. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Currently, the stock looks cheap, as it trades at a forward P/E of 10.40 and a current yield of 2.60%. I believe that the business is more exposed to economic cycles than the typical dividend growth stock that I usually focus on. However, when a business is cheap, it can still generate shareholder value even if there is only a small improvement. With Deere, the $8 billion share buyback could be one catalyst that could result in better returns going forward. As a result, I initiated a small position in the stock this week.

Full Disclosure: Long DE

Relevant Articles:

Dividend Stocks Offering Positive Feedback to Investors
Caterpillar (CAT) Dividend Stock Analysis
Look beyond P/E ratios dividend investors
Return on Investment with Dividend Stocks
Price is what you pay, value is what you get

Wednesday, July 9, 2014

Look abroad for higher dividend yields

US stocks these days are offering much lower yields than the rest of the world. For example, S&P 500 yields less than 2%, while UK stock indices are yielding more than that. Given the fact that foreign companies are paying more generous dividends that US ones, should dividend investors venture abroad?

Before investors decide to invest in foreign stocks, they need to understand the risks and peculiar characteristics of foreign dividend paying stocks.

In general, most foreign dividend paying companies pay fluctuating dividends each year. Foreign companies are quick to cut dividends if earnings fall even by a small amount, since they target a particular dividend payout ratio, rather than a particular level of dividend payments. US investors who are used to the stability of dividend payments that most American firms exhibit might be disappointed by this feature. Fluctuating dividends make it particularly difficult to live off your investments, and as a result it is best that these companies are avoided.

Adding to the injury, most foreign companies tend to distribute cash to shareholders once or twice per year at best. Many multinationals such as Nestle (NSRGY) for example pay distributions once per year. As a result, investors who like to reinvest dividends have only one instance/year to compound their profits. As a dividend investor, I have found that having the ability to reinvest the same annual dividend in four quarterly installments allows for faster compounding than having the dividend compound just once per year. For the companies that pay dividends twice annually, they tend to split distributions into interim and final payments. The interim payments typically represent 40% of the total annual dividend, while the final payment represents 60% of the total annual dividend. As a result, many US services such as Yahoo!Finance, routinely miscalculate the dividend yields of companies such as UK based company Diageo (DEO), or Vodafone (VOD).

Another factor to consider before purchasing foreign shares is taxes. Many countries such as Canada, France, Switzerland and Netherlands, to name a few, impose taxes on dividends paid out to US investors. These taxes are typically around 15% for Canadian stocks held by US investors for example. While US investors can claim a credit for any taxes withheld at a foreign source in taxable accounts, they cannot do that in tax-deffered ones such as ROTH IRA’s. In addition, some foreign companies such as Unilever have dual class shares with similar rights that trade both in London and Amsterdam. Purchasing the Netherland based ADRs for Unilever N.V. (UN) could lead to tax withholdings, whereas purchasing the United Kingdom based ADR’s for Unilever PLC (UL) could pose no such problems. US dividend taxes would still be due of course, but there is less paperwork trying to claim foreign taxes withheld on dividends.

Another factor to consider includes transaction costs. Many US investors tend to purchase American Depositary Receipts (ADRs) on foreign listed shares. As a result, they end up paying US capital gains taxes and US commissions. If you dare to venture abroad however, you would have to deal with finding the right broker, paying taxes abroad and paying commissions which are probably much higher than the ones in USA.

In general, many foreign companies also report results under IFRS, which is a different accounting standard than the US GAAP. Other factors to consider include the fact that many foreign companies listed in the US are typically global businesses, and therefore would trade similarly with their US competitors. In other words, during the financial crisis of 2007 – 2009, many stocks lost almost half of their values. As a result, venturing out abroad might not have delivered the diversification benefits that international investing is supposed to deliver. However, by expanding the time-frame to look at performance of foreign shares before and after the crisis, one could note a few differences. Because of the global nature of business these days, I avoid international over diversification by purchasing shares of US based multinationals.

There are a few lists with dividend growth stocks, which could aid investors in their search for dividend paying companies with dependable and rising distributions. These include the international dividend achievers index, which lists companies traded in US, which have boosted distributions for at least 5 years in a row. Another interesting benchmark is the Europe Dividend Aristocrats index, which lists European companies which have raised distributions for over 10 years in a row.

Some foreign companies that fit in this criteria include:

Diageo (DEO), which produces, distills, brews, bottles, packages, and distributes spirits, beer, wine, and ready to drink beverages. The company has managed to increase dividends for at least 15 years in a row. Currently, the stock is selling for 19.70 times forward earnings and yields 2.70%. Check my analysis of Diageo.

Nestle (NSRGY), which provides nutrition, health, and wellness products worldwide. The company has managed to increase dividends for 18 years in a row. Currently, the stock is selling for 18.60 times forward earnings and yields 3.10%. Check my analysis of Nestle.

Novartis (NVS), which is a multinational company specializing in the research, development, manufacturing and marketing of a range of healthcare products led by pharmaceuticals. The company has managed to increase dividends for 17 years in a row. Currently, the stock is selling for 17.50 times forward earnings and yields 3%. Check my analysis of Novartis.

Unilever (UL), which is a consumer goods company operating in Asia, Africa, the Middle East, Turkey, Russia, Ukraine, Belarus, Europe, and the Americas. The company has managed to increase dividends for at least 19 years in a row. Currently, the stock is selling for 20.20 times forward earnings and yields 3.50%. Check my analysis of Unilever.

BHP Billiton (BBL), which operates as a diversified natural resources company worldwide. The company has managed to increase dividends 15 years in a row. Currently, the stock is selling for 16.80 times forward earnings and yields 3.50%. Check my analysis of BHP Billiton.

Those companies are a little pricey today, but are good long-term holdings for long-term investors. If prices decrease from here, it would be nice to have those company on a watchlist.

Full Disclosure: Long NSRGY, UL, VOD and DEO

Relevant Articles:

International Over Diversification
Best International Dividend Stocks
International Dividend Stocks – Pros and Cons
Nine Quality Dividend Stocks Purchased for the Roth IRA
How to retire in 10 years with dividend stocks

Monday, July 7, 2014

Are you drowning in cash?

With dividend investing, I get a lot of cash every week/month/quarter/year. Since I started focusing exclusively on dividend growth investing 6-7 years ago, quarterly dividend income has been increasing exponentially. I get a lot of cash, which i have to deploy intelligently. By that I mean avoiding overpaying, keeping diversification intact, and always being on the lookout for bargains that offer dividend growth. I therefore try to benefit from multiple levels of compounding - one is the dividend income that grows because companies earn more and hike dividends. The second is reinvesting those dividends into more quality companies selling at attractive valuations. Too much of a good can be a good thing too.

Lately, it has been very difficult to find good ideas, which are also priced attractively. I am really trying hard, and had found some ideas. However, given elevated valuation levels, it is more difficult to deploy cash in the future. Many companies and investors have similar issues, because they are drowning in cash, and money is so cheap too. I am afraid this could create bad behavior, which will be punished a few years down the road at the next recession.

Cash might burn a hole in corporate boards pockets. If they pay out dividends, that could be smarter than buying back stock at inflated valuations. For example, companies like General Electric (GE) spent tens of billions repurchasing shares at $30 between 2004 – 2007, only to issue a bunch of shares and warrants at $23/share. This is also smarter than bidding for assets today and paying high prices in order to deploy that cash, without much margin of safety on the returns of those assets.

When you have a lot of cash on hand, the odds that u will do something stupid with it increase exponentially. Even Warren Buffett is not immune to this folly - examples include investments in United Airlines and Salomon Bros in the late 1980s. He was drowning in cash in the late 1980s and put capital to use at suboptimal prices in assets of questionable quality. I am not saying this to predict a crash, since i don’t forecast market or economic directions. It is a fools game to make predictions about prices, the economy etc. However, i am just venting how more difficult it is to find quality companies that are selling at good prices today. This increases the opportunity that I do something that is bad today, but looks cheap because i am drowning in cash.

Either way, I believe that for a long-term buyer of equities today, with a 20 year horizon would do much better than someone who holds cash waiting for lower prices. For example, ever since late 2009, I have been hearing from investors that they are accumulating cash and waiting for lower prices. I have also been hearing from those who are bearish on everything. These people seem to forget that over time, businesses become more valuable, as they plow more money in their operations and earn more. Then they pay out more to shareholders. That doesn’t happen every year of course, but over time, I believe that productivity gains, increases in numbers of consumers and reinvestment in operations will lead to stakes in quality corporations becoming more valuable. Therefore, it makes sense to put money to work as soon as you have it, and then hold on for 20 years. This strategy of regular dollar cost averaging worked even for those who started right around the Great Depression for example. There are always decent values out there, which would start the dividend compounding process for the investor. It is that the investor has to do the work to identify them. A few quality companies selling at decent prices today include:

Company
Ticker
Yrs Div Increase
5 year DG
Fwd P/E
Yield
Review
Target
TGT
47
21.40%
16.10
3.60%
Exxon Mobil
XOM
32
9.70%
13.20
2.70%
Philip Morris Intl
PM
6
28.40%
16.60
4.10%
McDonald's
MCD
38
13.90%
17.50
3.20%
Baxter International
BAX
8
16.40%
14.60
2.80%
Aflac
AFL
31
8.10%
10.20
2.30%
IBM
IBM
19
14.30%
10.60
2.40%
Lockheed Martin
LMT
11
21.20%
14.60
3.20%
Diageo
DEO
15
7.20%
19.80
2.70%
Wal-Mart
WMT
41
14.20%
14.70
2.50%


Since I get cash every week/month/quarter from my investments and my other income sources, I am well positioned for a stock decline. In fact, I took a big advantage of the declines in February, during which i maxed out SEP IRA, and put one third of the maximum for the 401k. Plus I bought shares in taxable accounts. I have been opportunistically looking for companies which are temporarily battered by short-term noise for decent entry points. This is how I managed to initiate a small position in Accenture (ACN). It is too bad I didn’t put much in Roth IRA. Of course, perfectionist thinking is dangerous in investing, as it can also cause folly, that can lead to stupid actions on my part.

What are you buying these days?

Full Disclosure: Long ACN, TGT, XOM, PM, MCD, AFL, IBM, DEO, WMT

Relevant Articles:

How to find long term dividend stock ideas
Six Compounding Machines for Long Term Dividend Investors
How to become a successful dividend investor
Best Brokerage Accounts for Dividend Investors
How to retire in 10 years with dividend stocks

Popular Posts