Wednesday, March 2, 2016

What dividend cuts? What market correction?

The beginning of this year was characterized with a correction in stock markets around the world. The big problem has been the energy sector, which has dragged down returns for investors. Some like myself have experienced dividend cuts in the likes of Kinder Morgan (KMI) and ConocoPhillips (COP). Others, have experienced dividend cuts in the likes of BHP Billiton (BBL). It is obvious that the energy sector is having a tough time, which by default translates into companies that do business in the energy field, their suppliers, their bankers and certain economies will experience turbulence as a result of this downturn.

As a somewhat visible private investor, I receive a lot of hate mail where the sender of the message secretly gloats at what they perceive to be my current misfortune. Unfortunately, their gloating cannot be further away from the truth. The sender ignores the following important facts when sending me hate mail:


1) When a company I own cuts dividends, I can immediately reinvest that money in another income producing opportunity.

2) If I sold at a loss in a taxable account, I receive a tax benefit that flows to my personal 1040 that could amount to anywhere from 15% - 25% of the loss.

3) Since I hold a diversified portfolio of dividend growth stocks, I will get dividend hikes that will offset the amount of the loss in income within a year or so at a conservative rates of 6% annual dividend growth. If I hold 50 companies on an equal weight basis, the complete loss of income in three of those companies can be offset by an average growth of approximately 6.40% by the other 47 components.

4) If I reinvest dividends, my dividend income will also be expected to increase at the rate of dividend yield

5) In points 1 – 4 above I am only discussing how existing investments have helped my dividend income bounce back after a dividend cut. This will likely be the case in 2016 as well. But please do not forget that I am also putting in fresh capital to work every two weeks – this increases the amount of future dividend income I can expect to collect.

- A large portion of that money provides me with a tax-break upfront ( and thus more money to compound for me than merely using taxable accounts),

- It also provides me with the ability to compound money without paying taxes for the next 30 – 40 years ( a portion of it will never incur taxes under current legislation)

- Since the largest portion of my tax-deferred money is in my 401 (k) and H S A accounts, I am limited to low cost index funds there. These funds have average yields of approximately 2%. If I were to sell those funds, and reinvest those proceeds in individual dividend growth stocks, I can immediately boost my dividend income from this source by at least 50%. Therefore, my expected dividend income is lower than what it could be under normal circumstances.

While the decline in stock prices in some sectors and the amount of dividend cuts has been unfortunate, there are a lot of other sectors that have kept doing well. For example, consumer staples, utilities, telecommunications have been pretty nice spots to be in. In fact, other than the energy sector, my portfolio looks in pretty good shape. I cannot forecast which sector will do badly next, but I can forecast that a diversified collection of quality businesses with a track record of growing earnings and boosting dividends will do well over time.

So at this stage, despite the losses in energy dividends, the rest of the portfolio continues to chug along pretty nicely. Dividend investing has its best moments when things are turbulent in the markets. I have had several companies I own hit all-time-highs, while everyone around me is suffering. Perhaps this is a temporary situation, and we will see losses across the board pretty soon within the next year or so?

During the 2007 – 2009 bear market, stable recession proof companies held up their own initially, while financials cratered, until they were indiscriminately sold off. During the 2000 – 2003 bear market, we saw a similar picture where old-economy stocks did very well initially while tech stocks cratered, until they were indiscriminately sold at the latter parts of the downturn. Perhaps, if this correction continues, we may be able to see quality companies available at attractive valuations.

For example, I am interested in increasing my exposure to quality companies like Hershey (HSY), McCormick (MKC), Brown-Forman (BF.B), Dr Pepper Snapple (DPS), General Mills (GIS), McGraw Hill (MHFI), Moody’s (MCO), Visa (V) etc. Those companies are either selling at the top range of what I am willing to pay for them, or are overvalued. As a result, I have not gotten excited much yet. I am aware that there are other bargains out there, but I have those companies on my wish list for more shares. Let's see if we can get those shares at 15 - 16 times earnings within one year.

Full Disclosure: Long HSY, MKC, BF.B, DPS, GIS, MHFI, V, KMI, COP,

Relevant Articles:

Five World Class Dividend Stocks to Buy During the next dip
Buying Quality Companies at a Reasonable Price is Very Important
Dividend Portfolios – concentrate or diversify?
Sector Allocations for Dividend Growth Investors
Market Declines: An Opportunity to Acquire Quality Dividend Stocks

30 comments:

  1. DGI, I agree with you that with exception of a few sectors, and some secondary sectors with energy exposure, a diversified portfolio is doing pretty well. What do you think would have to happen to reign in some of the higher valuation companies back to more reasonable entry points? My concern with that would be what event could reign them back in and at the same time not re-crush the gains I've made recently with this bounce. I guess it's not possible to have it both ways, but I thought I'd ask. Thanks.

    ReplyDelete
    Replies
    1. If we get a full blown panic, people will be willing to part with their shares at lower prices in a panicl. Otherwise, many slow and steady businesses grow earnings over time, pay higher dividends over time, so they become more valuablke over time. But share prices usually are much more volatile than the changes in earnings power would suggest.

      Delete
  2. I'm eagerly awaiting my quarterly SP500 dividend distribution in a few weeks to compare the dividend distribution to the same quarter last year. The Vanguard SP500 March per share dividend has been:
    2015 - $ .991
    2014 - $ .785
    2013 - $ .676
    2012 - $ .574

    The rates of increase have been fantastic, well over 6% per year, but I believe ultimately unsustainable. We shall see.

    ReplyDelete
    Replies
    1. The S&P 500 is a dividend contender by itself. Per my records, it has raised dividends since the low of 2009.

      Historical dividend growth rates have averaged a little over 5% over the past century, and is consistent with earnings growth over time.

      So if you believe that long-term earnings growth to be unsustainable, then you shouldn't be in stocks.

      Delete
  3. Ignore the haters and the hate mail, you're the one blowing it out of the park with your investments!

    ReplyDelete
    Replies
    1. I don’t care anymore what people think of me.
      On the other hand, I do like constructive feedback, which is helpful. I am always willing to listen to opposing viewpoints.

      Delete
  4. There is always a problem of over exposing yourself to a strategy & limiting yourself without diversification or end up selling
    when things go south. There is risks & limitations to dividend investing. However, with dividend strategy, I can enjoy the
    dividends when stocks do hit a rough patch. Then the big problem is forcing you to buy low! I for one, enjoy your emails.
    They help me keep on track. Also, thanks for the Sure discount.

    Michael


    ReplyDelete
    Replies
    1. There is a very common misconception about dividend stocks in that they are somehow completely different than any other stocks. When you have a portfolio of over 60 individual dividend stocks from a variety of sectors, you are actually pretty well diversified. Your portfolio will correlate highly with say Dow Jones or S&P 500. Dow Jones has 30 stocks and S&P 500 has 500 stocks, and they have similar long-term returns.

      Getting a cash dividend is helpful, because I get a positive feedback that I am invested in a real business with real earnings, so I can safely ignore fluctuations.

      You are welcome on the Sure Dividend discount.

      Delete
  5. DGI,

    I can't believe that you get hate mail. Your portfolio is in a very good place and has hardly even taken a small dent from these recent fluctuations in the market. Sounds like some people need to take a serious step back and evaluate their own portfolios before taking stabs at yours. Regardless, I like how you handled it and instead of lashing out, simply pointed out why it doesn't affect you going forward. Bravo!

    -Dividend Monster

    ReplyDelete
    Replies
    1. Hi DM,

      I wish your site to become so popular, that you start getting hate mail ;-)

      I can’t even imagine what the really big sites that are profiled in the mainstream media deal with.

      I think the sale of Dividend Mantra has actually increased attacks on those like myself too. But Jason did get a beating on his comment sections of his "former" site, and in a few reviews I have seen on the forums

      Delete
  6. The thing I enjoy about your writings and investing in general is that there are a multitude of ways and theories to invest ones money. None of them are wrong, they are all a matter of goals and comfort zones. That being said, I would never send hate mail or criticize an investor for doing what they believe in and matches their risk tolerance.

    I love reading your blog, DGI. I don't always agree but I appreciate / respect your thoughts and it keeps me on my toes and always thinking about my portfolio.

    Remember Bill Miller at Legg Mason. He beat the S&P handily for 17 consecutive years...until he didn't. He lost something like 72% in 2008. Wonder how those folks that invested with him in December of 2007 felt about his track record of the previous 17 years.

    Sorry for the long rant...keep up your good work.

    SAK



    ReplyDelete
    Replies
    1. I agree that there are multiple ways to reach your goals. I also agree that there isn’t a one size fits all approach. I find it easier to stick to a strategy when the investments pay me regularly – this is why DGI works for me.
      Indexing could work too, especially when I get a dividend every quarter. And given the tax advantages, it is a no brainer to do it in a 401K.
      Real Estate works too, but I don’t understand it well.
      The important thing is to develop a method that you are comfortable with, and you can stick to when things get rough. And trust me, every way of investing will go through rough patches.

      Delete
  7. It's so funny to see some of the biggest opponents of the dividend growth strategy come out once dividend cuts are announced and try to condemn the whole strategy. Yes a dividend cut is horrible for the strategy. But only if you're invested in or heavily weight to just a few companies that happen to have a cut. But the same can be said for anyone invested in a pure growth strategy and being underdiversified.

    If you have a diversified portfolio and the other companies you own continue to increase dividends you'll typically make up for the cut rather quickly. And that's assuming that you weren't able to salvage and then reinvest the capital from the company that cut their dividend.

    Trying to condemn a whole strategy, that you're comfortable with for your own needs/goals, based on the outcome of a few companies is pointless. You can argue that the pure growth strategy is fruitless whenever a company that doesn't pay a dividend goes bankrupt. Dividend cuts just reinforce the need to keep up to date on the safety of your dividends and the quality of the companies you own. In the end, no matter what strategy you use, investing in high quality companies is going to be a winning strategy in the long run. And a company can't really fake it's way through higher dividends for too long. A consistently rising dividend is as good a sign as any that the company could potentially be a high quality investment.

    ReplyDelete
    Replies
    1. I also find it interesting that many seem to be gloating about a temporary weakness in a strategy, such as a dividend cut, or a 10% correction in stock prices, and throw it in our faces. But of course, they do it after the fact. There was one blogger who was gloating about the dividend cut on COP, and claimed he had warned others and claimed that they were short the stock. But it turned out they had warned about CVX ( which didn't cut). And COP is up since they told us they were short. They haven't shared how they are doing. I do not like people who tell me how smart their calls us, but only in retrospect.

      I think that a lot of critics of dividend investing either do not understand it, do not understand how business works, or have a vested incentive against do it yourself dividend investing ( as evidenced by so many financial advisers out there who claim that dividend investing is wildly popular, when in fact it is the index funds they are selling to be extremely overcrowded to the tune of trillions in the likes of Vanguard or Blackrock).

      You may like this article I wrote last year:

      http://seekingalpha.com/article/3380245-the-dumbest-argument-against-dividend-paying-stocks

      Best Regards,

      DGI

      Delete
  8. I don't hate you. I read your blog religiously and feel that I have benefited greatly from your insight. Stay the course!

    ReplyDelete
    Replies
    1. Well, if my posts are terrible, someone needs to tell me. But please be constructive, and tell me how I can improve. Otehrwise, the feedback is not helpful to anyone.

      I am trying to learn and share what I have learned with others. It is important to keep the discussion flowing, so that everyone benefits and becomes a little smarter with their money.

      Delete
  9. Ignore the ignorant and keep up the good work..... love your posts.

    ReplyDelete
  10. DGI!

    Love your blog! I am a long time follower of your articles. I decided to keep COP. The cut is not even noticeable due to the power of reinvesting, increases, and fresh capital. The annualized income from my accounts are gaining over 25% a year!

    Keep up the good work and keep living the dream!
    -J

    ReplyDelete
    Replies
    1. Dividend Growth InvestorMarch 4, 2016 at 5:52 PM

      J,

      I agree 100% with you.

      Whoever kept their COP after the cut is better off from a TR perspective.

      Good luck in your investing journey!

      Delete
  11. Awesome read.

    To follow up one Passive Income Pursuit's comment, BBL makes up 0.8% of my portfolio not including 401ks. i will survive this dividend cut. I am going to ride it out since it such a small weight in my portfolio.

    Keep pushing on!

    ReplyDelete
    Replies
    1. Dividend Growth InvestorMarch 4, 2016 at 5:53 PM

      That is a small allocation to that BBL. Your portfolio has to grow dividends by less than 2% in order to get even. Anything extra will surely grow your income

      Delete
  12. I don't see anything wrong with dividend investing. In fact, I like the idea of never touching the principle. I am an index fund investor myself. However, what I don't understand is why dividend investors don't simply pick a fund like Vanguard High Dividend Yield ETF (VYM) and call it a day. I know the yield might not be a high at 3.37%, but at least you don't have to worry about individual stock risk or companies reducing their dividends. If I was a dividend investor, this is the route that I would take. You get higher dividends, capital appreciation, and safety with 433 dividend stocks in the ETF.

    ReplyDelete
    Replies
    1. So you will pay money every year for someone to hold stocks you already know about? The top 10 stocks account for one third of the value – why can’t you simply buy the largest 50 – 100 stocks using a no-commission broker and call it a day? And then hold tight for 30 years?
      Not all companies are attractive at all times – so this is where buying an ETF might not be best decision. So you get the good with the ugly. But you want to understand how they select companies, and make sure they do not tweak those weights too much – which they will – like the utilities index adding Enron in 1997 only to boot it out when it went bankrupt in 2001.
      The issue I have with ETFs is that holding composition and weights could be changed at a whim. Even the strategy could be changed, which could impact results going forward. For example, the S&P 500 used to include companies like Unilever through 2002, when they decided they were "foreign". Yet they include PM, which is US domiciled but does all business abroad.
      Plus many of the dividend ETF's make no sense to me - like SDY kicking out MO in 2007 after the Kraft spin-off. It seems like the index committee was blindly focusing on data, without understanding that the dividend was not cut.
      Plus the distributions on many ETFs fluctuate a lot due to changes and portfolio turnover.
      Of course, if you are limited as to what you can invest in, or do not want to spend any time on investing, then an etf or mutual fund makes sense. Just make sure the expense ratio is low. But personally, I can buy 30 – 60 -90 companies outright today, and then reinvest my dividends – this is not an inferior way to having someone else select 30 – 500 stocks for me, contrary to what anyone else says.

      Delete
  13. Hey DGI,

    Nice write-up. Had quite a few dividend cuts recently, just sold off one of the companies to reinvest to make up for the lost dividend. Since 2016 started I've shied away from the Energy sector a lot more than in 2015, and focused on Financials and my portfolio has been roaring back from the losses I faced last year. Looking forward to the rest of 2016. I think a lot of fears are overblown.

    DB

    ReplyDelete
    Replies
    1. Yep, when you sell and reinvest those dividends in other companies, you regain some dividend income back. When the rest of your portfolio grows dividends, you regain some income back. When you reinvest some of those dividends you receive, your dividend income grows back.

      If we get turbulence in 2016 and 2017, you may get quality companies at lower prices, and therefore will be able to invest your money at better entry yields, which further would increase you dividend income

      Good luck in your journey!

      Delete
  14. Grandson (21 yo) has expressed interest to Grandpa in learning about stocks and the stock market, and financial matters in general. I am glad he is thinking about this at his age. What would be on your required reading lists? Thanks a million, Karl

    ReplyDelete
  15. Dear DGI,
    I for one am very sorry to hear of the negative comments you may be receiving. I applaud the way you handle your investing, your blog, and all of the comments. I feel your blog has been a blessing to me and my family. I really look forward to reading and rereading your blog several times a week and hope you will continue and even write a book about your investing in dividend growth companies. You mention humility in learning and investing and that makes me appreciate you even more. Your willingness to take constructive criticism and keep growing and learning is inspiring to me. I have written a couple of comments before and feel you are like a wise friend and teacher. Thank you so much.

    ReplyDelete
  16. I love corrections - I recently scooped up a few dividend stocks with strong financials and payout history at a bargain price. There's nothing like locking in a strong dividend! :)

    ReplyDelete

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