Monday, November 24, 2014
1) Attractive entry price
The importance of the entry price cannot be overstated. Even the best company in the world is not worth overpaying for. It matters a lot that you can acquire those shares at low valuations, which ensures better entry yields. For example, if you bought Coca-Cola (KO) in 1999 at $23.50/share, you would have paid over 30 times earnings and received an initial yield of about 1.30%. Despite the fact that earnings and dividends increased rapidly, your yield on cost did not go that much higher than 5.20% although you did earn some capital gains in the subsequent 15 years. You would have been better served putting that money in REITs, oil companies or tobacco shares, which were cheap at the time and had better starting yields. Therefore, when you buy shares, it pays to always pick the ones with the cheapest valuations. Quality should never be sacrificed, but if you make a purchase at a cheap enough price, you can earn a decent return even if growth projections turn out to be poor. For example, I bought ED in 2008 – 2009 at really low valuations and entry of 6%. In hindsight, this was a mistake since the dividend was growing slower that inflation. But I still earned a high return despite that, and once I realized the mistake I sold and redeployed capital elsewhere.
2) Dividend growth
Dividend growth is the second important component in turbocharging the dividend income. A company that is cheap, and manages to grow dividends is a must to invest. Even if you spend your dividend income each year, your dividend income still increases. For example in 2004 Coca-Cola sold for 20-21 times earnings and yielded close to 2.50%. Since then the dividend income would have more than doubled by now, rising from 50 cents/share in 2004 to $1.22/share by 2014. Historically, dividends per share on US stocks have grown by 5%- 6%/year. This has beaten inflation, and ensured that the purchasing power of your passive income is maintained.
3) Dividend reinvestment
Another important component to grow income is the power of dividend reinvestment. Let’s assume a scenario where you have a company that yields 3% today, which manages to grow dividends by 7%/year and you spend all your dividend income. In this case, using the rule of 72, you will end up with double the dividend income in a decade. However, if you decided to reinvest those dividends into more shares yielding 3% and growing dividends by 7%/year, your dividend income will double in approximately seven years. It is important to treat reinvestment carefully however, and be mindful of valuations when doing so. In some cases, it might only be cost effective to automatically reinvest dividends, particularly if the position is only a few hundred dollars for example. In other cases however, it might be preferable to accumulate cash dividends for a month, and then put that amount to work in your best ideas at the time. This would work if you generate $600 - $800/month in dividend income.
4) Tax advantaged growth
Two things in life are certain – death and taxes. Investors who receive dividend income and are in the 25% tax bracket have to pay 15% tax on qualified dividend income. This reduces the amount of money one can feed their dividend machine. In order to reduce the effects of this obstacle, many dividend investors place their stocks in tax-advantaged accounts like Roth IRA’s. As a result, their dividends grow tax free, and therefore they could reinvest the whole amount into more dividend paying shares. If you are in the 15% tax bracket however, this means your qualified dividend income is essentially tax free.
The four points discussed above could be best illustrated by a small investment I made in Kinder Morgan Energy Management LLC (KMR) in 2009. This was one of the smartest investments I ever did, and hit the four points perfectly. I was bullish on the Kinder Morgan Partnership (KMP), which was a dividend achiever that offered sustainable current yield, and high distributions growth. I liked the prospect for high distributions growth and high current yields. However, I noticed that KMR was selling at a discount to KMP. KMR was equivalent to KMP in every single economics way, with the only exception being that it paid distributions in additional shares, and not in cash. Some investors disliked this idea, which explained why KMR was always cheaper by 5%-10%. In addition, since the distributions were payable in additional shares of KMR, this meant that IRS saw them as stock splits and considered them tax-free as long as the investor held on to shares. I thought of buying up KMR since I am in the accumulation phase, and then if the gap narrowed to sell and buy the limited partnership units and live off those distributions. For each dollar invested in August 2009, with distributions being reinvested tax-free at KMR that was selling at a massive discount, I ended up with approximately $2.80. Thus, an investment of $1000 back then would have turned into approximately $2800 today. Once the acquisition by Kinder Morgan Inc (KMI) is performed, and each of my shares of KMR is exchanged for 2.4849 shares of Kinder Morgan Inc, this small investment will result in an yield on cost of over 13% at the current rate of $1.76/share. At the $2/share annual dividend that is expected by Kinder Morgan Inc in 2015, that $1,000 investment in 2009 will generate close to $150 or a 15% yield on the amount invested. Not too shabby if you ask me.
As we all know however, Kinder Morgan Management LLC (KMR) is about to stop trading, since its shares will be exchanged for shares in Kinder Morgan Inc (KMI).
A recent example was the purchase of shares in several companies in tax-advantaged accounts such as Roth IRA and Sep IRA. I plan on maxing out the Roth IRA in 2015, and the SEP IRA, along with the 401 (k) and a newly started Health Savings Account. When you get the powers of compounding withing a tax-deferred vehicle, the results are truly spectacular.
Full Disclosure: Long KMR, KMI, KO,
- Kinder Morgan to Merge Partnerships into One Company
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Wednesday, June 18, 2014
Investors need to continually stress test their portfolio assumptions, in order to gauge whether their dividend machine can live up to its full potential in retirement. Investors need to understand if their portfolio would have produced increased income even if no new funds were added or if no dividends were reinvested. This is a very important step in dividend investing for retirement that would ensure that income is growing over time. Growing income is important, in order to maintain purchasing power of your dividend stream. For example, even if inflation was a low 3% per year, your purchasing power declines by 20% in year 7, 40% by year 17 and over 50% by year 24.
My expectation is that my dividend portfolio will deliver a six percent annual dividend increase, without adding any new money. For example, if I had a portfolio yielding 3% today valued at $100,000 I would generate $3,000 in annual income. If I add $6,000 to the portfolio in stocks whose average yield is 3%, I would have increased my dividend income by 6% to $3,180. Without new money, this income stream would lose purchasing power over time, which is a dangerous proposition in retirement. However, if the original stocks this this portfolio yielded 3% but also grew distributions by 6%/year, the distribution would be $3,180 without having to add $6,000 to the portfolio. As you can see, if all things were equal, organic dividend growth could be very valuable weapon in your quest for financial independence, because the internal compounding results in lower needs for capital to be placed in-service into your dividend machine.
In my income portfolio, I always look at my holdings at the end of the year, and then ignore any additions or deletions I made since the beginning of the year. I assume that I didn't add any funds and I also assume I put all dividends received in my checking account. I took a look at my starting portfolios at the end of 2008, 2009, 2010, and 2011 to come up with the following organic dividend growth rates:
I was building out my portfolio throughout 2008, which is the only reason why an organic dividend growth rate was not calculated for that year. In comparison, the dividend income assuming dividend reinvestment and new money addition was much higher.The cuts in General Electric (GE) and State Street (STT) really prevented me from achieving organic dividend growth in 2009. Since I reinvested the funds from the stocks I sold however, my total dividend income increased in 2009, even before accounting for purchases I made.
To summarize, I believe it is important to invest in companies that regularly increase dividends for their shareholders out of the earnings growth their business generates. This results in an increase in dividend income that is much cheaper for the dividend investor, and doesn't require constant reinvestment of dividends in order to keep up purchasing power or increase income.
Full Disclosure: None
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Monday, October 10, 2011
Companies which raise dividends at a high rate could easily generate double-digit yields on cost for investors who bought early and at the right time.
I have highlighted the following dividend champions with the highest consistent dividend growth rates:
Lowe's Companies, Inc. (LOW), together with its subsidiaries, operates as a home improvement retailer in the United States and Canada. The company has boosted distributions for 49 years in a row. Ten year Annual Dividend Growth Rate: 27.60%. Yield: 2.80% (analysis)
McDonalds’ Corporation (MCD), together with its subsidiaries, operates as a worldwide foodservice retailer. The company has increased distributions for 35 consecutive years. Ten year Annual Dividend Growth Rate: 26.50% Yield: 2.80% (analysis)
Raven Industries, Inc.(RAVN), manufactures various products for industrial, agricultural, construction, and military/aerospace markets in the United States and internationally. The company has boosted distributions for 25 years in a row. Ten year Annual Dividend Growth Rate: 18.20%. Yield: 1.50%
Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The company has increased distributions for 37 consecutive years. Ten year Annual Dividend Growth Rate: 17.80% Yield: 2.80% (analysis)
Medtronic, Inc. (MDT) manufactures and sells device-based medical therapies worldwide. The company has boosted distributions for 49 years in a row. The company has increased distributions for 34 consecutive years. Ten year Annual Dividend Growth Rate: 16.90%. Yield: 3% (analysis)
Walgreen Co. (WAG), together with its subsidiaries, engages in the operation of a chain of drugstores in the United States. The company has increased distributions for 36 consecutive years. Ten year Annual Dividend Growth Rate: 16.50%. Yield: 2.50% (analysis)
Sigma-Aldrich Corporation (SIAL), together with its subsidiaries, develops, manufactures, purchases, and distributes a range of chemicals, biochemicals, and equipment worldwide. The company has boosted distributions for 35 years in a row. Ten year Annual Dividend Growth Rate: 15.20%. Yield: 1.10%
Becton, Dickinson and Company (BDX) is a medical technology company which develops, manufactures, and sells medical devices, instrument systems, and reagents worldwide. The company has increased distributions for 38 consecutive years. Ten year Annual Dividend Growth Rate: 14.90%. Yield: 2.10% (analysis)
Target Corporation (TGT) operates general merchandise and food discount stores in the United States. The company has boosted distributions for 44 years in a row. Ten year Annual Dividend Growth Rate: 14.90%. Yield: 2.40% (analysis)
Colgate-Palmolive Company (CL), together with its subsidiaries, manufactures and markets consumer products worldwide. The company has increased distributions for 48 consecutive years. Ten year Annual Dividend Growth Rate: 12.40%. Yield: 2.70% (analysis)
Dividend investing is not an automatic process. Investors should analyze the stocks in detail in order to decide whether they stand a chance of increasing distributions in the double digits over the next decade. Investors should analyze not only quantitative factors such as earnings, dividend sustainability and ROE but also qualitative factors such as business model, competitive advantages, etc.
Full Disclosure: Long MCD, WMT, MDT, WAG, CL, LOW
Wednesday, October 13, 2010
What investors need, is an instrument, or an asset class, that not only provides decent current yields, but also generates an income stream that meets or exceeds inflation over time. One such class is dividend paying stocks. Stocks in general have been mostly flat over the past decade, with the majority of returns coming from dividends. One of the reasons why stocks didn’t perform so well over the past decade is because they were grossly overvalued in 2000. Investors who want to generate income in retirement however should focus only on a select number of companies which have the following characteristics:
1) A history of consistent dividend increases. I prefer companies which have raised dividends for at least ten consecutive years.
2) An adequately covered dividend from earnings. I search for companies where annual earnings per share are at least twice the amount of annual dividends
3) A low price earnings ratio and at least some earnings growth. Overpaying for stocks could turn costly, and lead to low returns over time. I prefer stocks which have a P/E of less than 20.
4) A current yield of at least 2.50%. While some investors see this yield as “low”, they tend to forget that with regular dividend increases, the yield on cost would increase over time. By stacking companies with varying yield and dividend growth characteristics it is possible to create a portfolio yielding 4% where dividend increases match or exceed the rate of inflation.
There are only 300 or so stocks trading on US exchanges that have a history of growing their distributions for at least ten years. By applying a simple screen where P/E ratio is less than 20, the current yield is 2.50% or more and where the dividend is sustainable, investors could end up with a manageable list of stocks for further research.
A sample of seven dividend growth stocks which met these criteria include:
Chevron Corporation (CVX) operates as an integrated energy company worldwide. The company is a dividend achiever, and has consistently raised its dividends for 23 years in a row. Annual dividend payments have increased by an average of 8.30% annually since 2000. Yield: 3.40% (analysis)
The Clorox Company (CLX) engages in the production, marketing, and sales of consumer products in the United States and internationally. The company operates through four segments: Cleaning, Lifestyle, Household, and International. Clorox has paid uninterrupted dividends on its common stock since it was spun out of Procter and Gamble (PG) in 1968 and increased payments to common shareholders every year for 32 years. The company is a member of the elite S&P Dividend Aristocrats Index.Annual dividends have increased by an average of 13% annually since 1999. Yield: 3.20% (analysis)
McDonald’s Corporation (MCD), together with its subsidiaries, operates as a worldwide foodservice retailer. It franchises and operates McDonalds restaurants that offer various food items, soft drinks, coffee, and other beverages. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. Annual dividend payments have increased by an average of 28.20% annually since 2000. Yield: 3.20% (Analysis)
Medtronic, Inc. (MDT) develops, manufactures, and sells device-based medical therapies worldwide. The company operates in the following segments:Cardiac Rhythm Disease Management , Spinal, CardioVascular, Neuromodulation, Diabetes, Surgical Technologies and Physio-Control. This dividend champion has raised distributions for 33 years in a row. The annual dividend payment has increased by 17% per year since 2000. Yield: 2.70% (analysis)
PepsiCo, Inc. (PEP) manufactures, markets, and sells various foods, snacks, and carbonated and non-carbonated beverages worldwide. The company operates in four divisions: PepsiCo Americas Foods (PAF), PepsiCo Americas Beverages (PAB), PepsiCo Europe, and PepsiCo Asia. The company is a member of the S&P Dividend Aristocrat index, after raising distributions for 38 years in a row. Annual dividend payments have increased by 13.60% on average since 2000. Yield: 2.90% (Analysis)
Sysco Corporation (SYY), through its subsidiaries, markets and distributes a range of food and related products primarily to the foodservice industry in the United States. SYSCO Corporation is a dividend champion as well as a component of the S&P 500 index. It has been increasing its dividends for the past 40 consecutive years. Annual dividend payments have increased by an average of 17% annually over the past 10 years. Yield: 3.50% (Analysis)
United Technologies Corporation (UTX) provides technology products and services to the building systems and aerospace industries worldwide. The company is a dividend achiever, and has been consistently increasing its dividends for 16 consecutive years. Annual dividends have increased by an average of 15.80% annually since 2000. Yield: 2.30% (analysis)
It is important to also hold a diversified portfolio of dividend stocks, in order to avoid concentration to particular segments, which could jeopardize dividend income in retirement. As a result holding at least 30 individual stocks representative of the ten industry groups of the S&P 500 makes sense.
Last but not least, while investing in dividend stocks would likely lead to a higher income stream in ten or thirty years, which would be much better than the fixed income from US Treasuries, dividend investing still has its risks. One of the biggest risks for dividend investors is that companies could cut or eliminate dividend payments. A diversified portfolio of stocks would soften the blow to total dividend income of course. However there have been times like during the Great Depression, when most companies cut dividends substantially. During those times investments in government bonds produced not only decent income, but also decent total returns as well. In addition to that, investors in Japan in the 1990’s were also faced with low yields on the long term government bonds. However this was a much wiser investment than buying Japanese stocks as represented by the Nikkei 225 index.
While dividend stocks would likely do much better than US Treasuries, investors should understand risks of dividend paying stocks before investing. This could provide them with the edge against investors who chase unsustainable yields and overpay for income streams.
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- The case for dividend investing in retirement
Wednesday, September 15, 2010
Before we begin with yield on cost, it is important to understand how current dividend yield is calculated. By dividing the annual dividend payment by the stock price, one gets the current dividend yield. For example Wal-Mart (WMT) trades at $49.43, and pays a dividend of $1.21/share. As a result the current dividend yield is 2.50%. Given the fact that the company has raised dividends for over 36 years however, to the novice investor this might not look like a big achievement. After all, it is easy to purchase a high yielding master limited partnership such as Kinder Morgan (KMP) and get a yield which is almost three times the amount of yield one could generate by purchasing Wal-Mart (WMT) stock.
The truth is that today’s investor will generate 2.50% dividend yield over the next year. In other words an investor who puts $100 in Wal-Mart (WMT) today will generate $2.50 in annual dividend income. As a result if the price of Wal-Mart (WMT) doubles from here, but the dividend payment remains unchanged, our investor will keep receiving $2.50 in annual dividend income, despite the fact that current yield would be 1.25%. What the current yield doesn’t tell is what the yield on cost over the next year or decade is going to be. If the price of Wal-Mart (WMT) stock doubles over the next decade, but the dividend payment doubles as well, the current yield would likely stay around 2.50% in ten years. The yield on cost of the original investor with the $100 investment would be a cool 5%. Most novice investors in ten years would likely still ignore Wal-Mart (WMT) because of its supposedly low yield, while missing the important fact that rising dividends will lead to rising yield on cost over time.
The investor who purchases stocks with yield on cost in mind will be able to generate yields on cost on his original investment that will be much higher than the current yields on even high yielding stocks such as mortgage reits American Capital Agency (AGNC) or Hatteras Financial (HTS), with just a fraction of the risk. The key component is selecting stocks with strong competitive advantages, which grow earnings and could therefore grow distributions. Last but not least, investors should also allow some time in order to generate high yields on cost. Some dividend investors prefer waiting for a decade before attaining an yield on cost of 10%. Others, myself included, simply focus on finding strong companies with long histories of dividend growth, and let yields on cost increase for the maximum periods of time possible, without setting any targets. Needless to say, purchasing high quality dividend stocks is more of an art than science. By focusing your attention on such lists as the dividend achievers or the dividend aristocrats however, dividend investors have a high chance of succeeding in their quest for growing income.
Most of the original dividend aristocrats were able to achieve substantial yields on cost for a period of 20 years. Even those that managed to freeze distributions were able to generate high yields on cost over time, in addition to generating capital gains as well.
Colgate Palmolive (CL) was deleted in the index in 1990 for no apparent reason. According to yahoo finance the company increased its distributions in 1989. In addition to that the company’s own web page claims that it has increased payments to common shareholders every year for 46 years. One dollar invested in CL in 1989 would have turned out to $16.94 with dividends reinvested. The yield on cost is 27.70%. (analysis)
Johnson & Johnson (JNJ), which recently announced its 47th consecutive annual dividend increase, is still part of the index. A dollar invested in JNJ in 1989 would have turned out to $10.84 with dividends reinvested. The yield on cost is 26.4%. (analysis)
Lowe’s Companies (LOW) is still a component of the index after 20 years. The company has increased its dividends for 47 consecutive years. A dollar invested in MAS in 1989 would have turned out to $25.40 with dividends reinvested. The yield on cost is 39%.
Procter & Gamble (PG) is one of the original 26 members still present in the index. The company has raised dividends for over 53 consecutive years. A dollar invested in PG in 1989 would have turned out to $9.05 with dividends reinvested. The yield on cost is 20%. (analysis)
Coca Cola (KO) is still a member of the dividend aristocrat’s index. The company has increased its dividends for 47 consecutive years. A dollar invested in KO in 1989 would have turned out to $7.15 with dividends reinvested. The yield on cost is 17%. (analysis)
As for Wal-Mart (WMT), investors who purchased shares 26 years ago when it became a dividend achiever received a paltry yield of 0.60% at the end of 1984. Split adjusted the shares ended $1.18 that year. The yield on cost on those investors would be over 100% today. For an investor who purchased the stock when it reached the status of a dividend champion in 1999 however, the yield was still paltry at 0.30%, but the price was steep at $69.12/share. Eleven years later their shares are yielding 1.80% on cost, while their shares are still underwater. So while a lot of money could be made with the dividend growth strategy, investors should not overpay for stocks today. (analysis)
This goes to show that a company could achieve high growth rates, while still being able to pay increasing dividends.
Full Disclosure: Long all stocks mentioned above
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Monday, July 12, 2010
Since 2003 there has been great interest in dividend paying stocks. Many companies such as Yum Brands (YUM) initiated dividends for the first time ever, while companies like Microsoft (MSFT) paid onetime special dividend payments to shareholders. In addition to that several dividend focused exchange traded funds such as iShares Dow Jones Select Dividend index (DVY) and SPDR S&P Dividend (SDY) were formed, attracting millions in assets under management. In addition to that many long time dividend payers such as PepsiCo (PEP) started increasing distributions at a higher pace than before, which further benefited their shareholders.
As a result, some dividend investors are concerned that the increase of tax rates on dividends will negatively affect payouts, which would negatively affect dividend stock prices for the next few years. In general the future tax rates on investment income for 2011 and beyond are still not set in stone by Congress, which makes most assumptions on taxation of dividends or capital gains pure speculation. It is possible that the top rate on dividend income could only increase to 23.60%, as 20% was the highest tax on dividend income for which Obama campaigned in 2008, while the 3.60% comes as the extra tax for high income earners which generate investment income.
So should dividend investors worry about the potential increase in taxes on dividend income? The answer is that it depends. While some companies might cut dividends as a result of the tax hike, many dividend payers would keep following a strategy of regularly raising distributions, provided that these companies can generate enough in free cash flow. Most dividend growth investors would not be affected by much, particularly since most dividend achievers and dividend aristocrats have increased distributions for over 10 and 25 years, which was before the Bush tax cuts were initiated. The companies that are less likely to cut distributions than grow them include:
Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide.Johnson & Johnson is a major component of the S&P 500, Dow Industrials and the Dividend Aristocrats Indexes. One of the company’s largest shareholders includes Warren Buffett. JNJ has been consistently increasing its dividends for 48 consecutive years.(analysis)
McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. (analysis)
The Procter & Gamble Company (P&G), together with its subsidiaries, provides branded consumer goods products worldwide. The company operates in three global business units (GBU): Beauty, Health and Well-Being, and Household Care. Procter & Gamble is a dividend aristocrat as well as a component of the S&P 500 index. One of its most prominent investors includes the legendary Warren Buffett. Procter & Gamble has been increasing its dividends for the past 54 consecutive years. (analysis)
Wal-Mart Stores, Inc. (WMT)operates retail stores in various formats worldwide. The company is member of the S&P 500, Dow Jones Industrials Average and the S&P Dividend Aristocrats indexes. Wal-Mart Stores has consistently increased dividends every year for 36 years. (analysis)
The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. The company is member of the S&P 500, Dow Jones Industrials and the S&P Dividend Aristocrats indexes. Coca-Cola has paid uninterrupted dividends on its common stock since 1893 and increased payments to common shareholders every year for 48 years. (analysis)
Exxon Mobil Corporation (XOM) engages in the exploration, production, transportation, and sale of crude oil and natural gas. The company is a component of the S&P 500, Dow Jones Industrials and the Dividend Aristocrats indexes. Exxon Mobil has been consistently increasing its dividends for 28 years in a row, and has paid dividends for over one hundred years. (analysis)
In addition to that, investors could avoid paying taxes on dividend income by investing through tax-deferred accounts such as the ROTH IRA. There is a contribution limit of $5000 for taxpayers, and there is also an additional catch up contribution for taxpayers over the age of 50. Those contributions should come from earned income (such as employee income) and are phased out for high income individuals. While a ROTH IRA would not generate any tax savings today, any money put in it compound tax free forever, there are no required minimum distributions and any distributions from it are tax free.
Furthermore I doubt that quality dividend stocks such as the dividend achievers or dividend aristocrats would be affected much even if tax rates increase, because not every individual would pay top rates on dividend income. In addition to that dividend returns are much less volatile than stock price returns, which is the reason why retirees prefer dividend stocks in retirement. Focusing too much on just one aspect of the investment process could lead to subpar returns over time. Many investors who wait for a few months longer before they sold their stock in order to qualify for long-term capital gains treatment could see their paper gains evaporate and turn into massive losses. This is just one reason why focusing just on tax rates while ignoring business or market fundamentals of the companies one is invested in is a dangerous exercise.
Full Disclosure: Long all stocks mentioned except MSFT
This article was featured on the Carnival of Money Stories – Starting A Sideline Edition
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Wednesday, May 19, 2010
The payback that these investors are targeting is mostly from the dividend income stream in order to estimate how long it might take to get their money back. Dividend payback is just that – how long it would take for the dividends from a stock investment to exceed the investment itself. Savers have two options – either go for a higher yielding but slower growing company or go for a stock with a lower current yield but has a huge dividend growth potential.
I compared the two strategies using a few stocks in my portfolio to illustrate my examples. In the first example I used electric utility Con Edison (ED). Right now the company is yielding 5.40%, which means that an investment in the company today could pay off for itself in 19 years. This estimate assumes limited dividend growth for the next two decades. I calculated it by dividing 100 by the current yield in order to come up with the number of years that it would take for the dividend checks to pay me back for the stock.
Based on this exercise, one might believe that in order for dividend checks to pay for the stock in the shortest amount of time possible, one should go for the high dividend stocks of the day. However even a small growth of 1% in the dividend payment however could shorten the time for the dividend payback to seventeen and a half years. If you are able to reinvest your dividends in the company, the payback would probably be even quicker.
That’s why I checked other stocks like Johnson & Johnson (JNJ) in order to estimate whether a low yield of 3% coupled with a dividend growth of 10% annually makes a difference. It seems that for an investment like that it would take fifteen and a half years in order to achieve a dividend payback. In fact if you had purchased Johnson & Johnson in 1994, the dividend income stream would have paid for the stock by 2009, without even reinvesting the dividends. The cost on your investment would have been returned to you, yet you would still maintain ownership.
Being a balanced investor I have highlighted six stocks which I believe would achieve a dividend payback of fifteen years. Some of the stocks mentioned below are high dividend stocks, while others are dividend growth stocks with good potential.
Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates through three segments: Consumer, Pharmaceutical, Medical Devices and Diagnostics. Johnson & Johnson has consistently increased dividends for 46 years in a row. The stock yields 3.40%. The yield on cost on stock purchased at the end of 1989 is 29.10%. (analysis)
The Procter & Gamble Company (PG) engages in the manufacture and sale of consumer goods worldwide. The company operates in three global business units (GBUs): Beauty, Health and Well-Being, and Household Care. The company has rewarded stockholders with dividend increases for 53 consecutive years. Check my analysis of the stock.
Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The world’s largest retailer has a 35 year record of annual dividend raises. I would be a buyer of WMT on dips. Check my analysis of the stock.
McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. The company's share of the US fast food market is several times larger than its closest competitors, Burger King (BKC) and Wendy's (WEN). McDonald’s is a major component of the S&P 500 and Dow Industrials indexes. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. (analysis)Consolidated Edison (ED) provides electric, gas, and steam utility services in the United States. This dividend aristocrat has raised annual distributions for 36 years in a row. The stock spots a yield of 5.3%, which a good compensation if you seek current income for the next 5 - 10 years. Check my analysis of Consolidated Edison.
Kinder Morgan (KMP) owns and manages energy transportation and storage assets in North America. This dividend achiever has raised annual distributions for the past 14 years. The stock currently yields 6.50%. Check my analysis of Kinder Morgan.
Full Disclosure: Long ED, JNJ, KMP, MCD, PG, WMT
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- Inflation Proof your income in retirement with Dividend Stocks
- Living off dividends in retirement
Wednesday, April 7, 2010
After looking at my portfolio, I have been able to identify three types of dividend stocks.
The first type is high yield stocks with low to no dividend growth.
Realty Income (O) (analysis)
Enbridge Energy Partners (EEP)
Kinder Morgan Partner (KMP) (analysis)
Consolidated Edison (ED) (analysis)
It is important not to fall in the trap of excessive high yields, caused by the market’s perceptions that the dividend is in peril. Recent examples of this included some of the financial companies such as Bank of America (BAC). While current dividend income is important, these stocks would produce little in capital gains over time.
The second type is low yielding stocks with a high dividend growth rate.
Wal-Mart (WMT) (analysis)
Aflac (AFL) (analysis)
Colgate Palmolive (CL) (analysis)
Archer Daniels Midland (ADM) (analysis)
Family Dollar (FDO) (analysis)
One of the issues with this type of strategy is that it might take a longer time to achieve a decent yield on cost on your investment. It is difficult to achieve a double digit dividend growth rate forever. Once you achieve an adequate yield on cost on your investment, it might slow down dividend increases. The positive side of this strategy is that many of the best dividend growth stocks such as Wal-Mart (WMT) or McDonald’s (MCD) never really yielded more than 2%-3% when they first joined the Dividend Achievers index. The main positive of this strategy is the possibility of achieving strong capital gains.
The third type is represented by companies with an average yield and an average dividend growth. Some investors call this the sweet spot of dividend investing.
Johnson & Johnson (JNJ) (analysis)
Procter & Gamble (PG) (analysis)
Clorox (CLX) (analysis)
Pepsi Co (PEP) (analysis)
Automatic Data Processing (ADP) (analysis)
There is a common misconception that buying the stocks in the middle, would produce average returns. Actually finding stocks with average market yields, which also produce a good dividend growth could produce not only exceptional yield on cost faster, but also capital gains as well.
At the end of the day successful dividend investing is much more than finding the highest yielding stocks. It is more about finding the stocks with sustainable competitive advantages which allow them to enjoy strong earnings growth, which would be the foundation of sustainable dividend growth. A company like Procter & Gamble (PG) which yields almost 3% today butraises dividends at 10% annually would double your yield on cost in 7 years to 6%. A company like Con Edison (ED) would likely yield around 6% on cost in 7 years. The main difference would be capital gains – Procter & Gamble (PG) would likely still yield 3%, while Con Edison (ED) would likely yield 6%. Thus the investor in Procter & Gamble would have most likely doubled their money in less than a decade, while also enjoying a rising stream of dividend income.
Full Disclosure: Long all stocks mentioned in the article except HTS and AGNC
This article was included in the Carnival of Personal Finance #252: Famous People With Tax Troubles Edition
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Wednesday, February 10, 2010
Let’s illustrate this with an example. Abbott Labs (ABT) is a dividend aristocrat which has raised distributions for 37 years in a row. It yields 3% right now, but has a ten year dividend growth rate of 9%. At this rate the company would double its dividend every 8 years. The growth has slowed over the past decade however – since 1983 the dividend growth was almost 13.1% per annum. The stock yielded 2.2% in 1983, which was hardly under the radar of any yield chaser. In fact the current yield at year-end for Abbott fluctuated between a low of 1.20% in 1998 and a high of 2.89% in 2009. The visionary investor who purchased Abbott at the end of 1983 achieved a yield on cost of 10% in 1992 in addition to holding onto a five-bagger. Twenty six years later this investor would have achieved a yield on cost of 55%, which is something that even the highest yielding stock out there cannot match.
Other companies which have a long history of raising dividends while also delivering a strong dividend growth, plus being attractively valued at the moment include Johnson & Johnson (JNJ) and Clorox (CLX).
Johnson & Johnson (JNJ) has raised distributions for 47 years in a row. The company has achieved a 10 year dividend growth rate of 13.30%. The latest dividend increase was 6.50% in 2009. The dividend payout ratio is at 43%, which makes it adequately covered. Check my analysis of the stock.
Clorox (CLX) has boosted dividends for 32 consecutive years. The company has achieved a ten year compound dividend growth rate of 9.60%. The company last raised its payout by 8.7% in 2009. Its dividend payout is at 50% right now, which means that the dividend is well-covered from earnings. Check my analysis of the stock.
Full Disclosure: Long ABT, CLX and JNJ
Wednesday, November 18, 2009
Great investors have goals and strategies are only the tools that help them accomplish their targets. My goal is to generate a rising stream of dividend income, which would allow me to leave the rat race and spend my time doing worthwhile things like education and charity and self-development.
By focusing on dividend growth, I am trying to pick the stocks, which have solid competitive advantages, whose revenues are relatively recession proof but could still grow earnings by innovation, acquisitions, and buybacks. Historical inflation rates have been around 3% for the US over the past one century. Thus, by focusing on companies, which have a long history of dividend increases of over 3%, I would create an inflation proof source of income.
In addition to that, if my stock picks raise dividends faster than the rate of inflation, I would be able to achieve very good yields on cost in the process. A company, which yields only 3% or 4%, might be scoffed at by yield chasing gurus, who wouldn’t even consider a stock unless it yields 8% or 10%. Those yield chasers might get the 10% yield now, but the cost of dividend cuts or no dividend increases makes chasing high yielding stocks a dangerous exercise with negative effects on wealth building.
At the same time a company that yields only 3% or 4% now, but grows its dividend payments at 12% annually, could generate a yield on cost of 6% to 8% in 6 years and yields on cost of 12% to 16% in 12 years. These companies exist in the market. It only takes an attentive dividend investor to uncover them. Examples of such companies are
Johnson & Johnson (JNJ) has regularly hiked dividends for 47 years in a row. The ten-year average dividend growth for the producer of Neutrogena, Tylenol and Remicade is an impressive 13.30% annually. (analysis)
Procter & Gamble (PG) has rewarded shareholders with dividend raises for 53 consecutive years. This consumer good juggernaut has managed to increase distributions at a rate of 10.70% annually over the past decade. (analysis)
Pepsi Co (PEP) has increased its dividends for 37 consecutive years. The producer of Pepsi Cola, Mountain Dew, Lays and Doritos has delivered a 12.80% average dividend growth annually over the past decade. (analysis)
McDonald’ s (MCD) has increased its dividends for 32 consecutive years. The worlds largest fast food chain has boosted dividends by an average of 27.30%/year over the past decade. (analysis)
I believe that even in 20 years people would still have a need to eat, drink, shower, shave and take pills. I would bet that even in 20 years people would still shop at McDonald’s – if not for their burgers then for the salads or whatever food sells the best.
Over time a portfolio of carefully selected dividend growth stocks could not only deliver a consistently increasing stream of dividend income which increases faster than inflation, but could also deliver outstanding total returns. Over the past fifteen, ten, five, three or one years, the dividend achievers index has outperformed the S&P 500. (source Mergent's)
The dividend achievers index consists of US stocks traded on NYSE, NASDAQ or AMEX, which have increased annual regular dividends for at least the past ten consecutive years. This index is a great shopping list for novice dividend investors. Even Peter Lynch, the famous manager of the Fidelity Magellan Fund, which outperformed the S&P 500 by a significant margin in the 1980’s, said : "The Dividend Achievers Handbook is one of my favorite bedside thrillers. Here's a simple way to succeed in Wall Street: Buy the stocks on Mergent's list and stick with them as long as they stay on the list"
As a dividend growth investor my primary objective is growth in dividend income without losing too much of my capital in the process. Capital appreciation is second of importance. I believe that if my portfolio generates enough dividend income for me, I would not have to rely on selling 4% of my portfolio at depressed prices in order to live off my investments.
Full disclosure: Long MCD, JNJ, PG and PEP
This post was featured on the Carnival of Personal Finance #234 – Weirdest Toy Crazes Edition
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Wednesday, October 7, 2009
The main problem with such attitude however is that it could cause investors to throw their carefully researched strategies out of the window and engage in careless speculating. This could cause severe losses of capital over time.
Investors have suffered two major blows over the past decade – the tech stock crash in 2000-2002 and the financial meltdown in 2007-2008. The first occasion was a complete euphoria for anything related to technology or dot coms. College dropouts were selling stock of their money losing eyeballs attracting online ventures in IPOs, which were valued at billions by Mr. Market. Needless to say the tech boom turned into a bust that left millions of investors suffering tremendous losses. Even investors in great companies such as Microsoft (MSFT) and Intel (INTC), which were enjoying double digit revenues and earnings growth even after the meltdown, suffered huge losses because they overpaid for future growth.
The financial meltdown was characterized by investors who were holding on to safe income investments such as Bank of America (BAC), Citigroup (C) and General Electric (GE), which had a long history of consecutive dividend increases. As these stocks began their slide, they cut their distributions and had to take billions in aid from the federal government. Investors who kept a cool head and didn’t chase high yielding stocks blindly, right before they cut their dividends would have saved a lot of precious capital to be used for later.
The point being taken is that entry price paid for stocks does matter. If you mindlessly reinvest dividends or dollar cost average your way into an index fund you would end up paying top dollar for the inflated future income stream from these investments. Thus, having strict entry criteria might prevent you from chasing hot stocks and losing a lot in the process. This entry criteria could also prevent you from investing in companies, simply because you like their brand or your hope that their business would turn up for the better. Even great brands such as Johnson & Johnson (JNJ) or Procter & Gamble (PG) were not good buys when they traded at more than 20 times earnings and yielded only 1% in the early 2000s. There were other companies, which yielded much more than that and traded at lower price to earnings multiples that should have been on investors’ radars. It is better to sit in cash than overpay for stocks and then have to wait for a decade before you start generating any meaningful return on your investments.
One also needs to have a sell policy, which lets you out of a losing position no matter what. When one buys a stock because it pays a stable dividend, it does not make sense for them to hold onto the stock if the company eliminates its streak of 30 consecutive distribution increases while citing the weak economy. When you take the loss, you would start thinking more clearly. If you hope that it would turn better, you would lose money in the process. When Citigroup (C) cut its dividends for the first time on January 15, 2008 the stock closed at $26.94. Investors who sold at the time would have saved themselves from huge losses in the process.
At the end of the day, only the disciplined dividend growth investor who is careful not to overpay for stocks, and has the discipline to sell when some of his criteria are no longer intact, would be able to generate a sufficient income stream for their future needs.
Full Disclosure: Long JNJ and PG
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- Bank of America (BAC) Dividend Analysis
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- When to sell my dividend stocks?
Friday, October 2, 2009
US Bancorp’s (USB) CEO is reviewing the company’s dividend payout, after it paid off $6.6 billion in TARP money back to the US Treasury."You will see us take action in the near-term that will be favorable," to the dividend, the company’s CEO said. The company cut dividends in March by 88% and is currently paying a quarterly dividend of 5 cents/share.
BB&T’s (BBT) President and CEO Kelly King informed shareholders the bank will "revist dividend level as soon as appropriate". The company cut its dividend by 68% in May 2009 in order to be able to repay the US Treasury. In addition to that the Winston-Salem, North Calorila based banking institution sold $1.5 billion in stock.
JP Morgan’s (JPM) CFO was a little less optimistic about the future dividend prospects of his company, citing that the company’s goal is to restore dividend only if economy doesn't "double dip". Despite the fact that he is still cautious on restoring the dividend, the CFO said the bank could raise its dividend to $0.75-$1.00/share. The company cut its dividend by 87% to 5 cents/share in February 2009.
Analysts are also expecting Pfizer (PFE) to increase dividends as well in the near future. Deutsche Bank analysts expect Pfizer Inc to increase its dividend in December. Deutsche Bank sees an increase of 15 percent to 25 percent. Pfizer cut its dividend by 50% in January in an effort to conserve cash in order to pay for its acquisition of Wyeth (WYE).
While I am generally very skeptical about companies which cut distributions, I view companies that begin raising distributions within a year of the cut very positively. It is too early to get excited about the companies listed above however. As long as they fail to actually increase distributions by sending bigger checks to shareholders, then the prospect of them raising dividends is a pure speculation.
Full disclosure: None
- BB&T Corporation (BBT) Stock Dividend Analysis
- Should you sell after a dividend cut?
- Is Pfizer (PFE) a value trap for investors?
- US Bancorp (USB) cuts its dividend by 88%
Wednesday, September 30, 2009
Utilities typically pay out a large portion of their earnings as dividends, which explains their slow dividend growth and high dividend yields. Most utilities operate as natural monopolies, which guarantees almost no competition in their specific geographic areas. It would be very costly to run two separate electrical grids, and such investment could take many decades to pay off. Thus utilities tend to generate stable earnings and revenues in any economic conditions, as people keep using water, gas and electricity in their daily lives no matter what.
A main risk factor for many utilities is government legislation in regards to greenhouse gases, which could increase their costs over time. Such legislation could force utilities to purchase CO2 pollution allowances, which could cut into earnings. The heavy government regulation could be the driving force behind future growth however. A recent phenomenon has been the smart grid initiative.
The smart grid initiative integrates information and communication technology into electricity generation, delivery, and consumption, making systems cleaner, safer, and more reliable and efficient. While it would be costly to modernize electric grids, there is some stimulus available from the department of energy. The department of energy plans to distribute $3.9 billion in Recovery Act funds for smart grid projects through two funding opportunities. The first provides $3.3 billion for deploying and implementing smart grid technologies across the country. The second provides $615 million for smart grid pilot projects. (Source: Yahoo Finance)
Because of the stability of their cash flows, utilities could afford increasing their dividends for long periods of time. Most utilities that I have stumbled upon have had a history of dividend increases, followed by a steep dividend cut, which is then followed by another string of dividend increases. More often than not however, dividend cuts in the Utilities Sector are followed by dividend increases for several years until the dividend payment reaches or exceeds the previous levels. Because of this cyclical nature of utility dividends I view the sector as more suitable for current income generation that for solid dividend growth. Thus for a younger investor who has more than 2 decades until they plan on living off their dividend income in retirement, I would not recommend a high exposure to utilities.
While current yields on utilities tend to be higher than the yields on S&P 500, dividend growth is much slower, which could erode the purchasing power of your utility dividend income over time. I view utilities stocks similarly to fixed income, as they are very sensitive to interest rates and have stable distributions.
Utility stocks typically lag during strong bull markets as investors chase higher growth prospects. In flat or bear markets however utility stocks do not decline as much and they are further helped by their generous dividend yields.
While it is true that some utilities don’t have a strong history of raising distributions, there are several utilities, which have raised their distributions for more than 25 consecutive years, and thus are part of the dividend champion’s list:
It is important to look at the dividend payout ratios, the EPS trends and the EBIT to interest expense ratio in order to gauge the sustainability of the dividend payment over time. The EBIT to interest expense or coverage ratio is an important indicator which shows whether utilities could afford servicing their debt obligations. While some investors focus only on the debt to asset ratios, I view the ability to service interest payments as an important factor that shows how sustainable the company’s ability to operate as a going concern actually is.
Because of the slow dividend growth, I would not consider initiating a position in utilities stocks yielding less than 4% to 5%.
Full Disclosure: Long ED
This post was included in the :The Carnival of Personal Finance #226 – The AFM Turn’s 5 Edition
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Wednesday, September 23, 2009
First, while typical fixed income securities provide a dependable income stream, its purchasing power is typically eroded by inflation. Even at 3% per annum, the purchasing power of one dollar decreases by 50% in 24 years. Double that inflation rate to 6% annually and now the purchasing power of one dollar is down by 50% in 12 years and by 75% in 24 years. Stocks that pay rising dividends provide the best inflation proof source of income. Dividend based distributions can grow, interest based distributions usually don't. Unless interest income is reinvested, the interest income cannot grow over time to compensate for the eroding value of inflation.
Second, right now qualified dividend income is taxes at 15% for the highest tax bracket in the US, which is almost half the top tax for interest income in the States. In Canada dividend income also received a preferential treatment relative to fixed income.
Third, bonds typically don’t increase their interest payments if the business is doing well. Stocks, which represent partial ownership of companies, tend to share higher profits with shareholders either through dividend increases or through stock buybacks. Thus stocks tend to provide higher total returns over time as they could provide higher capital gains and higher dividend incomes.
Stocks have disadvantages as well however.
First, if a company goes under and declared bankruptcy, fixed income holders are the only ones that get at least some return of their investment. Stockholders on the other hand typically receive nothing when the company emerges from bankruptcy.
Second if a company faces financial difficulties it could easily afford to cut or eliminate its dividends, but it would have to go through huge hurdles before it could get bondholders to agree to reduce or eliminate their interest payments.
Fixed income securities guarantee a return of your investment some time in the future, whereas stocks don’t provide that.
That being said I do believe that the best strategy for long-term investors is to have an allocation to both stocks and bonds. Fixed income tends to provide dependable income even in the worst bear markets. In addition to that fixed income investments provide diversification in bear markets and are the only asset to provide returns to investors during deflationary periods.
Stocks are great vehicles to own during average and high inflationary periods, and they could provide investors with rising inflation adjusted streams of dividend income over time. There are companies which have long records of raising their distributions. The possibility of receiving rising dividends from stocks, make equities a preferred method of investment for many investors. Some early holders of stocks like Johnson & Johnson (JNJ), Exxon Mobil (XOM), and Altria (MO) are now enjoying double or even triple digit yields on cost on their original investments, even without reinvesting their dividends. Similar investments even in the safest highest yielding fixed income securities would still be generating the same incomes, provided that they have not matured.
Currently I like several dividend stocks, which have the best prospects to grow their distributions over time.
Johnson & Johnson (JNJ) has increased dividends for 47 consecutive years. Johnson & Johnson engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Check my analysis of the stock.
Mcdonald’s (MCD) has increased dividends for 32 consecutive years. McDonald’s Corporation, together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. Check my analysis of Mcdonald’s.
Chevron (CVX) has increased dividends for 22 consecutive years. Chevron Corporation operates as an integrated energy company worldwide. Check my analysis of Chevron.
Abott Labs (ABT) has increased dividends for 37 consecutive years. Abbott Laboratories manufactures and sells health care products worldwide Check my analysis of the company.
Clorox (CLX) has increased dividends for 32 consecutive years. The Clorox Company manufactures and markets a range of consumer products Check my analysis of the stock.
Full Disclosure: Long ABT, CLX, CVX, JNJ, MCD, MO
This post was featured on the Carnival of Personal Finance #225- Planning Winter Edition
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