Showing posts with label dividend income. Show all posts
Showing posts with label dividend income. Show all posts

Thursday, April 18, 2013

The right time to sell dividend stocks

With the market hitting fresh 17 month highs, investors have to look hard in order to find attractively valued opportunities. Plenty of stocks such as Aflac (AFL), Emerson Electric (EMR), 3M (MMM) and Realty Income (O) ,which in early 2009 rewarded enterprising dividend investors with their highest yields in a decade, are now yielding much less. Many stocks are also trading at rich valuations, which suggests that investors these days are willing to pay a premium for future growth.

The rapid increase in prices since March 2009 lows has many dividend investors wondering whether they should lock in some or all of their gains today. Investors who were able to purchase stocks in 2008 and 2009 might be sitting at gains, which seem equal to the dividend payments they could expect from a stock for several years to come. The issue with this thinking is that dividends typically increase over time on average while cash in the bank typically loses its purchasing power over time. As a result the investor who takes profits today might lose on any increases in dividends as well as on any future price gains. They would also have to find a decent vehicle to park their cash, which is getting harder and harder to find these days.

Because of the reasons stated above I would not consider selling even if my position went up 1000%. It would not be a wise idea to sell a stock which was purchased as a long term holding and its business hasn’t changed much. What is important is that the original yield on cost that has been locked with the purchase in 2008 or 2009 is there to stay, as long as the dividend is at least maintained. I would only consider selling when the dividend is cut. If a stock you purchased had a current yield of 8%, your yield on cost of is 8%. The nice part about this is that you keep receiving 8% on your original cost as long as the dividend is maintained. Then it doesn't really matter if the stock is currently yielding 1% or 2% - you still earn 8% on your cost. If the dividend payment is increased then your yield on cost rises as well. Companies like Johnson & Johnson (JNJ) or Abbott Labs (ABT) for example have low current yields of 3%, but their growing dividend payments produce substantial yields on cost over time.

If you were thinking of selling a stock which generates great yield on cost, you should remember that currently the market is overvalued. But the market could keep getting overvalued for a far longer period than you or I could remain sane. Retirees need income, and in the current low interest environment dividend stocks seem to be the perfect vehicle for an inflation adjusted source of income in retirement.

Back in the late 1980s Procter & Gamble (PG) yielded less than 3% for the first time in decades, which was much lower than the 4% average yield that investors received in the mid 1980s. In early 1991 the stock traded at 10.50, yielded 2.40%, and paid 6.25 cents/quarter. Although bonds yielded at least three times what P&G yielded at the time, they couldn’t provide rising income payments and the possibility for high capital gains as well. By early 1994 Procter & Gamble stock increased to $14, after a 2 to 1 stock split, paid 8.25 cents/quarter and yielded 2.20%. In early 1999 Procter & Gamble traded at $46.50 and had split 2:1 in 1997. The company paid out 14.25 cents/share but yielded only 1.30%. The yield on cost for the early 1991 investor was a more comfortable 5.50%. Fast forward to 2010 and Procter & Gamble is trading close to $64 and yielding 2.80%. The yield on cost on the original 1991 purchase is 16.80%. This example goes on to show that selling Procter & Gamble (PG) when it became overvalued, was not a very good idea, because the company kept generating higher earnings and kept increasing its dividend payment. While investors could have found other stocks to reinvest Procter & Gamble (PG) dividends or allocate any new cash, they would have been well off simply holding on to Procter & Gamble (PG) and other dividend raisers despite them being overvalued for extended periods of time.

Right now Procter & Gamble (PG) looks like it could again stay below 3% for the foreseeable future. This time I am planning on adding to my position around $59 ,even though it is not exactly trading at a 3% yield.

Full Disclosure: Long ABT, AFL, EMR, JNJ, MMM, O, PG

Note to Readers: This article was originally published on March 24, 2010. The basic ideas behind it however are still valid, three years later.

Relevant Articles:

- Is now the time to sell your dividend stocks?
- The right time to buy dividend stocks
- Best Dividends Stocks for the Long Run
- Dividend Investors are getting paid for waiting

Wednesday, September 29, 2010

Another reason for companies to pay dividends

I am a firm believer that companies that pay dividends by default represent an elite group of sound enterprises which should comprise an investor’s watchlist for further research. The second criterion should be focusing on fundamentals in order to determine whether the company could afford to not only generate enough cash to grow and maintain its business, but also to be able to distribute any excess to shareholders in the form of dividends. The third criterion that I use is that the company has been able to grow distributions for at least ten consecutive years. These criteria pretty much decrease the list of eligible dividend stocks to less than 300.

Nonbelievers of dividend investing often claim that only poorly managed companies or companies which are in decline tend to pay dividends. This group of investors often is under the false belief that a company will be able to reinvest all of its earnings back into the business, while achieving high incremental returns on investment. The problem with this strategy is that in the real world of corporate governance, it is extremely difficult for companies to reinvest all of their earnings back into the business and still maintain high profitability on any excess reinvested dollars. This is because of constraints in the utilization of these assets, management’s desire to build an empire at all costs, expensive acquisitions, bad timing of capital allocations and simply because not all investments are guaranteed to earn a profit. Warren Buffett is often cited as the type of manager who has been able to allocate funds to profitable ventures, and thus has avoided paying dividends to shareholders of Berkshire Hathaway. The only issue with this analogy is that unfortunately few CEO’s have the business acumen of the Oracle of Omaha who built a small struggling textile mill into a diversified conglomerate with a market cap of over $200 billion.

The main issue with the Warren Buffett analogy however is that while he doesn’t like paying dividends to Berkshire Hathaway (BRK.B) shareholders he does enjoy investing in companies that pay dividends. Some of the top holdings of Berkshire Hathaway pay over $1.5 billion in dividends, not including the preferred dividends from Goldman Sachs (GS), General Electric (GE) and several other firms. In his 2007 letter to shareholders he explained the best type of business to own:

We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion. All of that, except for the $32 million, has been sent to Berkshire. After paying corporate taxes on the profits, we have used the rest to buy other attractive businesses.

As seen above however, few companies can do this for extended periods of time. Most companies keep growing for a while, after which they are bound to generate excess cash flows, which fills their coffers. After a while this extra cash is bound to be misspent, the same way that many individuals in the US recklessly spend their income on things they don’t need. Some examples include Vivendi, which was transformed from a sleepy water utility into a media conglomerate through expensive acquisitions that almost bankrupted the company. Incidentally the water utility operations were spun off in early 2000s as Veolia (VEO) and they have outperformed the media empire they created.

Other examples of companies with extra cash that spent too much on projects that didn’t generate much in excess returns include Microsoft (MSFT), which has been able to dominate any technology for over two decades. The main driver of its earnings growth in the meantime however continue being the Windows operating system. Even tech giant Google (GOOG) was misallocating cash in 2007 when it announced the $30 million Google Space program.

Typical companies that don’t pay dividends besides new companies in existence for less than a decade, include either firms that need to reinvest all of their earnings back into the business in order to maintain their business or companies that are so weak that they cannot afford to pay dividends. The first type will generate returns to shareholders only if someone buys the business at a premium. If they do all the work and all they could show at the end of the year after all the work has been done is no more cash than what was in the coffers at the beginning of the year, then intelligent investors should definitely ignore them. Technology companies generally fall into this category, because of rapid product obsolescence, competition and weak consumer loyalty. While Altavista and Yahoo (YHOO) were popular internet search engines in the late 1990’s, Google (GOOG) was able to overthrown them by offering a better solution to customers. The second type of business that cannot afford to distribute any cash because of its inherent weakness includes such industries such as Airlines or US Automakers.

Just because a company pays dividends, doesn't mean that it cannot grow earnings in the process. Companies like McDonald's (MCD), Wal-Mart (WMT), Procter & Gamble (PG), Altria Group (MO) and Abbott Labs(ABT) are examples of that.

McDonald's Corporation (MCD), together with its subsidiaries, operates as a worldwide foodservice retailer. This dividend aristocrat has raised dividends for 33 consecutive years. Yield: 2.90%(analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. This dividend aristocrat has rewarded shareholders with higher dividends for 36 years in a row. Yield: 2.30%(analysis)

The Procter & Gamble Company (PG) provides consumer packaged goods in the United States and internationally. This dividend king has boosted dividends for over half a century. Yield: 3.10%(analysis)

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. This dividend champion has rewarded shareholders with higher dividends for 43 consecutive years. Yield: 6.30% (analysis)

Abbott Laboratories (ABT) engages in the discovery, development, manufacture, and sale of health care products worldwide. The board of directors of this member of the S&P Dividend Aristocrats index has approved dividend increases for 38 consecutive years. Yield: 3.40%(analysis)

One issue with dividend stocks is that income earned by corporations is taxed twice. It is taxed first at the corporate level and then it is taxed at the individual shareholder income level once dividends are distributed. As a result of this double taxation some believe that investors are worse off. This being said I am a firm believer that if a company can reinvest all of its earnings in projects that would enable it to increase earnings while maintaining its returns on invested capitals it should not pay a dividend.

Unfortunately few investors realize that the IRS could tax companies on accumulated but undistributed earnings of corporations at its own discretion. The so called Accumulated Earnings Tax is imposed on regular C corporations whose accumulated retained earnings are in excess of $250,000 if improperly retained instead of being distributed as dividends to shareholders. To avoid unreasonable accumulation of earnings there should a specific plan for the use of accumulation. Otherwise the IRS will assess the tax at a flat 15%.

Full Disclosure: Long ABT,MCD,MO,PG,WMT

Relevant Articles:

- Ten Dividend Kings raising dividends for over 50 years

- Eight Dividend Stocks Yielding More than Fixed Income

- Buy and hold dividend investing is not dead

- Why Dividend Growth Stocks Rock?

Monday, July 12, 2010

Will higher taxes bring dividend stocks down?

Back in 2003 the Bush administration cut the top rates on dividends and capital gains to 15%. After seven years the preferential treatment of investment income is set to expire. If congress doesn’t extend the tax cuts, the top rates on dividend income could increase to as much as 39%. This leaves many investors wondering whether dividend stocks will be negatively affected by the tax hike.

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

Relevant Articles:

- The case for dividend investing in retirement
- Capital gains for dividend investors
- Dividend ETF or Dividend Stocks?
- Why Dividend Growth Stocks Rock?


Wednesday, June 30, 2010

Benchmarking Dividend income

The investment returns of most fund managers are generally compared against a common benchmark. This provides for an objective evaluation of their performance over a period of time. A common benchmark for most mutual fund managers is the total returns of the S&P 500 index. This benchmark is also useful for comparison to dividend investors as well. For many long-term dividend investors however, income growth is very important as well. Thus having an increase or decrease in dividend incomes does not mean much, unless it is being compared to a common benchmark.

While there have been several dividend indexes such as the Dividend Aristocrats and the Dividend Achievers, which have dividend ETFs that provide accurate information on dividend and price returns, these have not been around as much as the broad S&P 500 index. In addition to that the S&P 500 is sector diversified, and most information is widely available. Because of that, I would consider the changes in annual dividend income of the S&P 500 index as an important barometer against which to benchmark your dividend income over time.

Over the past 32 years, S&P 500 dividends have grown by 5% per year on average.


Below you could find a complete breakdown of annual changes in reported dividends of the S&P 500 companies:


The top ten holdings of S&P 500 have an almost 19% weight in the index. All of them pay dividends except for Apple Computers (AAPL), although three of them have cut distributions over the past one year. It is expected in a dividend portfolio that even some of the best dividend stocks are susceptible to dividend cuts or eliminations. General Electric (GE) and Bank of America (BAC) are two such examples of former dividend aristocrats which had to cut distributions during the financial crisis of 2007-2009. Many income investors which had an allocation to financial stocks, suffered similar drops in dividend income in 2008 and 2009.


(Ten S&P 500 components with the highest weight in the index)

Other companies such as International Business Machines (IBM), Johnson & Johnson (JNJ), Procter & Gamble (PG), AT&T (T) and Exxon-Mobil (XOM) continue raising dividends, despite the broad economic slowdown. Because of their large size, the companies in the S&P 500 are representative for most dividend stocks commonly held by dividend investors.
International Business Machines (IBM) has raised dividends for 15 consecutive years and thus is a member of the Dividend Achievers index. Yield: 2% (analysis)

Johnson & Johnson (JNJ) has raised dividends for 48 years in a row. Yield: 3.70%(analysis)

Procter & Gamble (PG) has boosted distributions for 54 consecutive years. Yield: 3.20% (analysis)

AT&T (T) has increased dividend payments for 26 years in a row. Yield: 6.80% (analysis)

Exxon-Mobil (XOM) has a record of 28 consecutive annual dividend increases. Yield: 3% (analysis)

Full Disclosure: Long CVX, PG, JNJ and XOM

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Wednesday, June 9, 2010

How to increase your dividend income with these four stocks

Dividend investing could be helpful for those investors who are trying to establish a viable income stream that would support their lifestyle in retirement. To get to that point however, investors have to give themselves several years of regular investing in income producing assets that they understand, before they generate enough in dividend income. While the recent financial crisis has not let the universe of dividend stocks unscatered, most diversified portfolios did not experience large drops in incomes. Dividend investing is different than traditional retirement investing strategies, since it focuses on living off the income stream generated by the portfolio and does not focus on selling a chunk of one’s portfolio each year in retirement.


There are three major factors, which will allow you to build a viable income stream in retirement.

The first one is to invest in dividend growth stocks, or companies which have followed a policy of regular dividend increases for at least ten years. While companies cannot control the dividend yields or the stock prices their securities are selling for in the public markets, they could control the amount of distributions paid to stockholders on a quarterly or annual basis. Good starting places for investors interested in researching companies with long dividend growth histories are the dividend achievers, the dividend aristocrats and the dividend champion’s lists. The goal is to include companies which raise dividends consistently in order to produce an income stream which increases at or above the average rate of inflation. Two companies which have managed to achieve that over the past four or five decades include Johnson & Johnson (JNJ) and Procter & Gamble (PG).


Johnson & Johnson (JNJ) is engaged in the research and development, manufacture and sale of a range of products in the healthcare field. Johnson & Johnson owns more than 250 operating companies under 3 segments – Consumer, Pharmaceutical as well as Medical Devices and Diagnostics. Johnson & Johnson has increased its dividend for forty-seven consecutive years. This dividend aristocrat has a ten year distribution growth rate of 13.30% per year. Check my analysis of the stock. Yield: 3.60%

The Procter & Gamble Company (PG) is focused on providing branded consumer packaged goods. The Company’s products are sold in over 180 countries worldwide primarily through mass merchandisers, grocery stores, membership club stores, drug stores and in high-frequency stores, the neighborhood stores, which serve consumers in developing markets. The Company was organized into three Global Business Units: Beauty; Health and Well-Being, and Household Care. Procter & Gamble has increased its dividend for fifty-three consecutive years. This dividend aristocrat has a ten year dividend growth rate of 10.70% per year. Check my analysis of the stock. Yield: 3.10%

The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. Coca Cola has increased dividends for 48 consecutive years. This dividend aristocrat has a ten year distribution growth rate of 10.00% per year. Check my analysis of the stock. Yield: 3.30%

Colgate-Palmolive Company (CL), together with its subsidiaries, manufactures and markets consumer products worldwide. This dividend champion has rewarded shareholders with dividend raises for 47 years in a row. The company has a ten year dividend growth rate of 12.90%. Check my analysis of the stock. Yield: 2.70%.

The second tool that would help investors increase their dividend income is the power of dividend reinvestment. During the accumulation stage, dividends should be re-invested back by purchasing more stock, which further compounds investment returns over time.

The last but not least factor includes portfolio contributions on a regular basis. The general rule of thumb is that for each dollar saved in your twenties in stocks, one would be able to generate one dollar in income in their sixties. Therefore, investing even only a small amount regularly should add to the income potential of one’s portfolio.

Let’s illustrate this point with the following example. Let’s assume that we have an investor with $1000 at the end of 1979. They have selected Johnson & Johnson (JNJ) as their investment choice and have three options to consider:

1) Spend all of their dividends and never contribute anything to the portfolio
2) Reinvest dividends in JNJ stock
3) Reinvest dividends in JNJ stock and also add $100 to the account each year


By the end of 2009 the first option would be generating almost $1169 in annual dividend income, for an yield on cost of 116.90%. The second option would be generating $2072 in annual dividend income, while the third option would be generating $3228 in annual dividend income. With the last option, the investor would have invested a total of $4000 throughout their lifetime.



To check the calculations behind the chart, open the spreadsheet from this location.

Full Disclosure: Long CL, JNJ,KO and PG


Relevant Articles:

- Dividend Aristocrats List for 2010
- The case for dividend investing in retirement
- Dividend Grouping for Dividend Income
- Inflation Proof your income in retirement with Dividend Stocks

Wednesday, May 19, 2010

Dividend Payback from six quality dividend stocks

When investors put their hard earned money to work, they are always hoping that they would receive a positive return on their investment. The profits could come either through capital gains, from dividends or from a combination of both. Dividends have traditionally been more stable than capital gain returns. Stock prices are volatile, and it would not be unheard of experiencing 40% losses in one year, which is then followed by 30% gains in the following year. That’s why many retirees these days are building their retirement income strategies exclusively off of dividend stocks.

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

Relevant Articles:

- 2010’s Top Dividend Plays
- Six Dividend Stocks for current income
- Inflation Proof your income in retirement with Dividend Stocks
- Living off dividends in retirement

Wednesday, April 7, 2010

Three Dividend Strategies to pick from

Most new investors typically tend to focus on the companies with the highest dividend yields. I am often being asked why I never write about companies such as Hatteras Financial (HTS) or American Agency (AGNC), each of which yields 16% and 19% respectively. While some of my holdings are higher yielding companies, I typically tend to invest in stocks with strong competitive advantages, which have achieved a balance between the need to finance their growth and the need to pay their shareholders.
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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- 2010’s Top Dividend Plays
- Six Dividend Stocks for current income
- Best Dividends Stocks for the Long Run
- Capital gains for dividend investors
- Dividend Growth beats Dividend Yield in the long run

Wednesday, January 27, 2010

Stocks with fluctuating dividends to avoid

Many investors who are looking for an income stream in retirement choose the relative safety of US Treasury bonds. While the coupon payments lose their purchasing power each year due to inflation, they are fixed and guaranteed by the US government. This makes budgeting expenses somewhat easier. With dividend stocks on the other hand, distributions are not guaranteed which is probably why pundits advise retirees to increase their asset location in fixed income instruments. This is despite the fact that for most US companies which pay dividends, distributions do not fluctuate.

Most companies try to get a following from long-term investors by enticing them with a stable or growing distribution over time. That way there is a greater chance that those investors would not sell even under the best or worst of circumstances. If dividend growers have a stable business model which allows them to pass on cost of increases to their customers while still earning a respectable return on capital, they could afford to raise distributions to their stockholders. Stocks that pay rising distributions could essentially provide investors with a real inflation adjusted stream of income, which is something that most fixed income securities do not provide. This makes it easier for investors to budget for their expenses, since their revenues would now be keeping up pace with inflation. One issue with these payers however is that they offer yields ranging from 3% to 5%, which is not enough for some investors.

Not all dividend stocks pay a stable distribution however. Some high yielding but speculative stocks which investors hold pay dividends which fluctuate from quarter to quarter. Companies which pay all of their operating earnings are typically the ones which pay fluctuating dividends. Examples include Canadian royalty trusts such as Pengrowth (PGH), PennWest (PWE) and shipping companies such as Nordic American Tanker (NAT). These stocks spot high yields most of the times, which might not truly reflect the yield on cost of original holders. Pengrowth Energy (PGH) for example yielded 15.30% at the end of 2007 while paying out a distribution of 22.70 cents monthly. Two years later it paid out a distribution of 6.70 cents/share, while yielding 8.40%. Obviously investors who purchased the stock in 2007 are not earning as much on their invested capital as they had originally planned to do- their yield on cost was 4.50% by the end of 2009.

Another example of this situation is Nordic American Tanker which has paid a quarterly distribution ranging from a low of 30 cents/share to a high of $1.88/share. Investors who relied on the high dividends which NAT paid must have been terribly surprised when the company announced a quarterly distribution of just 10 cents. Having limited to no visibility as to what the distribution might be next quarter could impose a strain on an already thin retirement budget.

The stocks which investors should concentrate on are the ones which pay a stable and growing distribution, which are adequately covered by earnings. That way investors’ portfolios would not be exposed to temporary fluctuations in earnings, which would affect the amount of dividend payouts. Companies, which pay consistent dividends, pay out up to a certain sustainable amount of their earnings to shareholders as dividends. They reinvest the rest in the business, which could bring in a solid foundation from which further growth in earnings and distributions is achieved. While there is always a risk that a company could slash or eliminate its distribution, few regular dividend growers do that unless they face unforeseen circumstances.
An example of such stock is Abbott Labs (ABT) has increased dividends for 37 consecutive years. Abbott Laboratories manufactures and sells health care products worldwide Check my analysis of the company.

Full Disclosure: Long ABT

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- Best Dividends Stocks for the Long Run
- High yield Canadian Royalty Trusts
- High yield stocks for current income
- The Dividend Investment Journey
- Dividends Stocks versus Fixed Income

Wednesday, January 21, 2009

Dividend Yields for major US indexes

When investing in index funds, Investors typically focus on the dividend yields on the indexes as a barometer for the whole market. With yields on major US indexes rising above the 10 year Treasury Notes for the first time in over 50 years, dividend stocks look more promising to investors seeking current investment income.

















One thing to note however is that not all stocks in major US indexes pay dividends. Only 368 out of 500 stocks in the S&P 500 pay dividends. The average yield on those is 3.73% , which is a full percentage point higher than the yield on the broad market benchmark. (source indexarb). Dow Industrials is the most “dividend friendly” index as 29 out of 30 of its components pay dividends. Furthermore most of the stocks in the Dow Industrials also have had a long history of stable dividend rates or consistent dividend raises. General Motors is the only stock in the Dow Jones that doesn't pay a dividend.

Nasdaq 100 is the tech heavy index which consists of only 31 dividend payers, out of 100 stocks in the index overall. Without the power of dividends, the once high flying index might take much longer to reach its 2000 highs versus the fifteen years that took Dow Industrials to reach its 1929 highs after the Great Depression.

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Monday, March 24, 2008

Wal-Mart Dividend Analysis

Wal-Mart Stores, Inc. operates retail stores in various formats worldwide. It operates through three segments: Wal-Mart Stores, Sam's Club, and International.
The company is a dividend aristocrat as well as a major component of the S&P 500 and Dow Jones Industrials indexes. Over the past 10 years this dividend growth stock has delivered an annual average total return of 10.50 % to its shareholders. The majority of the gains came in the late 1990’s. After peaking at 70.25 in late 1999 though, the stock has gone nowhere for 8 years.
At the same time company has managed to deliver an impressive 16% average annual increase in its EPS.
















The ROE has been hovering in the 18% - 20 % range over the past 10 years.













Annual dividend payments have increased over the past 10 years by an average of 21% annually, which exceeds the growth in EPS. A 21% growth in dividends translates into the dividend payment doubling almost every 3.5 years. If we look at historical data, going as far back as 1993, WMT has indeed managed to double its dividend payments every three and a half years.














If we invested $100,000 in WMT on December 31, 1997 we would have bought 5071 shares (Adjusted for 2:1 stock split in April 1999). Your first dividend payment would have been $197.77 in March 1998. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend payment would have risen to $1211 by December 2007. For a period of 10 years, your quarterly dividend income has increased by 464 %. If you reinvested it though, your quarterly dividend income would have increased by 612%.














The dividend payout has increased from 20% to 30% over the past 10 years. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.















I think that WMT is attractively valued with its low price/earnings multiple of 17 and yield at 1.90%.

Disclosure: I own shares of WMT
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Friday, March 21, 2008

Dividend Growth Stocks Watchlist

The two lists that I am concentrating right now are the S&P 500 Dividend Aristocrats and the S&P High Yield Dividend Aristocrats Index.
I created custom watch lists in Yahoo! Finance in order to summarize the two groups of dividend achievers by a variety of criteria such as Symbol, Yield, P/E , Div/Shr, Last Price,EPS (ttm) ,PEG Ratio ,Dividend Payout, 5 year dividend growth rate.
What I did was first exclude any stocks which had a dividend payout ratio of more than 50%. That gives me some reasonable assurance that the company is less likely to cut its dividends. I also look at P/E ratios, since I do not want to overpay for a company. Anything with a P/E of over 20 is out of my watchlist.
I also look for the PEG ratio but just to find stocks which might be expensive in terms of their growth prospects.
A third thing that I look for is a dividend yield of at least 2%, which is a little bit over than the current yield of 2.00% that SPY is rewarding its shareholders.
The last but not least criteria that I screen for is the 5 dividend growth ratio. I am looking for an average annual dividend growth of at least 5% over the past 5 years. The reason why I selected dividend growth in the end is because I want to decrease to a minimum the rush to buy a stock that simply increased its dividend for whatever reason, whose fundamentals cannot support any significant further increases in the dividend payments.
Based off of this screen, here is my stock lists that I follow :























I would continue screening for potential stocks to add to my buy watchlist on a monthly basis. I might add or remove stocks from my watchlist depending on how undervalued/overvalued I perceive them to be. If I stock in which I have a position drops off my buy watchlist, I would keep holding it, but I won’t be adding to that position until the technical’s and the fundamentals match my criteria.

Thursday, March 20, 2008

3M dividend analysis

3M Company, together with its subsidiaries, operates as a diversified technology company worldwide. It operates in six segments: Industrial and Transportation; Health Care; Display and Graphics; Consumer and Office; Safety, Security, and Protection Services; and Electro and Communications.


It is a dividend aristocrat as well as a major component of the S&P 500 and Dow Jones Industrials indexes. Over the past 10 years this dividend growth stock has delivered an annual average total return of 11.20% to its shareholders. The company has managed to deliver an impressive 17.90% average annual increase in its EPS through organic growth and share buybacks. Management has consistently bought back 1.2% of outstanding shares each year for the past 10 years, spending a little over $9.9 billion in the process.



The ROE has been increasing steadily over our study period, rising from a low of 20% in 1998 to 35% by 2007.















Annual dividend payments have increased over the past 10 years by an average of 6.20% annually, which is significantly below the growth in EPS. The company is moving aggressively into growth markets and has been fairly active on the acquisition front, which explains the relatively low dividend growth rate. A 6 % growth in dividends translates into the dividend payment doubling every 12 years. If we look at historical data, going as far back as 1970, MMM has actually managed to double its dividend payments on average every eight and a half years.















If we invested $100,000 in MMM on December 31, 1997 we would have bought 2437 shares (Adjusted for 2:1 stock split in September 2003). Your first quarterly dividend check would have been $670.17 in February 1998. If you kept reinvesting the dividends though instead of spending them, your quarterly dividend payment would have risen to $1455.84 by November 2007. For a period of 10 years, your quarterly dividend payment has increased by 75 %. If you reinvested it though, your quarterly dividend income would have increased by 128%.














The dividend payout has been in a downtrend over the past 10 years, falling from 76% in 1998 to 34% in 2007. Normally this is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings. In 3M’s case cash is being invested in new business ventures which could provide nice payoffs for shareholders if executed properly. 3M is the ultimate dividend aristocrat but also growth stock.













I think that MMM is attractively valued with its low price/earnings multiple of 14 and above-average yield at 2.50%.
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