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

Wednesday, December 17, 2014

What dividend stocks would I buy if I were just starting out as an income investor?

I have been investing in dividend growth stocks and discussing dividend growth stocks on this site since early 2008. I have learned that dividend investors need to be flexible, and constantly be on the lookout for attractive investments.

This is because companies from different sectors are attractive at different times. In addition, there are many companies within a sector that could have strikingly different fundamentals and valuations. It is very rare that the whole market and all sectors are cheap at the same time, like they were in 2008 – 2009. For someone who invests a little every month however, I need to find cheap stocks with attractive economics and good prospects all the time. I do not believe in keeping too much cash in my brokerage account, and waiting for the perfect opportunity that might or might not materialize. I would much rather have the capital work for me and start its compounding process right away.

I usually start with a list of dividend growth stocks like the dividend champions, and then narrow down based on my entry criteria. I usually notice that many of the most attractive companies are from a single sector or sectors. I then look at each company that meet my entry screen, and delve further into trends in revenue, expense, earnings, returns and dividends over the preceding decade. I also read annual reports and analyst reports to gain an understanding of the company and its inner workings.

The typical dividend stocks I purchased since 2008 included the likes of Colgate-Palmolive (CL and Kimberly Clark (KMB) up until 2012. Over the past two years however, I have been hard pressed to find good ideas among the typical suspects of the preceding 5 years. As a result, I have been looking for other income investments.

Right now, the best values I could find are in Energy sector.  As I mentioned before however, I want to be diversified across time, industries, and not pile everything at once in one sector or company. Safety of capital is important to me. I also find a few consumer staples that are cheap, although not as many as in 2012. I also identified a few other good stocks, with favorable business prospects from other sectors below:

Yrs Div Gro
10 yr DG
Baxter International Inc.
Chubb Corp.
Chevron Corp.
Diageo plc
Eaton Corp. plc
General Mills
International Business Machines
Johnson & Johnson
Kellogg Company
Kimberly-Clark Corp.
McDonald's Corp.
PepsiCo Inc.
Philip Morris International
Republic Services Inc.
United Technologies
ExxonMobil Corp.

I have not included real estate investment trusts or master limited partnerships, because those are a little bit more challenging to research from the standpoint of a beginner investor.

That being said, I am not envious of the investor who starts their dividend investing journey today. It is much more challenging to find quality companies selling at attractive valuations today, than it was 7 years ago. If someone were putting a set amount of cash to work every single month for several years however, the math should work well in their favor due to the fact that intrinsic valuations rise over time as companies earn more and thus pay more dividends. The power of dividends to grow over time, and for those dividends to be reinvested into more dividend producing investments should not be underestimated. In addition, if we get the bear market in stocks that everyone has been waiting for, the beginner investor would be able to deploy their cash at much better entry prices.

However, if the investor has a lump-sum to invest, the best idea might be to spread purchases over the next 12 - 24 months, especially if they are relatively new to the world of dividend investing. The importance of quality in selecting investments and the need for continuous education cannot be underestimated. To me, a quality company is the one which manages to have recurring revenues and earnings, which tend to increase over time and do that without much lumpy-ness. To achieve that, a company needs to have strong competitive advantages such as strong brands, advantages of scale or location, being a cost leader, and/or selling a unique product that commands pricing power. Check this article on wide-moat companies for more information.

Full Disclosure: I have a position in all companies mentioned above

Relevant Articles:

Seven wide-moat dividends stocks to consider
Five Metrics of Successful Dividend Companies
How to create a bulletproof dividend portfolio
Why Sustainable Dividends Matter
Dividend Growth Investing is a Perfect Strategy for Young Investors

Friday, October 17, 2014

Two and a half purchases I made this week

This is going to be a short article. The purpose is to discuss how I was able to acquire shares in two companies this week. The third transaction is explained in more detail below.

The first company I purchased shares in included Eaton (ETN). Eaton Corporation plc operates as a power management company worldwide. The company has increased dividends for five years in a row. However, it has not cut dividends to shareholders but increased it every other year since 1983. The company has managed to deliver an 11.80% average increase in annual EPS over the past decade. Eaton is expected to earn $4.60 per share in 2014 and $5.34 per share in 2015. In comparison, the company earned $3.90/share in 2013. The annual dividend payment has increased by 13.80% per year over the past decade, which is higher than the growth in EPS. Currently, Eaton is attractively valued at 13 times forward earnings, and has a dividend yield of 3.30%. I initiated a position in the company in the past quarter, and have since added to it. I would be looking forward to adding to my position in the company in the coming years, subject to availability of funds, opportunity cost and valuation. Check my analysis of Eaton on Seeking Alpha.

The second company in which I purchased shares was Williams Companies (WMB). It owns the general partner interest in Williams Partners (WPZ) and Access Midstream Partners (ACMP) along with any limited partnership units in both MLPs. Those are pretty valuable, especially if the pipelines do manage to increase cashflows. Williams Companies is a dividend achiever, which has managed to raise dividends for 11 years in a row. The company has a pretty aggressive plan to increase dividends per share through 2017 and expects to pay $2.46 in 2015, $2.82 in 2016, and $3.25 in 2017. Given the current annual payment of $2.24/share, which translates to a roughly 4.70% current yield, I would be interested in the company even if growth slows down to 5% – 6%/year. But no, Williams Companies expects to grow dividends by 15%/year through 2017. Those projections are one of the reasons I initiated a position in the company a few months ago. Given that pipelines are under pressure in the past two weeks, I think prices are starting to get more attractive. I probably need to write a more detailed analysis of the company, so please stay tuned.

These purchases are relatively small, given that I didn’t expect to have enough funds till sometime in November. I might make another small purchase either next or the week after next week. The purchases I am trying to make are basically additions to shares of companies I own, in an effort to increase positions by taking advantage of decreasing prices.

The third transaction I did earlier did week involved some shares of Kinder Morgan Inc (KMI), which I sold in my taxable account and purchased Kinder Morgan Management LLC (KMR). Since I am replacing one security for another, I view this as a half “purchase”. Actually, since once the deal closes I will end up with KMI anyway, it shouldn’t even be considered a purchase. A few weeks ago, I discussed that there is an arbitrage opportunity, where by purchasing KMR shares, an investor who waits till the acquisition by Kinder Morgan Inc is complete, can end up with more KMI shares than purchasing them outright. This is because the price of KMR shares is lower than the conversion factor times the value of KMI shares. If that paragraph is making your head spin, read the whole article explaining the process.

On the plus side, Kinder Morgan Inc (KMI) announced it increased quarterly dividends to 44 cents/share, which is a 7.30% increase over the same rate paid in the same quarter last year. Unitholders of Kinder Morgan Energy Partners (KMP) will get a quarterly distribution of $1.40/unit, which is a 4% increase over the same distribution paid to unitholders in the same quarter last year. Given that Kinder Morgan Management LLC (KMR) is equivalent to KMP, minus the ominous tax structure of a partnership, and given its higher yield relative to Kinder Morgan Inc ( plus it is not taxable since I get shares "reinvested" without triggering any taxable liabilities to the IRS), I think that I made the right choice. Now if Kinder Morgan Inc (KMI) drops to $30 or below, I would replace my remaining position with Kinder Morgan Management LLC (KMR) shares.

The other half I transaction I did was the fact that I replaced most of my position (90% or so) in ONEOK Partners (OKS) in my taxable account with the general partner ONEOK Inc (OKE). There are multiple reasons for the switch. The first reason is that if you like an MLP, the best returns in terms of dividend growth and capital appreciation are always derived from investing in the general partner. Thus I believe that OKE will do better than OKS over the next decade. I also made a mistake by chasing yields in the first place in 2011, when I sold OKE to buy OKS. Chasing yield on my part is not the smartest thing to do. I discussed this mistake in a previous article I posted a few months earlier. I needed to fix the mistake, once I identified it. Another reason for the change is that I need to simplify my life, as I will no longer have to do K-1 forms. They are not that difficult for me to do, and ONEOK Partners (OKS) does a really good job in showing you what forms to file with the IRS. However, if I am no longer in charge of the DGI portfolio ( due to death, disability, insanity etc), I know that this would make it more difficult for whoever inherits the dough. Thus, I used the sell-off in the pipeline sector to get in on the general partner, which declined much faster and much more than the limited partner units. On the surface, it sounds crazy that I replaced a 5.80% current yield for a 4% current yield. The thing of course is that the second yield is expected to grow by 10%/year, while the first higher yield would grow much slower. Over time, investing in the general partner interest will likely achieve better yields on cost. For the time being, I am still going to keep the remaining ONEOK Partners (OKS) in my IRA however.

Full Disclosure: Long ETN, WMB, KMI, KMR, OKE, OKS

Relevant Articles:

Ten Dividend Seeds I Planted for Long Term Income
Canadian Banks for Long Term Dividend Growth
How to buy Kinder Morgan at a discount
Kinder Morgan Limited Partners Could Face Steep Tax Bills
Seven Dividend Stocks I purchased for the long-term

Wednesday, October 2, 2013

Two dividend payers I recently purchased for my taxable accounts

For the first five years of this site, I have mostly discussed companies I found attractively valued for investment, as well as my dividend investing strategy. However, I rarely discussed the companies I have been purchasing in my accounts. This is because I believed that it was much better to discuss the tools of the trade and my investment philosophy and ideas, rather than focus too much in on recent investments. I never even published my investment portfolio in detail, until recently. Readers could only guess what I owned by going through articles, and checking my full disclosures. However, through interactions with readers over the years, I have realized that some enjoy reading about specific investment ideas that I have added money to.

Over the past ten days, I made two purchases in my regular taxable stock accounts. I purchased Realty Income (O) and British Petroleum (BP).

When I last analyzed Realty Income (O), I mentioned that I would only purchase it at a specific yield. Well, back on September 21 I tweeted about my purchase of the stock as I found the yield to be attractive. The company has managed to raise dividends multiple times per year since going public in 1994, and continued raising even during the dark days of the Great Recession in 2008 and 2009. After an acquisition closed in early 2013, Realty Income raised distributions by over 19%. I like that this triple net REIT continues growing through targeted acquisitions of competitors and properties and that it is not afraid to look outside the box in order to find attractive uses of its capital at attractive cap rates of return. You are also paying for the expertise of the management team, which has done a superb job of ensuring quality tenants, diversification and keeping the properties occupied.

One of the risks behind REITs is that rising interest rates would cause investors to sell their stocks off, and purchase bonds instead. As an investor, I realize this could potentially increase the cost of capital for Realty Income, which obtains money to grow through stock or debt issuance. As long as new properties are acquired at rates of return above cost of capital however, future acquisitions should continue adding to the pool of funds available for shareholder distributions. In addition, while interest rates would increase, they would likely do so very slowly and would likely reach about the same levels that we had prior to the 2008 – 2009 crisis first. In addition, I would much rather have my money in a business like Realty Income that provides the potential to generate a high dividend yield today and the opportunity for dividend growth versus a long US Treasury Bond at a similar yield. This is because an increasing dividend payment over time would keep the purchasing power of my income and protect it from inflation. Fixed income instruments do not do this for you. Currently, Realty Income yields 5.40% and has a ten year dividend growth rate of 4.20%/year. It trades at 16.70 times FFO ( assuming FFO of $2.40/share).

The other company I purchased was British Petroleum (BP) on September 30. In addition, I also sold a January 2015 put with a strike of $42. If the stock trades below $42 at expiration date, I would have to buy it at $42/share. However, my effective cost would be slightly less than $37/share. If the stock trades above $42/share, I would end up with the equivalent of slightly more than $5/share. The option premium received financed a portion of my purchase of BP.

Before I discuss the purchase, I wanted to discuss my history with the company. I initially purchased shares back in 2008, and considered them one of the safest dividends for current income. However, the events in 2010 led to a dividend cut, after which I sold out my position completely and reinvested the proceeds into Royal Dutch Shell (RDS.B). I sell automatically after a dividend cut, as a means to protect myself from getting married to a company that is collapsing. I do not want to be in a position of someone who has received dividends from a company for 40 years, and is emotionally attached to the stock, and therefore ignores warning signs that the business is in trouble. This could lead to losses in investment capital, which could result in going back to work. There have been investors who hold on for too long to a lost cause, and then end up not only losing their income source but also their capital. I also do not want to end up justifying to myself that a business will bounce back, while I am experiencing the pain from losses and hoping, rather than assessing the situation with a cool head.

Since the company has started raising dividends after the cut however, I am willing to give it another try. I think that the Gulf of Mexico spill is a major reason why the stock is still so cheap at 9 times forward 2013 earnings and 7.90 times forward 2014 earnings. However, I think that the fear of bankruptcy for BP is larger than the total cash outlays it would end up expending over time for the oil spill. Therefore, I sense an opportunity to purchase an asset at reasonable valuations that no one likes. The stock also yields 5.10% with a $2.16 in annual dividend. The total amount dividends paid annually was $3.36/share prior to the oil Spill in the Gulf of Mexico. I believe that this could easily be achieved by the end of this decade, especially if oil prices keep steady.

British Petroleum owns 19.75% of Russian Company Rosneft, which is the largest energy company in the world by reserves, and has a market capitalization of over 80 billion. BP also received a sizable cash consideration in the process, and will be using $8 billion from that to repurchase shares over the next 12 – 18 months. This would offset the reduction in earnings following the sale of its stake of BP –TNT to Rosneft for the cash and stock consideration.

In addition, BP has managed to replenish its reserves continuously over the past two decades. This is an important metric for oil companies, because it shows that they can replace the oil and gas extracted from developed fields through exploring for or acquiring fields that hold an equivalent amount or more of these precious carbons it sells worldwide.

Just like all other integrated energy companies, BP could suffer if oil and gas prices fall and stay low. However, I think that in the long-term, energy demand is only going higher from here. For example oil has so many uses outside of energy, that even if the whole world was running on solar and wind, there would still be a massive need for oil and gas. Even if the whole world used renewable energy to power the economy, realistically this is at least a couple decades away from it becoming mainstream. In the meantime, you can use the sizable dividend from BP as a sort of “rebate” to lower your cost basis in the stock.

Overall, I don't think I can go too wrong on a company like BP, which is cheap but has room to grow over time, offers a good dividend and buys back its cheap stock.

I would hate to turn this site into a stock picking service, but if there is interest, I would keep posting recent investments. As was the cash with my Roth IRA investments, I am going to post those in a couple weeks. I do post the tickers on Twitter, the day I make the transactions in that portfolio.

Please remember that I am making investments in my own accounts with my own money, based on information, estimates and biases (or experience) I have. These are not investment recommendations for you, but merely examples of the end result behind my investment philosophy and strategy in action. Do your own research before putting your money to work.

Full Disclosure: Long O, BP, RDS.B

Relevant Articles:

Ten Dividend Paying Stocks I purchased in September.
Realty Income (O) – The Monthly Dividend Company
Is BP’s dividend safe?
Royal Dutch Shell – An Undiscovered Dividend Gem
Three Dividend Stocks to Capitalize on BP’s weakness

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