Showing posts with label dividend stock ideas. Show all posts
Showing posts with label dividend stock ideas. 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, December 12, 2014

Six Dividend Investments I Made Last Week

I was able to purchase shares in a few companies last week. As many of you know, I have been building out my dividend portfolio for several years. Building a dividend machine takes time, dedication and consistency in saving money, doing my homework in analyzing companies and investing those savings. This means that every month, I purchase shares in companies which are attractively valued, and offer prospects for future dividend growth. Because I try to build and maintain a diversified portfolio of dividend growth stocks, I tend to stop adding new money to certain companies where I am overweight in. For example, despite the fact that I like Johnson & Johnson (JNJ) and Kinder Morgan (KMI), I am highly unlikely to add more money there, because those are one of the largest positions in my portfolio. The set of guidelines I have built up over the years and the discipline in following them have definitely been helpful during difficult times, and have allowed me to keep plugging in despite the great recession, QE1,2 and 3, double dip recessions in Europe and fluctuations in prices, expectations and inflation. This is why identifying goals, having a plan and sticking to it is important to reach those goals.

The companies I purchased in the past week include three names in which I added to my existing positions as well as two new names I have never owned before. I tend to build my positions slowly over time, since I tend to dollar cost average every month. The companies I purchased include:

Baxter International Inc. (BAX) develops, manufactures, and markets products for people with hemophilia, immune disorders, infectious diseases, kidney diseases, trauma, and other chronic and acute medical conditions. This dividend challenger has managed to boost dividends for 8 years in a row. The ten year dividend growth rate is 12.40%. Currently, the stock is selling at 15.20 times forward earnings and yields 2.80%. Check my analysis of Baxter for more information.

The Chubb Corporation (CB), through its subsidiaries, provides property and casualty insurance to businesses and individuals. This dividend champion has managed to boost dividends for 32 years in a row. The ten year dividend growth rate is 9.20%. Currently, the stock is selling at 13.90 times forward earnings and yields 1.90%. Check my analysis of Chubb for more information.

The Williams Companies, Inc. (WMB) is the general partner behind Williams Partners (WPZ), which is in the process of combining with Access Midstream (ACMP). Williams Companies is a dividend achiever, which has managed to raise dividends for 11 years in a row. Given the current annual payment of $2.28/share, which translates to a roughly 4.50% 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. 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. Those projections are one of the reasons I initiated a position in the company a few months ago. I find investments in general partners to be superior to those of the underlying limited partnerships for long-term investors.

Omega Healthcare Investors, Inc. (OHI) is a real estate investment firm which invests in healthcare facilities, primarily in long-term healthcare facilities in order to create its portfolio. This dividend achiever has managed to boost dividends for12 years in a row. The five year annual dividend growth rate is 9.30%. Currently, this REIT is selling at 13.40 times FFO and yields 5.40%. Check my analysis of Omega Healthcare Investors for more information.

The two new positions include HCP, Inc. and W. P. Carey Inc. I analyzed those in the past two weeks, and will be posting those analyses over the next few weeks. I do not think that now is the perfect time to buy Real Estate Investment Trusts (REITs), given the fact that they have gone up this year, and given the fact that interest rates will likely increase in the future. Since interest rates are the cost of capital, this could decrease relative attractiveness of the sector as whole. That being said, for those who hold quality REITs in their portfolios, they should keep receiving those dividends, and those dividends will likely keep up with inflation over time. Therefore, the future returns will be largely dependent on entry price, growth in underlying business and quality of management and business to support growth and sustainability of dividends. As a result, the expected returns for a REIT yielding 5% today, which managed to grow distributions by 4% over the next 20 years will likely be around 9%. The other thing I wanted to mention is that I will be building out positions in HCP Inc, W. P. Carey Inc. and Omega Healthcare Investors slowly over time. For example, I would try to make approximately two purchases per year for each of those securities, for approximately 3- 5 years. Therefore, if prices go down a lot, I would be protected somewhat, since I would not have purchased everything at the high price. If prices do not fall however, but keep increasing, I would likely end up putting the funds elsewhere and not build those positions out.

HCP, Inc.(HCP) engages in acquisition, development, leasing, selling and managing of healthcare real estate and provides mortgage and other financing to healthcare providers. This dividend champion has managed to boost dividends for 29 years in a row. The ten year dividend growth rate is 2.40%. Currently, this REIT is selling at 14.60 times FFO and yields 4.90%.

W. P. Carey Inc. (WPC) is an independent equity real estate investment trust. The firm also provides long-term sale-leaseback and build-to-suit financing for companies. This dividend achiever has managed to boost dividends for 17 years in a row. The ten year dividend growth rate is 6.30%. Currently, this REIT is selling at 14.80 times FFO and yields 5.50%.

Full Disclosure: I own shares in KMI, JNJ, CB,BAX, WMB, OHI, HCP, WPC

Relevant Articles:

Five Things to Look For in a Real Estate Investment Trust
Should Dividend Investors Worry About Rising Interest Rates?
How to stay motivated on your road to financial independence
Why I don’t do discounted cash flow analysis on dividend stocks
Why do I use a P/E below 20 for valuation purposes?

Monday, December 8, 2014

Are Energy Stock Values Today a Once in a Lifetime Opportunity?

As most of you are aware, oil prices have decreased significantly since hitting a high in June 2014. This has reduced earnings projections for energy companies, and therefore depressed share prices. The question on the minds of many dividend investors is what to do in this situation. I generally operate under the belief that the upside will take care of itself, meaning that if prices rebound, earnings will go up and dividends will continue growing as well. This is why in this article, I will focus mostly on risks, and how to mitigate their potential impact. I will also discuss how I plan to deal with this situation.

The goal of a dividend investor is not how much a company can earn today, but whether it can earn more over time. Oil companies earn more by finding and producing more oil, or if prices they sell at increase over time. Before we dig further, there are several risks which are discussed, concerning energy companies these days. I will address those below.

The first risk is that demand for oil and gas will be drastically less in 20 – 30 years due to it being replaced by by green energy sources such as wind and solar. The first risk is mitigated by the fact that renewal energy sources are intermittent, which means that there will always be a need for fossil fuels. The risk is also mitigated by the fact that our modern economy is based on oil, as this is the base for things like plastics, pharmaceuticals and hundreds of other things. The risk is also mitigated by the fact that it would take a tremendous amount of time, and investment in infrastructure before renewable energy sources replace significant energy needs of society. This means infrastructure, as well as retrofitting machinery needed for the energy available. For example, most cars these days run on oil and some run on natural gas. Very few cars run on electricity alone. In order for all cars to run on fuel that is not gasoline, but something else, we need time, money and effort to build out refueling stations, replace millions of existing cars and not make any more new cars that run on traditional fuels.

Another risk that somewhat goes along with this first one is the notion that oil and gas companies will somehow end up with reserves in the ground, which they won't be able to tap because of concerns related to greenhouse gases. I agree that global warming is an issue, and that the world needs to be more effective in doing so. However, I find it very difficult to believe that the world will stop using conventional energy sources within the next 20 years. The technology might be here to harness power of sun and wind, but the technology to store energy is not here. Plus again, it would take a tremendous amount of time, investment and dedication from ALL countries to make the switch. I would say the next 20 years would be fine for energy companies.  I also find it hard to believe that all countries in the world will act together for the long-term benefit of everyone, while foregoing their short-term economic and policy needs. Hence, I am going to bet my money that the next 20 years will be good for energy companies. Plus, it would be very helpful to stock pickers like me, when large investors decline to invest in companies despite their excellent value and growth prospects, merely because of a "moral objection".  Less competition and demand means better prospects for better long-term returns. Just check how that worked out for those who stuck with Altria/Phillip Morris investors over the past 50 years. ( Hint: It compounded at almost 20%/year)

The other risk is that with much fuel efficiency out there that oil demand further decreases over time. The second risk is mitigated by the fact that energy use will increase, as global economies keeps expanding, and as hundreds of millions of people join the middle class over the next 20 – 30 years. As poor countries become less poor, they will need to manufacture more goods and deliver more services, which should only increase demand for energy. Thus, I would expect worldwide energy needs to increase over time.

The other risk is due to oversupply we are facing today. You have governments such as Russia, Venezuela whose major exports is crude. If prices go down, they need to sell more in order to maintain revenues from falling. This further depreciates prices. When your main export is a commodity, your budget is under a lot of pressure to keep selling even more, especially if the price of that commodity drops a lot quickly.

You also have so much in unconventional oil and gas now, particularly in the US, which further decreases US demand for foreign oil. This is because there is more supply of US oil and gas. This depresses prices. However, many of the unconventional oil and gas is only economical to produce at higher prices for the commodity. In addition, if prices for oil and gas stay low for longer periods of time, companies like ExxonMobil (XOM), Royal Dutch (RDS.B),  ConocoPhillips (COP), Total (TOT), Chevron (CVX) will slash their E&P budgets, since would not be economically viable to produce oil and those lower prices for the commodity. This would be a self-correcting mechanism, which will ensure that supply of oil drops below a certain price. Therefore, a low price is a self-correcting mechanism which reduces supply from higher cost producers and also reduces the incentives to invest in more fields that will bring more supply a few years into the future. The problem of course is that this process takes a few years to work itself out.

Those risk items I am discussing of course represent longer-term risks affecting oil and gas, not fluctuations in oil and gas prices that are temporary in nature. That means the risks I describe are risks that oil and gas prices will stay down because of those risks, because demand has decreased or supply increased. Prices will always fluctuate due to supply/demand, and could just as easily rebound next year as they are likely to keep falling further south in 2015. Nobody can accurately predict commodity prices consistently, which is why it is important to look at the idea of investing in energy companies from the attitude that requires attractive entry prices and margin of safety in price and time.

Oil Prices are volatile, and could go easily to $35 or $105 easily through end of 2015. However, it is also important to not get too focused on short-term fluctuations, and end up missing the forest for the trees. What I am trying to say is that this current decline in oil prices is not the end of the world. Oil companies do not sell all of their oil at once, but almost ratably every month - hence for 2014, most oil has already been sold at higher prices. Because the oil price pendulum swings both ways, it is important to focus on average prices per month, over the course of an year to smooth out volatility. In addition, a portion of oil and gas is hedged. Furthermore, energy companies do not just sell oil, but they also sell natural gas, the prices of which have done pretty well this year. Also, if you look at oil futures prices over the next decade, you can see prices increasing by 3-4%/year. An oil executive could simply hedge their whole production over the next 10 years, and not have to worry about fluctuations. However, would you rather have all production hedged out, and expect smooth returns, while potentially missing out if prices really do better than 3-4%/year? Thus investors should not be scared by lumpy results - as the pendulum swings both ways. While EPS is not going to be as smooth as that for a Brown-Forman (BF.B), patient investors with long-term horizons could be pretty well compensated for the risks they took 15 - 20 years ago.

In another article, I discussed how not all P/E ratios are created equal. Because oil companies are cyclicals who explore for and produce oil and gas, they are price takers. This is because oil is a commodity, that sells on a global scale and is virtually not differentiated ( yes there are differences in type, such as heavy, sweet etc, but one cannot demand premium price for those if needed). Thus, their EPS and revenues are going to be volatile than revenues for Procter & Gamble (PG), Johnson & Johnson (JNJ) or PepsiCo (PEP). Hence, investors should not have taken the Low P/E’s at face value, but should have done their own independent assessments and stress test what earnings per share should be under variety of scenarios.

The point is that an investor buying energy companies today should not throw caution out the window. One needs to always maintain a risk-averse attitude, which would enable them to continue investing, even if they are temporarily wrong.

The first line in defense is to own energy companies in the context of a diversified dividend growth portfolio.

The second line of defense is the type of energy companies to own. For example, there are some energy companies such as pipelines, that are not dependent on prices of oil and gas. Those are dependent on volume of oil and gas transported throughout their vast network. The volume are generally stable and not volatile like the prices of underlying commodities. Many of these could be temporarily knocked down by program selling where some heavy hitter wants to get out of “energy” exposure and thus indiscriminately selling everything, pipelines included.

The third line of defense is to acquire positions in those energy companies which have managed to increase and maintain dividends for several decades. If a company has managed to maintain dividend payments and even increase them in the 1980s or 1990s, when energy prices were mostly flat, they get gold stars in my book. Those companies include majors like Exxon Mobil (XOM), Chevron (CVX), and ConocoPhillips (COP). Companies that are facing some weaknesses today, might be in a tougher positions, since lower prices are putting an extra squeeze on the situation. This is why quality blue chip energy companies, with demonstrated staying power in earnings and dividends during previous difficult times for oil and gas prices is important.

The fourth line of defense is acquiring stakes in those energy companies slowly, in case one does not get the timing right. I always like to give myself some room for error, in case I am wrong, when I am building out a position in a company. For example, if energy prices keep sliding from here, many energy companies might not only have to report much lower earnings, but they might also have to have big one-time impairment expenses. Writing down assets is one of the major reason why ConocoPhillips lost money in the fourth quarter of 2008. The last but not least line of defense is to focus on companies that offer a sustainable dividend payout ratio. Exxon Mobil (XOM), Chevron (CVX), and ConocoPhillips (COP). have sustainable dividend payout ratios today. I believe that dividends per share will be maintained, even if earnings dropped by half in 2015.

Tomorrow I will continue the discussion on whether energy stock values represent a good opportunity for investment. I will discuss the investments I am considering in this environment, and dig into more detail behind each company. Stay tuned for another article tomorrow.

Full Disclosure: Long COP, XOM, CVX, RDS/B, BP, PEP, JNJ, PG, BF.B,

Relevant Articles:

How to Generate Energy Dividends Despite the Peak Oil Non Sense
Why Warren Buffett purchased Exxon Mobil stock?
Dividend Investors Should Ignore Price Fluctuations
The predictive value of rising dividends
You don’t need to be right all the time to succeed with dividend investing

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