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

Monday, July 7, 2014

Are you drowning in cash?

With dividend investing, I get a lot of cash every week/month/quarter/year. Since I started focusing exclusively on dividend growth investing 6-7 years ago, quarterly dividend income has been increasing exponentially. I get a lot of cash, which i have to deploy intelligently. By that I mean avoiding overpaying, keeping diversification intact, and always being on the lookout for bargains that offer dividend growth. I therefore try to benefit from multiple levels of compounding - one is the dividend income that grows because companies earn more and hike dividends. The second is reinvesting those dividends into more quality companies selling at attractive valuations. Too much of a good can be a good thing too.

Lately, it has been very difficult to find good ideas, which are also priced attractively. I am really trying hard, and had found some ideas. However, given elevated valuation levels, it is more difficult to deploy cash in the future. Many companies and investors have similar issues, because they are drowning in cash, and money is so cheap too. I am afraid this could create bad behavior, which will be punished a few years down the road at the next recession.

Cash might burn a hole in corporate boards pockets. If they pay out dividends, that could be smarter than buying back stock at inflated valuations. For example, companies like General Electric (GE) spent tens of billions repurchasing shares at $30 between 2004 – 2007, only to issue a bunch of shares and warrants at $23/share. This is also smarter than bidding for assets today and paying high prices in order to deploy that cash, without much margin of safety on the returns of those assets.

When you have a lot of cash on hand, the odds that u will do something stupid with it increase exponentially. Even Warren Buffett is not immune to this folly - examples include investments in United Airlines and Salomon Bros in the late 1980s. He was drowning in cash in the late 1980s and put capital to use at suboptimal prices in assets of questionable quality. I am not saying this to predict a crash, since i don’t forecast market or economic directions. It is a fools game to make predictions about prices, the economy etc. However, i am just venting how more difficult it is to find quality companies that are selling at good prices today. This increases the opportunity that I do something that is bad today, but looks cheap because i am drowning in cash.

Either way, I believe that for a long-term buyer of equities today, with a 20 year horizon would do much better than someone who holds cash waiting for lower prices. For example, ever since late 2009, I have been hearing from investors that they are accumulating cash and waiting for lower prices. I have also been hearing from those who are bearish on everything. These people seem to forget that over time, businesses become more valuable, as they plow more money in their operations and earn more. Then they pay out more to shareholders. That doesn’t happen every year of course, but over time, I believe that productivity gains, increases in numbers of consumers and reinvestment in operations will lead to stakes in quality corporations becoming more valuable. Therefore, it makes sense to put money to work as soon as you have it, and then hold on for 20 years. This strategy of regular dollar cost averaging worked even for those who started right around the Great Depression for example. There are always decent values out there, which would start the dividend compounding process for the investor. It is that the investor has to do the work to identify them. A few quality companies selling at decent prices today include:

Company
Ticker
Yrs Div Increase
5 year DG
Fwd P/E
Yield
Review
Target
TGT
47
21.40%
16.10
3.60%
Exxon Mobil
XOM
32
9.70%
13.20
2.70%
Philip Morris Intl
PM
6
28.40%
16.60
4.10%
McDonald's
MCD
38
13.90%
17.50
3.20%
Baxter International
BAX
8
16.40%
14.60
2.80%
Aflac
AFL
31
8.10%
10.20
2.30%
IBM
IBM
19
14.30%
10.60
2.40%
Lockheed Martin
LMT
11
21.20%
14.60
3.20%
Diageo
DEO
15
7.20%
19.80
2.70%
Wal-Mart
WMT
41
14.20%
14.70
2.50%


Since I get cash every week/month/quarter from my investments and my other income sources, I am well positioned for a stock decline. In fact, I took a big advantage of the declines in February, during which i maxed out SEP IRA, and put one third of the maximum for the 401k. Plus I bought shares in taxable accounts. I have been opportunistically looking for companies which are temporarily battered by short-term noise for decent entry points. This is how I managed to initiate a small position in Accenture (ACN). It is too bad I didn’t put much in Roth IRA. Of course, perfectionist thinking is dangerous in investing, as it can also cause folly, that can lead to stupid actions on my part.

What are you buying these days?

Full Disclosure: Long ACN, TGT, XOM, PM, MCD, AFL, IBM, DEO, WMT

Relevant Articles:

How to find long term dividend stock ideas
Six Compounding Machines for Long Term Dividend Investors
How to become a successful dividend investor
Best Brokerage Accounts for Dividend Investors
How to retire in 10 years with dividend stocks

Wednesday, June 25, 2014

Does diversification lead to lower quality of investments in dividend portfolios?

Diversification matters, because it protects investors from the proverbial bad apple that can take a serious bite out of your dividend income at the worst possible time. Dividend investors should construct an income producing portfolio consisting of at least 30 individual stocks, which are representative of as many sectors that make sense, in order to be somewhat diversified.

One of the main concerns that some investors have against diversification involves time spent keeping up with companies and the quality of new investments purchased.

The problem is that not every company is a quality one, and by expanding their list of holdings from 20 to 40, some investors are concerned that the quality of the portfolio would be deteriorating. This could be particularly true, if investors were simply adding additional positions in companies the sake of adding new positions simply to meet the number of positions requirement. Investors should never sacrifice quality of the companies they buy stock in, simply for the purposes of diversification. Owning shares of a company that makes horse-carriages just so you have exposure to the sector would have been a bad idea ever since the automobile became mainstream in the early 20th century. Investors should choose only these quality stocks that make sense and which are attractively valued.

The number of positions in a portfolio will depend on the external environment and the availability of quality firms at attractive valuations. It is much easier to start a dividend portfolio when stocks are undervalued, than when stocks are hitting new all-time-highs every day. However, in my investing I have found that there are usually at least 20 quality dividend companies with sustainable competitive advantages which I find attractively valued. I still monitor companies with solid competitive advantages that I have added to a wish list for a potential inclusion to my portfolio, in order to be ready when the right time comes. For example, in early February, I bought shares in McCormick (MKC) and Diageo (DEO) on the dip, thus taking advantage of a brief sell-off that had temporarily taken those shares into value territory.

The initial amount of time spent to research new positions can easily consume 10 – 30 hours per week. However, keeping up with new material developments affecting the company should not take more than a few hours per week. This makes a diversified portfolio of 30 - 40 individual securities manageable to maintain and monitor.

There are ten major sectors as identified by Standard and Poor’s. For my portfolio, I try to gain exposure to as many of these sectors as possible by purchasing the top three or four companies that pay rising dividends. This provides for an easy pool of at least 30 – 40 companies to own at some point in a diversified dividend portfolio, without lowering the quality of an income portfolio. By selecting the top three or four players in a given industry, when one incidentally ends up cutting dividends or going under, the other major players in the field will win business or might be available for purchasing on dips. As a result, the overall risk to the portfolio is not going to be that high, unless the whole sector is imploding. Of course, it doesn't make sense to merely add companies for the purposes of diversification. If a company is not perceived as a good quality by the investor, and it cannot be purchased for a good value today, then it should not be acquired, even if that means no exposure to the sector altogether. In some sectors such as energy, it is easier to select the top players, since most companies in this group of stocks tend to pay a stable and rising dividend. In other sectors such as Technology, it is more difficult to find a company that has raised distributions for over 20 years in a row for example. The availability of good stock candidates for inclusion in a dividend portfolio is going to vary over time. For example, back in 2008 - 2009, I found utilities like Con Edison (ED) or Dominion Resources (D) to be decent picks.  Currently, I am having a hard time justifying a purchase in any utility company in the US.

In my personal experience, having a diversified portfolio, representative of many sectors, and involving multiple companies per sector has definitely shielded me during difficult times.

For example, back in 2010, my energy holdings included Exxon Mobil (XOM), Chevron (CVX), British Petroleum (BP), Kinder Morgan (KMR) and Enbirdge Energy Management (EEQ). When British Petroleum (BP) cut dividends in 2010, I immediately sold the stock. With the cash proceeds I purchased a stock which was in the energy sector and was also based outside of the US. The company I purchased was Royal Dutch (RDS/B). I could have easily purchased any of the other major oil players, and had similar results. Whenever I sell a stock, I try to replace it with the stock of a company in the same industry when possible. However, this is not always a viable alternative.

Another example was during the 2008 – 2009 period, when many financials cut dividends. I ended up selling State Street (STT), General Electric (GE) and American Capital (ACAS). However, other financials such as Aflac (AFL) or M&T Bank (MTB) did not cut dividends, which is why I hung on to them. I even ended up adding to Aflac at some crazy low prices. Unfortunately, the financial sector did not offer many financial companies that fit my models, which is why I ended up reinvesting most of the funds generated from the sales in stock from other sectors.

To summarize, it is important for ordinary investors to spread their risk out, in order to protect their nest egg. This could be easily done by creating a diversified dividend portfolio that includes at least 30 - 40 equally weighted positions, that are built slowly over time, and purchased at attractive valuations. One should not add companies merely for the sake of adding companies of course. However, based on my experience since 2007 - 2008, a decent number of quality dividend paying stocks is always available at attractive valuations to the enterprising dividend investor. Therefore, it is quite possible to build a diversified portfolio of quality companies, and live off dividends, without being exposed too much to sector risk. As I frequently say, the goal of dividend growth investor is to get rich, and stay rich. I believe that one needs to get rich just once in their lifetime, and then reap the rewards for the rest of their life.

Full Disclosure: Long XOM, CVX,  KMR, EEQ, BP, AFL, MTB,

Relevant Articles:

Diversified Dividend Portfolios – Don’t forget about quality
Dividend Portfolios – concentrate or diversify?
- Replacing Dividend Stocks Sold
How long does it take to manage a dividend portfolio?
Myths about Warren Buffett

Wednesday, June 11, 2014

Margin of Safety in Financial Independence

Financial independence is the point at which your annual dividend income meets or exceeds your annual expenditures. At this point, the dividend investor does not need to have a job, although they could decide to keep doing their work if they enjoy it. The best part is that the investor does not need to work for money again in their life, and can choose to spend their time as they please. They could do volunteer work, take care of younger or elder family members, travel, read or write, or even watch soap operas all the time. If they enjoy their work, they could continue doing that, or they might decide to start their own independent business. The sky is the limit when you have taken care of the downside, by having a dividend portfolio generate an ever rising amount of cash every year, which covers your expenses.

I believe that a dividend portfolio will generate rising income for decades, and solid capital gains in the process of 30 years or more. Even at a total return of 7%/year, $1 million today will grow to $8 million over that time period. That of course assume that dividends are spent, and very little is reinvested back. Some companies will be sold, acquired, merged or fail, but in general this will be a very passive portfolio. I am pretty optimistic about my portfolio after I reach financial independence and believe I will ultimately end up earning much more in dividends than what I would ever earn from paid employment. Once I select a quality dividend paying company, my only downside is the price I paid for the stock. My upside is the sum of all future dividends I will receive until the end of time. The rest is unrealized capital gains, which would result in a step-up basis for whoever inherits the DGI nest egg. However, I am also operating under the belief that the upside will take care of itself. Therefore, I need to spend my time to protect my downside risks. As a result, I believe in generating redundancies in my portfolio, in order to ensure that I stay financially independent. This is where the concept of margin of safety in Financial Independence comes from.

I took the idea of redundancies from the concept of engineering, where bridges are constructed, so that they can carry several times their projected peak load. They have built in overlaps and redundancies just in case peak loads increase over time, and also to withstand a long period of normal wear and tear.

For my portfolio, I want to ensure I it withstands as much pressure without breaking. Thus, i expect to have multiple layers of redundancies built into my portfolio.

- I buy stocks that have many products/services with revenues derived from many continents/countries. This diversity in revenue streams ensures that company is not overly reliant on a single product for which demand softens.

- I buy stocks from different industries, and I try to be diversified so that a total collapse of one of these companies doesn't derail my plans. I seek safety in numbers and believe that a portfolio should include at least 30 – 40 individual components for diversification purposes.

- I focus on companies that regularly hike dividends, and have an established track record of doing so. This provides an extra layer protection that my dividend income will keep up with inflation over time.

- I make sure dividend payments are adequately covered for any new companies I buy, so that short term fluctuations in earnings per share do not leave dividends in danger. In addition, I make sure that dividend growth is not largely achieved by the expansion in the payout ratio.

- I also plan to retire when dividend income covers expenses by a nice margin of up to 1.30- 1.50 times expenses. I am placing the money that generates the excess dividends in tax-deferred accounts, so that they grow uninterrupted if I never use them. In addition, putting money in tax-deferred accounts further diversifies my asset base, and would shelter this portion of networth from taxes for several decades from now.

- I hold my stocks through several brokerages, in order to make sure I would always be under the SIPC covered amounts, and protect myself in case of broker failures

On a personal note, I also try to keep 3 – 6 months of expenses in my checking account. I do these funds just in case, even though I do not really need an emergency fund. I do not need an emergency fund, because I am disciplined about my spending. In addition, my dividend portfolio is an emergency fund of itself, since it would throw off enough cash to support me for 12 months. Currently, this figure is close to 7 months worth of expenses being covered by dividend income. Plus, I view my dividend portfolio as an emergency fund that has enough resources to pay for somewhere around 240 months’ worth of expenses.

In addition to that, I also have a line of credit equivalent to 2 years expenses I can draw on, in case my cash reserves are depleted. I honestly doubt that I would ever use the cash or line of credit for emergency purposes, but then you never know what the future holds for.

Next, I also expect that I will be able to collect some Social Security benefits in the future, when I become eligible for them. I strongly doubt that Social Security will ever be destroyed, although I wouldn’t be surprised if it gets modified in the future. I view Social Security income as similar to an investment in an inflation-protected annuity or inflation protected treasury bond.

The one weak spot in my retirement planning is the absolutely low amount of fixed income allocation I have. In order to withstand the next Great Depression or Japan of the past 20 years, I would need to have exposure to domestic government bonds. If we get deflation, this would jeopardize corporate profits and the ability to maintain dividend payments for a lot of companies. My allocation to fixed income is currently less than 1% today. I do not believe that the current environment offers good prospects for buyers of US Treasuries, which is why I have abstained from investing there. I simply do not want to invest my money in an asset whose principal and income are certain to lose purchasing power over time. However, I am monitoring the situation, and would gladly change my mind if attractive offers are present.

Relevant Articles:

Dividend Investing Is Not As Risky As It Is Portrayed
Dividends Offer an Instant Rebate on Your Purchase Price
How to define risk in dividend paying stocks?
Stress Testing Your Dividend Portfolio
Where are the original Dividend Aristocrats now?

Tuesday, June 10, 2014

Dividend Growth Stocks are Compounding Machines

Compounding is one of the eight wonders of the world. The steady methodical reinvestment at a particular rate of a return, over a period of time results in a much larger amount in the future.

In my studies of dividend growth stocks I have always be amazed how otherwise large, boring, and slow growing enterprises can end up delivering outstanding returns to their shareholders. Most people on the street believe that the way to make money in stocks is by finding a company that can double your money overnight. Many of those lose thousands of dollars each year, trying to find a method to identify the next Microsoft, Google, Amazon, Tesla etc. At the same time the blue chip dividend stocks that provide spectacular long-term results are familiar to everyone, are usually selling at decent valuations, and provide steady a dependable growth of their earnings and dividends. All the while the first group of investors is looking for the best get rich quick scheme, the investors in the mature dividend growth stocks are quietly compounding their wealth and dividend incomes.

The largest gains are harvested by those that have the patience to buy a portfolio of quality dividend growth stocks, patiently reinvest dividends into more quality dividend paying stocks over long periods of time. To someone who doesn’t want to open their mind to the world of successful dividend investing, a 3% current dividend yield and a steady 6% annual dividend growth does not sound glamorous at all. To an investor with a vision however, this is seen as $400 in annual dividend income on a $1000 investment in 30 years. In other words, this investor will be getting massive amounts of dividend income in the future, for a decision they made 30 years before. If we extend the time period to 40 years, the annual dividend income will be close to $960. Those are of course extremely conservative estimates, as they are close to the historical growth in dividends in US stocks on average throughout most of the 20th century.

In essence, those companies earn excess cash flows. After they reinvest cash in the business in order to maintain and increase the size of operations, there is a plenty of cash left over. They are then sending those growing piles of dividend checks to their shareholders. If you are drowning in liquidity, you cannot help it but prosper as an enterprise or as an investor.

I have highlighted here a few examples of compounding machines. This is not an exhaustive list, as there are a lot more companies to start researching. So here are the examples below:

Exxon-Mobil (XOM)

The company has managed to grow earnings per share from $1.04 in 1993 to $7.37 in 2013. At the same time, the company has managed to increase annual dividends per share from 72 cents in 1993 to $2.46 in 2013. If you invested $1000 in 1993, your investment would be worth almost $10,983 today, and would be earning $300 in annual dividend income.

Johnson & Johnson (JNJ)

The company has managed to grow earnings per share from $0.69 in 1993 to $4.81 in 2013. At the same time, the company has managed to increase annual dividends per share from 25 cents in 1993 to $2.59 in 2013. If you invested $1000 in 1993, your investment would be worth $14,491 today, and would be earning $393 in annual dividend income.

PepsiCo (PEP)

The company has managed to grow earnings per share from $0.98 in 1993 to $4.32 in 2013. At the same time, the company has managed to increase annual dividends per share from 30 cents in 1993 to $2.24 in 2013. If you invested $1000 in 1993, your investment would be worth $7,061 today, and would be earning $210 in annual dividend income.

Many investors refuse to purchase these companies, because they believe that most of the profits have already been made. They believe that there is not much to look forward to for those companies, which is why they keep ignoring them. This is precisely why those investments have done so well for their shareholders – there have always been low expectations for them. As a result, those dividends have been patiently reinvested into more shares at low valuations, resulting in more dividend income, that is then reinvesting into more shares at depressed valuations.. This is a virtuous cycle, that is almost guaranteed to lift the investor fortunes.

Full Disclosure: Long XOM, JNJ, PEP

Relevant Articles:

Six Compounding Machines for Long Term Dividend Investors
How to retire in 10 years with dividend stocks
How to find long term dividend stock ideas
How to become a successful dividend investor
Achieve Financial Independence with Dividend Paying Stocks

Monday, June 9, 2014

7 Dividend Paying Stocks I Purchased Without Paying Commissions

Several months ago, I opened an account with Loyal3, which is a commission free stock brokerage. The nice part about this brokerage was that one could buy shares in companies with as little as $10 per transaction, and not pay any commissions. In addition, one can use a credit card to purchase shares in some of America’s greatest brands. The issue was that there are only 50 or so companies that are available to be purchased directly using Loyal3. On the bright side however, there are several world-class dividend champions, which are core holdings for many dividend growth investors. Those strong brands will likely grow dividends and enhance shareholder value for decades to come.

Once I signed up for the service, I decided to put about $50/month in several of those companies, which had increased dividends for a set number of years and met some basic valuation guidelines. The appeal of not paying commissions, and obtaining a 1% credit card rebate was attractive. For one of the companies, Target (TGT), I put more than $50 using Loyal3. For a few others, I played around and increased or decreased contributions. In one case, I stopped contributions to Wal-Mart Stores (WMT) after they announced the lowest dividend increase in their history. Currently, I am putting $50/month in the following companies:

The Coca-Cola Company (KO), a beverage company, engages in the manufacture, marketing, and sale of nonalcoholic beverages worldwide. This dividend champion has consistently raised distributions for 52 years in a row. Over the past decade, the company as managed to boost dividends by 9.80%/year. Currently, the stock is trading at 19.50 times forward earnings and yields 3%. Check my analysis of Coca-Cola for more details.

Dr Pepper Snapple Group, Inc. (DPS) operates as a brand owner, manufacturer, and distributor of non-alcoholic beverages in the United States, Canada, Mexico, and the Caribbean. This dividend stock initiated dividends in 2009 and has been raising them annually ever since. Currently, the stock is trading at 16.70 times forward earnings and yields 2.80%. Check my analysis of Dr Pepper for more details.

Kellogg Company (K), together with its subsidiaries, manufactures and markets ready-to-eat cereal and convenience food products primarily in North America, Europe, Latin America, and the Asia Pacific. This dividend stock has managed to raise distributions for ten years in a row. Over the past decade, the company has managed to boost dividends by 5.90%/year. Currently, the stock is trading at 17.30 times forward earnings and yields 2.70%. Check my analysis of Kellogg for more details.

McDonald'’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has consistently raised distributions for 38 years in a row. Over the past decade, it has managed to boost dividends by 22.80%/year. Currently, the stock is trading at 17.80 times forward earnings and yields 3.20%. Check my analysis of McDonald's for more details.

PepsiCo, Inc. (PEP) operates as a food and beverage company worldwide. This dividend champion has consistently raised distributions for 42 years in a row. Over the past decade, it has managed to boost dividends by 13.70%/year. Currently, the stock is trading at 19.30 times forward earnings and yields 3%. Check my analysis of PepsiCo for more details.

Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has consistently raised distributions for 46 years in a row. Over the past decade, it has managed to boost dividends by 19.80%/year. Currently, the stock is trading at 15.50 times forward earnings and yields 3%. Check my analysis of Target for more details.

Unilever PLC (UL) operates as a fast-moving consumer goods company in Asia, Africa, the Middle East, Turkey, Europe, and the Americas. This international dividend achiever has consistently raised distributions for over 19 years in a row. Over the past decade, Unilever has managed to boost dividends by 9.90%/year. Currently, the stock is trading at 19.90 times forward earnings and yields 3.50%. Check my analysis of Unilever for more details.

If any of those companies sell for more than 20 times forward earnings 1 - 2 days prior to purchase date, I would cancel the recurring transaction however. Several of the companies on that list are interesting, but I would only consider them at better valuations. Hershey (HSY), Yum! Brands (YUM) and Starbucks (SBUX) are examples of such ideas.

I view this as an experiment than anything else. If you put $50/month in several individual dividend paying stocks, and you do this for a long period of time, you could end up with a lot of money in the future. This mass of enterprises could deliver tens of thousands of dollars in annual dividend income decades down the road. The only things you need to do is make sure to not overpay, diversify and then let the capital compound over long periods of time. If you think that $400 is nothing, you definitely need to spend more time learning about investments, time value of money, and the power of compounding. There are plenty of examples of successful dividend investors, who have turned small amounts of capital into multi-million dollar bequests to their favorite charities after their death. Therefore, do not despise the days of small beginnings.

The one thing that surprised me is how effortless automatic dividend investment could be. Over the course of 5 – 6 months, regularly putting money in several companies has resulted in a balance of several thousand dollars without much effort. The annual dividend income from this portfolio is now in the hundreds of dollars per year. This income will keep increasing over the next 30 – 40 years. This growth would be further compounded by selective dividend reinvestment.

The other lesson to learn is to start investing as early as possible, and try to put as much capital to work as possible. Consumption today is expensive from the lens of what the capital could generate if you let it compound for 30 – 40 years. For those who say that they do not have money to invest today, there is no absolutely no excuse to avoid investing, given that Loyal3 allows commission free investing with as little as $10.

Full Disclosure: Long KO, DPS, K, MCD, PEP, TGT, UL, WMT, YUM and short HSY puts

Relevant Articles:

How to buy dividend stocks with as little as $10
How to become a successful dividend investor
Warren Buffett – A Closet Dividend Investor
The Most Successful Dividend Investors of all time
Living off dividends in retirement

Monday, June 2, 2014

How to stay motivated on your road to financial independence

In my post related to my 2014 goals and objectives, I shared with readers my roadmap to financial independence by 2018. Currently, the goal is to have more than 2/3rds of expenses to be covered by dividends. I believe that a 100% coverage of expenses by dividends by 2018 is very doable, as long as existing companies I own manage to raise dividends by 6%-7%/year on average and I manage to reinvest distributions at 3%-4%. As I had mentioned earlier, most of my contributions are now going into tax-deferred accounts, in order to create a tax-free buffer for the excess dividend income I will be generating.

The road to financial independence is very exciting and liberating. I find it really liberating to check every quarter how much of my expenses is being covered by my dividend income. Ever since I converted to Dividend Growth Investing in late 2007 – early 2008, my dividend income has been increasing exponentially. This is a result of my plan to retire early.

So for the past 7 or so years, I have been focusing on several levers within my control, in order to achieve financial independence. The levers include saving a lot, finding ways to earn extra money, investing my hard earned money in the best values at the moment, and focusing my attention on researching companies and continuously increasing my knowledge about investing matters. The most difficult part of the journey however is the job situation, which has resulted in increased levels of stress for the past several years. The pay has been decent, but the increase in level of responsibilities has exceeded the level of income growth by a large factor. It is very difficult to keep producing and keeping up to those high expectations and stress, when you are also so close to the finish line. The problem is that the finish line is about 5 years down the road. ( 2014, 2015, 2016, 2017 and 2018). The one thing that I find difficult, is to endure the daily grind that leads to the dividend crossover point. I do not believe that it is healthy to sit in a cubicle for 60 hours on a slow week, while getting stressed out over impossible deadlines.

This means I still need to keep motivated enough, and work harder, before getting to the Promised Land. I find it tough to keep up with the daily grind, which is why I try to motivate myself to perform, because the daily grind is a major source of capital for my FI. I motivate myself by consistently trying to save a large portion every month, in order to put it to work, and have the asset base to generate more dividends. I motivate myself by searching for quality companies at bargain prices, and researching their business models in order to determine whether they can be sustainable engines of dividend growth for the foreseeable future. I also motivate myself by charting my dividend income over time, and visualizing the point in time when expenses will be more than covered by dividends by a nice factor of 1.3 - 1.5. I do want to do it the right way, and not quit in the middle of the journey. That’s why 2018 is the reasonable goal to have.

For me this is the point where my dividend income increases expenses, and technically I would never again have to work for money. That doesn’t mean I would do nothing, but would provide me with freedom of choice to pursue only projects and people I find interesting. I may still choose to work after that point, or do something else. However, having options in life is something that is extremely valuable.

The types of dividend growth stocks that will pay for my retirement, provide me with consistent raises include:

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has managed to increase dividends for 6 years in a row, and currently sells for 17.10 times forward earnings and yields 4.30%. Check my analysis of PMI.

PepsiCo, Inc. (PEP) operates as a food and beverage company worldwide. This dividend champion has managed to increase dividends for 42 years in a row, and over the past decade has managed to boost them by 13.70%/year.  Currently, the stock is trading at 19.40 times forward earning and yields 3%. Check my analysis of PepsiCo.

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has managed to increase dividends for 32 years in a row, and over the past decade has managed to boost them by 9.60%/year.  Currently, the stock is trading at 13 times forward earning and yields 2.70%. Check my analysis of Exxon Mobil.

Johnson & Johnson (JNJ), together with its subsidiaries, is engaged in the research and development, manufacture, and sale of various products in the health care field worldwide. This dividend champion has managed to increase dividends for 52 years in a row, and over the past decade has managed to boost them by 10.80%/year.  Currently, the stock is trading at 17.30 times forward earning and yields 2.80%. Check my analysis of Johnson & Johnson.

General Mills, Inc. (GIS) produces and markets branded consumer foods in the United States and internationally. This dividend achiever has managed to increase dividends for 11 years in a row, and over the past decade has managed to boost them by 9.90%/year.  Currently, the stock is trading at 19.10 times forward earning and yields 3%. Check my analysis of General Mills.

There are several lessons however, which are applicable to everyone reading, even if you really enjoy your work and never want to retire. Things change, people change, companies change, which is why it is quite possible to really start hating what you do in the future, which might be unthinkable to you today. I am very lucky that I never had much in terms of debt, other than a credit card I pay off in full every month. I am also very lucky that I have had the frugal mentality to save as much as possible from my income, and also focus on increasing it over time. The problem of course is that reaching the goal takes time, which is the one commodity we can never buy back. On the bright side of course, once you reach the point of your goals, you would only have to deal with the rest of life’s challenges.

So how do you stay motivated on your road to financial independence?

Full Disclosure: Long PM, PEP, XOM, JNJ, GIS

Relevant Articles:

How to become a successful dividend investor
My Retirement Strategy for Tax-Free Income
Dividends Provide a Tax-Efficient Form of Income
What is Dividend Growth Investing?
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Thursday, May 29, 2014

Let dividends do the heavy lifting for your retirement

As a dividend growth investor, my goal is to build a portfolio of quality dividend paying companies, that grow dividends over time. My success in achieving that is dependent on amount of savings I can put to work each month, the returns I can generate and the time I allow the investments to compound.

I believe that consistently saving a portion of my income is the basic foundation behind my financial independence calculation. However what I do with that money is equally as important, because if I am successful, the amounts I earn from investing will be many times what I would have earned during my lifetime. In other words, if I saved $1000/month for 20 years, I would have ended up putting approximately $240,000. Let’s assume that I invest it all in dividend growth stocks that yield 3% today and grow distributions by 7% annually. Distributions are then reinvested in more companies yielding 3%, which grow dividends by 7% per year.

After 20 years, the value of this hypothetical portfolio would be approximately $715,000. It would be earning over $21,500 in annual dividend income. The power of compounding has resulted in a gain of over half a million dollars in net income. This power of compounding was created when earnings were plowed back in the business to maintain and increase profits and have the capacity to increase dividends. Those increased dividends are then also plowed back to buy more shares, which turbocharges the income growth potential.

As you can see, by year 20, the amount of dividends that is earned covers the amount of funds put to work in the portfolio almost by a factor of two. This shows that consistent compounding of capital and dividend income can result in much more funds that those initially put to work. The amounts put to work are really minuscule relative to the ending amounts, after a period of consistent compounding of capital and income.
If you continued compounding for another 30 years, the amounts put would look even smaller, relative to the ending amounts of capital and income.

Of course, this goes on to show that even small amounts of money that are left to compound over long periods of time and a consistent rate of return, could mushroom into pretty sizeable fortunes. This is why you should never despise the days of small beginnings, but should start investing as soon as possible. The earlier your start, the more time do you have to compound your capital.

For example, if you are 25 years old and you can only afford to put $10,000 to work in dividend paying stocks once, you can do pretty well over a 40 year period. When you are 65, you can end up with a portfolio earning almost $13,800 in annual dividend income. If you are 50 years old, and you want to earn the same type of income at the age of 65, you need to put $114,000 to work for you. You can definitely see with this example that starting as early as possible lets your dividend growth stocks do the heavy lifting for you. I have shared the spreadsheet I used to create those calculations here.

For example, one of the largest beneficiaries of the power of compounding is Warren Buffett. He became a billionaire in 1986, at the age of 56. Now, at the tender age of 84, he is worth $58.50 billion. In other words, 98% of this fortune was achieved in the past 28 years. This was mostly done because of the power of compounding.

I keep seeing investors that do not understand why it makes sense to buy dividend growth companies that yield only 2.5% - 3% today. What those investors are missing however is really obvious. They miss that those companies regularly manage to grow their dividends, because they are able to increase profits over time. If you start with a 3% yield today, but you grow the dividend by 7%/year for 30 years, you will end up with a stock that pays you a 24% yield on your cost eventually. In other words, if you put $1000 in a dividend paying stock that yields 3% today, but grows those dividends by 7% per year, you will end up with an annual dividend income of $240 in 30 years. This example of course assumes that you spend all the dividends. If you reinvested those dividends into more stock for 30 years, the annual dividend income produced by that dividend machine would be $520 ever year.

I am going to feature nine quality companies that look attractively valued today, and which could result in pretty decent results if compounded over the next 30 years include:

Altria Group, Inc. (MO), through its subsidiaries, manufactures and sells cigarettes, smokeless products, and wine in the United States and internationally. This dividend champion has managed to raise dividends for 44 years in a row and has managed to grow dividends by 11.40%/year over the past decade. Currently, is trading at 15.80 times forward earnings and yields 4.70%. Check my analysis of Altria.

Chevron Corporation (CVX), through its subsidiaries, is engaged in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion has managed to raise dividends for 26 years in a row and has managed to grow dividends by 10.60%/year over the past decade. Currently, is trading at 11.50 times forward earnings and yields 3.50%. Check my analysis of Chevron.

The Coca-Cola Company (KO), a beverage company, manufactures and distributes coke, diet coke, and other soft drinks worldwide. This dividend champion has managed to raise dividends 52 for years in a row and has managed to grow dividends by 9.80%/year over the past decade. Currently, is trading at 19.40 times forward earnings and yields 3%. Check my analysis of Coca-Cola.

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has managed to raise dividends for 32 years in a row and has managed to grow dividends by 9.60%/year over the past decade. Currently, is trading at 13.10 times forward earnings and yields 2.70%. Check my analysis of Exxon Mobil.

Genuine Parts Company (GPC) distributes automotive replacement parts, industrial replacement parts, office products, and electrical/electronic materials in the United States, Puerto Rico, the Dominican Republic, Mexico, and Canada. This dividend champion has managed to raise dividends for 58 years in a row and has managed to grow dividends by 6.20%/year over the past decade. Currently, is trading at 18.50 times forward earnings and yields 2.70%. Check my analysis of Genuine Parts Company.

Johnson & Johnson (JNJ), together with its subsidiaries, is engaged in the research and development, manufacture, and sale of various products in the health care field worldwide. This dividend champion has managed to raise dividends for 52 years in a row and has managed to grow dividends by 10.80%/year over the past decade. Currently, is trading at 17.20 times forward earnings and yields 2.80%. Check my analysis of Johnson & Johnson.

PepsiCo, Inc. (PEP) operates as a food and beverage company worldwide. This dividend champion has managed to raise dividends for 42 years in a row and has managed to grow dividends by 13.70%/year over the past decade. Currently, is trading at 18.90 times forward earnings and yields 3.10%. Check my analysis of PepsiCo.

The Procter & Gamble Company (PG), together with its subsidiaries, manufactures and sells branded consumer packaged goods. This dividend champion has managed to raise dividends for 58 years in a row and has managed to grow dividends by 10.60%/year over the past decade. Currently, is trading at 19.20 times forward earnings and yields 3.20%. Check my analysis of Procter & Gamble.

Target Corporation (TGT) operates general merchandise stores in the United States and Canada. This dividend champion has managed to raise dividends for 46 years in a row and has managed to grow dividends by 19.80%/year over the past decade. Currently, is trading at 14.50 times forward earnings and yields 3.10%. Check my analysis of Target.

General Mills, Inc. (GIS) produces and markets branded consumer foods in the United States and internationally. This dividend achiever has managed to raise dividends for 11 years in a row and has managed to grow dividends by 10.80%/year over the past decade. Currently, is trading at 18.70 times forward earnings and yields 3%. Check my analysis of General Mills.

Eight of these companies are dividend champions whose annual dividend growth rate exceeded 6%/year over the past 1, 3, 5, and 10 years, yield as above 2.50% and selling for less than 20 times earnings. The last one is a dividend achiever, which I am trying to build a sizeable position in over the next couple of years.

To summarize, savings is important to get you started in investing. However, at some point, the power of compounding is a much stronger and more powerful driving force that would help you achieve your dividend income objectives. This is why it is important to start investing as early as possible, in order to allow your capital maximum amount of compounding time. As they say, it is time in the market that truly counts, not timing the market.

Full Disclosure: Long MO, CVX, KO, XOM, JNJ, PEP, PG, TGT, GIS

Relevant Articles:

Dividend Investors Should Ignore Market Fluctuations
Dividend Investing Is Not As Risky As It Is Portrait out to be
How to buy dividend stocks with as little as $10
Warren Buffett Investing Resource Page
The importance of investing for retirement as early as possible

Tuesday, May 27, 2014

Why I don’t do discounted cash flow analysis on dividend stocks

Imagine that you have two companies that are selling for the same valuation, which are also in the same industry and have similar current yields. Both companies would be characterized as “quality dividend paying ones”, as they each have strong branded products that consumers buy, good pricing power, and opportunities for growth. Coca-Cola (KO) and PepsiCo (PEP) fit my idea of what a quality dividend growth company is.

The question to answer is, if you wanted to buy the shares in just one of the companies, which one would you purchase?

For me, the answer is always to look for the one with the higher growth potential. It is a no brainer decision to select the company with the highest expected growth, particularly if the valuations are similar.

In reality however, investor expectations are just that, expectations. They do not become tangible fact, until enough time has passed in order for you to determine if those expectations occurred or not. In other words, if I expect Coca-Cola to double earnings per share every decade for the next 30 years, I would have to wait until 2044 until I can say if my expectation was right. One can expect a lot of things changing from now until 2044, many of which might not be even comprehensible for someone thinking about the future in 2014.

Therefore, in my stock selection process, I focus on the quantitative factors and the qualitative factors, but I always try to leave room for error. This is why I never really put exact fair values on stock prices, based on coming up with a future growth rate, and then discounting it back. At the end of the day this method could provide the investor with a fair value and a premium or discount relative to current prices for companies they are analyzing. However, this method would also provide you with a precise numbers, which in reality are just an illusion that is dependent on investors assumptions. If you change your assumptions, and the “precise numbers” changes as well. This is why I merely bump companies against each other, and select the ones that look best. I described how I compare between dividend companies in a previous article.

The precision behind those fair values is an illusion that is derived from making expectations on future growth rates in earnings or dividends, and discounting them back using an estimated rate. I believe that investors who only look at that are essentially outsourcing their ability to think critically to a formula.

Instead, I believe that the better way to do things is to keep it simple. If you have companies with similar valuations but higher growth rates, you might want to go for the growth one. However, you might also decide to hedge your bet and purchase the lower growth one, just in case. It doesn’t make sense to make a lot of projections, do excess calculations, and discount those amounts to the present, when you can merely compare the expectations at the same levels of valuations and be done with it. However, if you can find a company that sells at a lower valuation, and can still provide consistent growth, I would say you might have found yourself a winner. In the case of Coca-Cola versus PepsiCo, I would say both companies might be good acquisitions today, even if one has different growth expectations behind each.

For example, Coca-Cola (KO) sells for 19.40 times forward earnings. The company yields between 3% and has a five year dividend growth rate of 8.10%/year. The ten year dividend growth rate is 9.80%/year. In comparison, the company has managed to grow earnings per share by 7.90%/year in the past decade. Check my analysis of Coca-Cola.

PepsiCo (PEP) sells for 18.90 times forward earnings, yields 3.10%, and has a five year dividend growth rate of 7%/year. The ten year dividend growth rate is 13.70%/year. In comparison, the company has managed to grow earnings per share by 7.70%/year in the past decade. Check my analysis of PepsiCo.

I also believe one needs to do the actual work in looking at companies, researching past data, and making some assumptions about the future. However, as we know that assumptions are tough to figure out exactly in advance, it is important to try and focus on best valuations available at the present time. This could be evidenced by a low price to earnings ratios for example. After all, sustainable earnings per share, coupled with a moderate but consistent growth in those earnings per share will result in quiet but sure compounding of wealth and dividend income over time. In other words, why swing for the fences, chasing a percent in yield or growth, when you can do reasonably well and protect and grow wealth and income? The risk in chasing growth at any price is that if growth does not materialize, you may be stuck holding on to a company that doesn’t deliver much in dividends and dividend growth, while your capital contracts in value. In contrast, for a company with a dependable earnings and dividends growth, purchased at an attractive valuation, a decline in growth would not affect an investor as badly.

For example, if you purchase a company that yields 2% and grows dividends at 15%/year, you might do well for many years, while getting an increasing yield on cost. However, if growth slows down, you might be left holding a low yielder without the benefit of fast growth. In comparison, a 3% yielder that grows by 7% is not too bad of a choice, even if growth drops to say 3- 4%, because the yield is sufficient to cover a higher portion of expenses in retirement. Of course, those growth rates are not known in advance, as only the yield is locked at time of purchase. However, even assumptions about its sustainability are subject to folly as well.

In reality, each company will have different yield/growth characteristics, which is why you need to assemble a diverse portfolio of quality businesses, purchased at attractive valuations. That safety in numbers can be very beneficial in guarding the investor against folly. I have chased high yielding stocks before, and have gotten burned in the process. I have also chased high dividend growth stocks which stopped raising dividends as fast. But by assembling a mix of the three types of dividend growth stocks I focus on, I ensure that my diversified portfolio can withstand different pressures on its components, and still provide me with the growing income in retirement.

Full Disclosure: Long KO and PEP

Relevant Articles:

The Tradeoff between Dividend Yield and Dividend Growth
How to read my stock analysis reports
My Retirement Strategy for Tax-Free Income
How to be a successful dividend investor
Should I buy more high yielding stocks in order to retire early?




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