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

Wednesday, October 29, 2014

Key Ingredients for Successful Dividend Investing

There are four key attributes that need to be considered, in order to be successful at dividend investing. These ingredients include focusing on quality, earnings growth, entry price and sustainable distributions. In this article, I would focus in more detail behind each of these four items.

Quality

I believe in purchasing quality dividend paying companies. This means that I try to focus on companies with strong competitive advantages, strong brand names and/or wide moats. Companies like that offer a product or service which customers desire, and are willing to pay a price which would deliver a fair profit. In addition, companies which offer products which are perceived to have quality characteristics, which typically translates into repeated purchases of the goods or services. In addition, companies that offer a unique product or service are able to compete based upon the added value they bring to the marketplace, and avoid costly price wars with competitors. Furthermore, the company would be able to have pricing power and pass on costs to customers, which will be much less likely to switch to another product. I understand that quality lies in the eyes of the beholder, but through experience, dividend investors should be able to uncover quality dividend paying gems.

Earnings growth

My strategy focuses on purchasing shares in companies which will grow dividends over time. In order to achieve that however in a sustainable manner, companies need to be able to grow earnings. Businesses that manage to grow earnings also tend to become more valuable over time. I also prefer to focus on earnings per share rather than total net income. Companies can grow earnings either by expanding in new markets, introducing new products, marketing existing products to new customers, acquiring competitors, cutting costs or raising prices. I like to read about companies which have specific earnings growth targets. Coca-Cola (KO) is anexample that immediately come to mind when I think about specific growth plans, as I outlined in an earlier article. I also like to see companies riding a long-term economic trend. Many of the companies I own in my portfolio for example will benefit from the increase in number of middle class customers in emerging markets such as China and India. Others like Eaton Vance (EV) or Ameriprise Financial (AMP) will benefit from the increased need for financial products that generate income in retirement by the millions of baby boomers that are expected to retire over the next two decades.

Entry price

The price at which shares are acquired matters a great deal to investors. Even if an investor has identified the best dividend growth stock in the world, with the widest moat, and excellent prospects for earnings and dividend growth, they could still end up losing money for extended periods of time. The reason is that even the best dividend stocks are not worth owning at any price. If you overpay for your stocks, you might end up with losses or not gains to show for your efforts for extended periods of time, even if the underlying fundamentals improve according to your initial plan. In an earlier article I argued that this was one of the main reasons behind the so called “lost decade for stocks” in the US in the early 2000s. Companies such as Coca-Cola (KO) and Wal-Mart (WMT) were grossly overvalued in 2000, which is the primary reason why the stocks didn’t generate much in total returns over the next decade, despite the fact that earnings and dividend increased substantially during the period. I am not proposing that investors time the market and only invest when stocks are super cheap. Instead, I focus on screening the dividend growth lists for attractively valued companies on a regular basis, and then analyze in detail the companies that are spitted out by my screen before adding money to them.

Sustainable distributions

The next key ingredient for successful dividend investing involves the sustainability of distributions. Investors who purchase dividend stocks for income should check whether the company is able to adequately support distributions from current earnings or cash flows for certain entities such as Master Limited Partnerships or Real Estate Investment Trusts. For most corporations, a dividend payout ratio below 60% is generally preferred. A higher ratio could jeopardize the dividend payment even if earnings dip temporarily. That being said, even if a company has a sustainable payout at the time of purchase, over time it could become unsustainable if it grow distributions faster than earnings or earnings decrease due to tectonic shifts in the business model. The best situation I like to observe is when earnings and dividends grow at similar rates. For new dividend payers I typically observe situations where dividend growth is higher than earnings growth up to a certain payout ratio, after which it closely trails growth in profitability.

While investors could argue that one cannot put success in a pre-packaged recipe for achieving it, I have found the four ingredients above to be essential for my income investing strategy.

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

Relevant Articles:

Seven Sleep Well at Night Dividend Stocks
Three Questions That Every Dividend Investor Should Ask Themselves
How to retire in 10 years with dividend stocks
The work required to have an opinion
Three Characteristics of Successful Dividend Investors

Wednesday, October 22, 2014

Time in the market is more important than timing the market

There is so much mental energy spent by investors, media and gurus spent on “guessing” the market top, market bottom, and whether we are in a bull or bear market, it is exhausting for me to watch. Frankly, in order to be successful in investing, one needs to keep it simple, and follow common sense principles. You do not need to successfully pick tops or bottoms in order to be successful, but have goals, and patiently hold quality companies for the long term that shower you with rising dividend income every year. If you have goals you want to achieve, you only need to develop a strategy to achieve it, and then stick to your plan through thick and thin.

Time in an investment is more important than perfect timing based on following fluctuations in the stock price. This is because if you hold a quality company purchased at a fair price, and then let the power of compounding do its magic over a long stretch of time, you will do really well. Those who are always looking to buy at the bottom or sell at the top end up missing out on the compounding of their income and capital. This is because noone can correctly buy at the top or sell at the bottom, except for a lucky accident once in their lifetime. At the end of the day, even a broken clock is right twice per day. Those who can tell you they can consistently do it, are either liars, are trying to get famous by being right once, or are trying to sell you an expensive investment service.

I did a quick experiment using Yahoo Finance historical data, where we have two investors buying shares of Johnson & Johnson (JNJ) between 1/1/1980 and 12/31/1989. The first investor has $1,200 to put to work each year, and manages to buy Johnson & Johnson shares at the lowest monthly close for each year. They reinvest dividends into more Johnson & Johnson shares with each payment from the company. This investor manages to get this lucky for 10 years in a row. They then stop adding new money, reinvest their dividends automatically into Johnson & Johnson stock and hold on to the end of September 2014. The first investor thus ends up with a stake worth roughly $1,011,000 million, which generates approximately $26,600 in annual dividend income.

The second investor simply puts $100 per month, every month between 1/1/1980 and 12/31/1989. They also reinvest those dividends in more Johnson & Johnson stock in the accumulation phase. After that, no new money is added, although dividends keep getting reinvested automatically. By September 2014, the second investor has a portfolio worth roughly $875,000, which generates approximately $23,000 in annual dividend income. As you can see, while the second investor ends up with a little lower final portfolio values and annual dividend incomes, their returns are much more realistic and achievable by ordinary investors. Again, the goal is to try and keep a simple plan to stick to. It is highly UNLIKELY that someone will be able to allocate money at the lowest point in a company for 10 years in a row. Most keep trying, and as a result end up missing the big moves. The important thing in the case of Johnson & Johnson was to buy the shares, and then patiently reinvest dividends for decades, and let the power of compounding do the heavy lifting for you.

This example is where you have an edge in investing, that noone else on Wall Street has - you can hold patiently to your passive portfolio of quality dividend paying stocks, and collect those rising dividends through thick and thin. You do not care about high frequency traders, irrelevant relative performance bench-marking against some index over a meaningless time frame of a month or an year. If you have patience, you are very likely to successfully fund your long-term goals.

My goal is to reach a certain level in dividend income by 2018 – 2019. In order to reach this goal, I know that I need to save a certain portion of my paycheck, and then invest it every month in quality dividend paying stocks. As those dividend paying companies pay me more in dividend income, I then reinvest that income into more dividend paying companies. Life is much easier when you create a positive loop.

You can see that my strategy is only dependent on finding enough quality dividend paying companies to invest in each month. Therefore, it does not matter whether we are in a bull market, bear market or sideways market. As a dividend investor, I am a stock picker, not a market timer or prognosticator anyways. I focus on individual businesses available at attractive prices, which can earn more over time and thus afford to increase my dividends regularly. The only difference that a bear market makes to me is that there are more companies that are attractively prices. Since my timeframe for holding those companies and living off those dividends is approximately forever, my success is determined on letting those dividends compound over time into a meaningful stream of income to live off forever.

The toughest part of my plan is patience. As Munger Says, the most difficult thing a person can do is sit alone and do nothing. Given the fact that I am constantly bombarded by useless chatter from the media about the economy, shares, the FED, the world etc, I feel inclined to do something when in reality no action on my part is needed. I believe that investors should tune everything out, and just stick to their plan. At least that’s what I am doing. I know that the odds for success are very high for the investor who buys stakes in quality blue chip dividend payers every single month, reinvests dividends selectively, and then patiently sits on those companies for the next 20 – 30 years.

For example, did you know that if you started investing in in blue chip companies at the start of the great depression in 1929, and you reinvested dividends you broke even within 6 years. You did pretty well if you held on for 30 years. Even if you bought shares right at the top in 1972, and held on for 30 years, you made a lot money as well. The lesson is very clear – keep holding to quality dividend paying companies through thick and thin, keep adding money to dividend portfolios every single month and keep reinvesting those dividends. If you are unwilling to hold through a company through a 50% correction in the stock price, you should not be investing in stocks. 50% corrections would not bother me, as I see them as opportunities, since my dollars buy more shares when prices are lower. I also try to invest in companies, where I would not be afraid to hold, even if the stock market was closed for a decade.

The lesson to long-term investors is clear; it doesn't matter whether we are in a bull market or bear market. The goal is to dollar cost average each month in quality dividend growth stocks selling at attractive valuations, reinvest dividends, and hold patiently for the next 20 – 30 years. I cannot emphasize quality factor, since the quality companies are more likely to survive a deep recession unscatered, and continue paying and growing dividends, even during the hardest of times. If you are already retired, then you shouldn’t really care about stock prices anyways – just withdraw those growing dividends and enjoy life. Dividends are more stable than capital gains, they are always positive, which makes them an ideal way of living off a nest egg.

Full Disclosure: Long JNJ

Relevant Articles:

Dividend Investors Will Make Money Even if the Stock Market Closed for Ten Years
Let dividends do the heavy lifting for your retirement
How to retire in 10 years with dividend stocks
My Dividend Goals for 2014 and after
Dividend Investors Should Ignore Price Fluctuations

Wednesday, October 1, 2014

You don’t need to be right all the time to succeed with dividend investing

One of the simplest truths about dividend growth investing is that not all companies you select will do as expected. Some will fail outright, while others will merely deliver some dividends which would barely match the rate of inflation. Based on studies I have performed, I have noticed that another small group of stocks will provide a large portion of returns in a dividend stock portfolio. You might not realize at the time of purchase, but the reality is that it is difficult to say in advance which company will do the best.

Even with those odds however, a dividend investor does not need to be right about all stock selections. In fact, even if they are correct for about 50% of the securities they pick, they should do fine as long as the dividend increases and capital gains from the winners offset the capital put to work in the “losers”. This of course is a very worst case scenario, since many of the “losers” will keep paying a slowly rising dividend, which could be spent or put to work into other dividend paying stocks. Therefore, I know that even by selecting my fair share of “losers”, I still have a very high chance of living off dividends. I follow a few principles to ensure I have the odds in my favor for a successful dividend investing.

This is why I stick to a few fundamental principles. The first principle is that I always strive to create a portfolio of dividend growth companies which are in one of the three types. The main goal is to be patient, and enjoy the ride. I view my portfolio like a a symphony. Each company in it has a role to play and together they make beautiful, income producing music. It is important to diversify risk with at least 30 – 40 securities, which will be purchased slowly and over time. Diversification helps when the proverbial bad apple takes a bite out of dividend income.

The second principle is to have patience. I have learned the hard way that once I purchase shares in a company I like and at a valuation I like, I should let it quietly do the compounding for me. I am a long-term investor, and my holding period is the next three decades. I am hopeful that my dividend portfolio will provide growing income for the next 30 years. This is why I need to view things in perspective, and think about longer term trends that span years, rather than get scared away from a single bad quarter or a single bad year. In the grand scheme of a 30 year investing time frame, one or two years are almost irrelevant data points. That doesn’t mean not to sell if there are any troubles brewing – it just means not to jump ship at the first “correction” or sign of “trouble”.

The third principle is being really selective about selling. After reviewing data about investor performance and psychology, I have come to believe that those who sell too quickly face reinvestment risk. Many investors tend to get a gain in a stock, see that the yield has gotten too low, and sell to get into a higher yielding security. As a result, they end up paying taxes, having less capital to invest, and in a large portion o the cases they end up with less in dividend income growth and capital gains than if they had patiently sat on their hands.

When you buy a stock, the worst think that can happen is that it can go to zero. The next thing that could happen is that you keep earning dividends, which reduce the amount you have at risk in the security, and then put those to work into more dividend paying stocks.

This is where the fourth principle lies in – hold on to your winners. The best case is that the company ends up performing like the next Wal-Mart (WMT), McDonald’s (MCD) or Coca-Cola (KO). You do not know at the time of purchase whether the company you picked will be profitable and paying more dividends in 30 years. You can make an educated guess, but the truth is you will not know which of your 40 stocks will be the best and which one will be the worst by 2044 – 2050. This is why I am trying to be as passive as possible, and reduce reinvestment risk as much as possible. I am often afraid that I will end up selling the next Coca-Cola (KO) to buy the next Jones Soda (JSDA), than missing out on the next Sigma-Aldrich (SIAL) because I stuck with Coke.

What I am trying to say is that with dividend stocks, your losses are limited, but your gains are unlimited and potentially much more than the amount you have at risk. This is why mistakes of omission, or the opportunity cost of not getting into a company prior to take off is a bigger problem than buying a bad stock. This is why I keep holding on to my winners, even if they end up delivering over 1000% profit.

Investors need to think probabilistically. In their portfolio of say 40 securities, there will be 10 which will likely do most of the heavy lifting for the next 30 – 40 years. If you sell those today, your portfolio will be mediocre. This is why it is also important to give companies a chance, provided you understand them well, they are available at a good price, and there are catalysts for future earnings growth. However, even for those who are average, it is helpful to understand that with each dividend check, the amount at risk in those securities is reduced. Therefore, even if in 2007 you had owned Bank of America for 20 years, you would have had received enough dividends to put in other dividend paying stocks that would almost cover for the capital you put to work initially

Full Disclosure: Long KO, WMT, MCD,

Relevant Articles:

- Accumulating Dividend Stocks is a Long Term Process
Dividend Stocks For Long Term Wealth Accumulation
When to sell my dividend stocks?
How to generate income from your nest egg
Dividends Offer an Instant Rebate on Your Purchase Price.

Wednesday, September 24, 2014

Never Stop Learning and Improving

Some of my readers know that I own a lot of stocks. I even dedicated a whole article on the topic.

Readers also know that I have more than one brokerage account. I also dedicated another article on the topic here.

What can I say - I try a lot of different things. I think I do all of that because I like tinkering, and testing in real time what happens, and see how I react to it. Investing is all about having a method, and then trying to improve it, drop things that don't work. The lessons from all that have been invaluable, and have shattered my beliefs time and again. But as a result, I have become much more successful.

One account I own has exclusively low yield, high growth securities in the initial stage of dividend growth. An example includes the company Visa (V). From time to time, I also do something else, like participate in merger arbitrage, or buy a really under loved and undervalued security like I did with Gazprom in 2013 and early 2014. This portfolio has a myriad of small positions, which could mushroom to very big opportunities, particularly if they grow at mid-to-high teens for long periods of time. I believe it is important to try and monitor the dividend growth universe for the next big dividend growth story.

Another account is used exclusively for selling long-term puts. Check this article on selling puts if you are unsure what this means or how I approach that strategy. The account can have up to 25% of value in naked long-term puts I have sold. Meaning if account value was $100,000, I have sold puts on securities I like. If those puts are exercised at the same time, I would have to buy $25,000 worth of securities. Usually this would occur at lower prices, and into the future, matching expected inflows with future outflows. Too bad most long-term puts expire in Jan 2015 or Jan 2016. There aren't any long-dated put options on companies I am interested in going beyond that yet (unless you want to invest in ETFs like SPY, which goes as far out as December 2016). The main portfolio is fully invested, and the options expirations are layered into the future, so that they do not occur at the same time. This means that the $100,000 is invested in dividend paying stocks, and in addition, I have sold puts which would trigger a purchase of $25,000 worth of stocks, if puts are exercised. The put selling is a way to mostly try and buy certain companies at a discount, and generate some float in the process. I only do companies now, although for a while I sold puts on S&P 500. A recent example is the sale of puts on Hershey, which would result in an entry price of approximately $84/share, provided that the stock price is below $90 by January 2016.

Another account has up to 15% of value on margin. Check this article on leveraged dividend investing. Meaning if account is $100,000, I have bought 15,000 worth of securities on margin. I have figured out that this margin would be paid off by my dividend income within 3- 4 years. At the current time, the interest rate is a paltry 1.09% - 1,59%/year. Actually, several of the purchases I have made in 2014 occurred in this account at Interactive Brokers. I am also considering moving some of the options selling to this account as well, given the low commissions and super low margin rates I enjoy at this broker. However, I might need to beef up the equity there first before I combine both activities. I find investing using borrowed money to be a very interesting exercise, which could be disastrous however. This is why I am only doing this with one of the accounts, because the risks are high. However, I strongly doubt that it is that risky to buy shares on margin today, which would be paid off by my dividends alone in three to four years, while paying a very low margin rate.

A third account has some CD’s, which will likely expire in 2015. I had high hopes of putting approximately 20% of my portfolio in treasury bonds, and CD’s, but the low interest rate environment means this would be unlikely. This account used to be very high in 2007 and 2008, but has been steadily decreasing since 2008. I used to own a ladder of CD's, which have been expiring since 2008. I also owned some Treasury Bonds at one time a few years ago, but I sold them all in 2010. As those remaining CD's have expired, I allocated the proceeds into dividend paying stocks.

Another account simply collects all dividend, interest and other portfolio income received. It then distributes the cash to the account which I am trying to build up. I do not automatically reinvest dividends, but allocate them in the best values at the moment. This is honestly a very important account.

Over time, the activities in those portfolios have added to cash flow, and provided extra power to deploy in dividend paying securities.

I am not going to even list the retirement account such as 401 (k), which lets me defer taxes today, and which I hope to convert to a Roth IRA tax free when or if I drop out of the rat race, and reduce my effective taxable income to the lowest brackets possible. Nor am I going to discuss the SEP IRA, Roth IRA, Rollover IRA or Employer Stock I hold. The retirement accounts are mostly a cash outflow right now, since they are being built out and limited by the maximum contributions by our friends at the IRS. The employer stock plan provides the opportunity to buy shares at a discount, which are then hedged, and sold at the first possible opportunity. Small investors have opportunities to generate "alpha" all the time, particularly those employed at companies with benefits.

All of these accounts holds a purpose, despite the fact that the picture looks complicated on the surface. The retirement accounts are essentially taking care of themselves, and so are most of the other accounts I hold that are fully built up. A lot of the work involves having a list of holdings in a spreadsheet, and then monitoring the actual holdings and overall allocation to those. The rest is covered in my monitoring process, which involves researching companies to invest, looking at dividend increases, checking material company information such as quarterly or annual financials as well as other major items such as mergers and acquisitions. Those might or might not be driven by tax inversions.

At tax time, each brokerage account generates a 1099 that is just inputted into the tax form, and it is sent out to our friends at the IRS.

I often get asked why don't I simply buy 20 dividend stocks, and concentrate myself to those. The things is, if I had limited myself to a set number of companies, without looking for my own strategy that fit my way of investing, I would not have been as successful as I have been today. Investing environments change, which is why you need to be adaptable to the situation, and not impose your own set of values on the environment. If you place self-imposed limits on your growth as an investor, you are wasting your potential.

Full Disclosure: Long V

Relevant Articles:

Why do I own so many individual dividend paying stocks?
Dividend Portfolios – concentrate or diversify?
My Retirement Strategy for Tax-Free Income
Stress Testing Your Dividend Portfolio
How to become a successful dividend investor


Wednesday, August 27, 2014

Dividend Growth Stocks Are Still Great Acquisition Targets

Imagine that you are the CEO of a major corporation, which is sitting on a lot of cash. You are desperate to find some use for this cash, in order to justify a bigger bonus for yourself, and in order to grow the company you are managing. One of the things you can do is start a new division, invent a new product or try to expand organically. However, this is risky, since there is absolutely no guarantee that the expansion, or the new product will be a success. Another option is to acquire an existing business, which already has the products or services that customers want, is available at a good price, has a unique competitive position, and which also manages to earn a lot of profit s every year, while drowning shareholders in cash. It does seem like a lower risk proposition to acquire that business. Of course, if those managements have the discipline to pay a regular dividend to shareholders, they would have much less money for squandering, which would limit their focus to only the best ideas with the most potential for return on investment. But this is a topic of a whole other article.

The business to be acquired that I just described at a very high level is essentially what most dividend growth companies represent. A business that manages to grow dividends every year for a long time, indicates in many cases a business which manages to earn more profits over time. This is an attractive business to invest in, whether you are an acquirer or an ordinary mom and pop investor, provided valuation is not excessive. Thus, dividend growth stocks make great acquisitions.

In most cases however, shareholders would have been better off simply holding on to the companies they are owning and collecting a growing a stream of dividend checks with the passing of every single year. Unfortunately, many shareholders these days have an extremely short-term holding horizon, which is why they approve of those deals to earn a quick buck, while sacrificing future potential.

This is why I believe that even for long-term passive buy and hold dividend investors, it is highly unlikely that their portfolios will be static over a 20 – 30 year time period. A portfolio of dividend growth stocks selected in 2014 will likely look much different in 2044. Contrary to popular belief however, this is not because of a high failure rate in dividend growth stocks. The reason is because a large portion of dividend growth stocks are indeed attractive acquisition or merger partners. When you are the prettiest girl at the prom, odds are much higher that more than one person will ask you to dance with them. Same is true with those dividend growth stocks, which make excellent merger partners or great acquisitions to tap into. As for failure rates, based on historical research I have conducted, only a small portion of companies fail outright.

When I look at the dividend aristocrats list from 25 years ago, I notice that there are a lot of companies that are no longer here. As I mentioned in the earlier paragraph, this is because a large part of those companies either were acquired or merged. As a passive investor, I seldom sell. However, if the company that acquired my dividend holdings pays me cash for my stock, I will have to dispose of my shares. This is what happened with Anheuser Busch in 2008, when it was acquired for $70/share by InBev. This is also what happened to Rohm & Haas in 2009, when it was acquired by Dow Chemical (DOW). Nowadays, this is what is happening to Family Dollar Stores (FDO), which is being acquired by Dollar Tree for mostly in cash. Only a small portion of acquisition will be paid in stock, thus triggering a taxable event. Because I expected more in taxable income in 2015, that will potentially put me in a higher tax bracket, it made sense for me to sell today, as much as I don’t want to get any tax waste.

Based on my tax situation, it made more sense to sell my Family Dollar holdings in taxable accounts this year. For any tax-deferred accounts, I would simply hold on to the shares I receive, but reinvest the cash I receive in other quality companies selling at attractive valuations. Thus, I am saving on one commission, rather than sell all the stock, then buy another stock. In an essence I am holding in my retirement account, and then when the cash is paid, I can use it to buy other shares. At the same time I will probably keep the Dollar Tree shares, despite the fact that they won’t pay a dividend.

Of course, the issue with selling was that I missed out on the bidding war from Dollar General. The problem is that Dollar General’s offer, while a few dollars per share higher, was all in cash. Whoever acquires Family Dollar, will reward their shareholders tremendously, because they are paying for a great asset with cash that costs very little today. If you add in synergies expected, that deal will result in great returns for Dollar Tree or Dollar General shareholders, depending on who ends up owning Family Dollar stores.

Full Disclosure: Long FDO

Relevant Articles:

Dividend Stocks make great acquisitions
I bought this quality dividend paying stock last week
Dividend Stocks make great acquisitions
Where are the original Dividend Aristocrats now?
1991 Dividend Achievers additions- Where are they now?

Wednesday, July 30, 2014

Dividend Investing Over the Past Seven Years Was Never Easy

Very often, I hear the following comment:

Well, the stock market has been going up non-stop in the past several years. Anyone who purchased stocks would have done very well. It was easy to buy stocks in the past five - six years, since they only went up. When stocks go down by 15%- 20%, all dividend investors will cry for their mommy and abandon their strategy

I take great offense with those comments. First, they show the lack of prep work made by the commenter, and second, they show that the commenter is subject to hindsight bias, where everything looks easy but only in retrospect. In reality, there was always a reason not to invest in dividend paying stocks during each of those past seven years that I dedicated to dividend growth investing.

There is never a perfect time to start investing in dividend stocks. There is always a reason not to invest in dividend stocks. The truth is that dividend investing was never easy.

I myself started investing in dividend paying stocks at the worst time possible, which was in late 2007 – early 2008 period. This was the worst time possible to start investing in stocks in general, let alone dividend paying ones. I also launched my site at the time, in order to write down my ideas, and make myself do the work required to form an opinion on quality dividend paying stocks.

Some of you remember the dark days from 2008 and 2009, when many companies crashed, stocks kept falling from their highs by over 50% and several prominent bank payers slashed dividends. Those were some pretty scary times, as evidenced by the fact that some companies accepted usurious interest rates on loans from Berkshire Hathaway (BRK.B), mostly because they needed the funds, but also because they wanted Buffett's stamp of approval to calm investors.

It was pretty scary to watch any news during that time, because I feared the whole economy would collapse.
Nevertheless, I kept putting money to work every month during that time. It is insane to think about it now, but some of the best blue chip dividend stocks like were available at fire-sale prices. For example, I was able to purchase shares of Altria (MO) at $15.11 and Chevron (CVX) at $64.35 in early 2009. Even as late as August - September 2009, one could buy companies like Phillip Morris International (PM) at $46.94/share.

Then in 2009, stocks started going up after hitting multi-year lows. That’s when we had fears of inflation, fears that there was a disconnect between stock prices and the real economy, unemployment was bad and stocks were too high. That’s when I kept adding to my portfolios, and were still able to find stable dividend paying companies, that were available at attractive prices.

In 2010, I was able to keep putting money in dividend paying stocks, every single month. I was doing much better income-wise starting in 2010, relative to 2007, 2008, or 2009, which is why I was able to put even more money to work in dividend paying stocks. In 2010, we had fears of a double-dip recession, the TARP plan was being ridiculed left and right, and everywhere I looked there was doom and gloom. In fact, this doom and gloom is everywhere, and has only recently started to fade away. The majority of individuals I have talked to since 2009 have been in disbelief whenever I would inform them that the recession has been over since 2009. What made it psychologically difficult to commit money to dividend paying stocks in 2010 as the fact that preferential tax rates on dividends and capital gains were set to expire that year. This was a fear a couple of years later, although congress finally managed to extend those breaks, while raising rates for highest earners.

The years 2011 and 2012 were characterized by double dip recessions in Europe, Greece defaulting on its debt, and more fears about debt ceilings, and tax rates. It was not an easy time to put $1000, $2000 to work in Aflac (AFL) or McDonald's (MCD) or Walgreen (WAG). It was also tough because some of the companies, like Johnson & Johnson had issues on their own, which made many investors want to sell their shares at $60. This is when I kept adding to the stock, which is one of my largest portfolio holdings today. When I look at old articles I have written between 2010 and 2012, they mention Johnson & Johnson quite frequently. Yet, many readers didn’t like that and complained about it. In retrospect, what looks like a no-brainer decision when Johnson & Johnson is at $105/share, looked like a very scary decision back in 2010 – 2012.

Between 2009 and early 2013, a common fear I heard from investors was that “stocks are too high”. Looking at my archives, I even wrote several articles which discussed the fact that there are always some quality companies that are selling at attractive valuations.

The reason why I kept putting money to work for me in my dividend portfolio is because I had goals and a dividend growth plan to achieve them. This plan was helpful in outlining the steps that need to be taken in order to achieve my goals. I didn’t have all the steps codified, but the message has been clearly repeated ad nauseum on this site for several years: invest in quality companies at attractive valuations, diversify, dollar cost average, reinvest dividend selectively, keep screening the list of dividend growth stocks regularly, keep learning more about companies, business and develop strategy. Ignore the noise.

The other factor that really made me stick through my strategy through thick and thin was the reinforcing power of cash dividends which I receive in my brokerage accounts. When you get a dividend check from the company you invested in, it further solidified the idea that I am investing in real businesses, and not in some lottery tickets. The first dividend checks were a small drop in the bucket initially. This stream has been increasing in size, frequency and intensity. The goal is that this stream will cover my expenses in a few years or so. When you receive a stream of income which grows faster than raises at your job, which comes from global business powerhouses with growing earnings, it is pretty easy to ignore the opinion of the stock market and keep at your plan.

There is always something to worry about. The way to be successful is to buy shares in good companies that you understand, and buy them at attractive prices. If you have a diversified portfolio of solid blue chips, purchased at attractive prices, with long histories of dividend growth, which have catalysts for further growth in earnings, you can’t go wrong if you are patient and have a long-term time frame. And by long-term, I don’t mean next week, I mean that you should be fine collecting dividends, even if they closed the stock market for 10 years.

In fact, the dividend haters often claim that dividend investors will get scared from a 20% decrease in stock prices. I am really hopeful that they are right and we do get a 20% drop. I promise to act scared, as long as I can get that 20% drop. Inside, I would be ecstatic, since I would be able to buy more future dividend income with less dollars. As someone in the accumulation phase, a bear market would definitely make it easier to achieve my goals faster.

To end up with the words of superinvestor Charlie Munger” If You Can’t Stomach 50% Declines In Your Investment You Will Get The Mediocre Returns You Deserve

Full Disclosure: Long MO, CVX, JNJ, AFL, MCD, WAG, PM

Relevant Articles:

Common Misconceptions about Dividend Growth Investing
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Monday, July 28, 2014

Dividend Yield or Dividend Growth:My Experience With Both

There is a ranging debate of whether someone should go with high yielding companies today, or they should go with lower yielding investments, which however offer the promise of increasing payouts at a faster clip. As I have discussed earlier, there is a tradeoff between dividend yield and dividend growth, with the decision of which path to take ultimately being dependent on the underlying unique characteristics that an investor has in his or her own opportunity set.

Nevertheless, I still get asked the following question. The question goes something like this: Why go for an investment that yields 3%, with the potential for a 7% in annual dividend growth, when someone can get an investment yielding 6% today? Even if all the expectations turn out to be correct, an investor would have to wait for a long ten years, before they collect a 6% yield on their cost. With the other investment, they would have been collecting that 6% yield for 10 years already.

I usually answer those questions with examples, which discuss the probabilities of different events happening. However, the reason why I usually go with the lower yielding stock is due to my experiences. Actually, one of my investing mistakes pretty much sums up why I do what I do.

I will tell you what the risks behind the thinking in the question asked above are, by discussing my experience with ONEOK Inc (OKE).

I bought shares of ONEOK Inc (OKE) in three separate transactions in 2010 – 2011 at the following price points - $25.31, $25.71 and $30.20. I liked the fact that shares were offered at a low P/E ratio, had adequate current yield, and offered the opportunity for growth. As a general partner in ONEOK Partners (OKS), there was plenty of opportunity for growth. And I think there still is. ONEOK Inc paid a quarterly dividend of approximately 21/cents per share.

In 2011, I decided that I wanted to earn more in distribution income right away, rather than wait for a few years. I also believed that the shares were too high. So I ended up selling all my shares at $36.18/share and purchasing shares of ONEOK Partners at $41.71/unit.

Since then, ONEOK Inc spun-off One Gas (OGS). Investors received one share of One Gas (OGS) stock for every four shares of ONEOK Inc (OKE). If I had stayed with ONEOK Inc, I would be earning a quarterly dividend of 56 cents/share from ONEOK shares as well as dividends from One Gas shares, where rate is 28 cents/quarter. This comes out to a total of 63 cents/quarter for shares that were bought at an average price of $27.07/share, or an yield on cost of 9.30%. Instead, I am earning an yield on cost of 7.10% by sticking to ONEOK Partners (OKS). If growth continues further, as it should, investors in ONEOK Inc will be generating even higher yields on cost, due to high distribution growth.

I violated two of my rules. One is never to sell, even if I had a 1000% gain on the investment.  The other rule is that activity is bad for your performance. According to research, 80% of the time the investor is better off staying with their original investment and not doing anything else. I also chased yield by replacing ONEOK Inc (OKE) with ONEOK Partners (OKS).

I also ended up paying taxes on a portion of the gains. The opportunity cost of the taxes I paid could be very high, because this is money that could have quietly compounded for decades for me and made me even wealthier in the future. It could have meant more money for the causes and people I care about when I die. Instead, I threw the money away and gave it to the government.

Overall, the investment in ONEOK Partners has been satisfactory. However, I made a few mistakes, and probably should not have sold the original shares purchased in ONEOK Inc. Once again, as Warren Buffett says, some of the largest mistakes he has made were mistakes of omission, not mistakes of commission. Other mistakes of omission I have made include watching Williams Companies (WMB) go from $32 to $36 in 2013, and not purchasing because I wanted to buy it cheaper. The company might still be a good investment, given the high forecasted growth in dividends. As a matter of fact I recently initiated a position in it, and I am hoping it drops from here.

I believe that smart people, learn from the mistakes of others. Hence, I hope that my smart readers will learn from those mistakes I made. The goal of every investor is to always be learning, and always be improving. If one stops learning and improving, they have a high chance of failing to reach their goals and objectives. The goal is to get a little smarter every single day, and removing ignorance one item at a time.

Relevant Articles:

The Tradeoff between Dividend Yield and Dividend Growth
Why I am replacing ConEdison (ED) with ONEOK Partners
ONEOK Partners (OKS) Dividend Stock Analysis
Seven Dividend Stocks I purchased for the long-term
Types of dividend growth stocks

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:

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