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

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
Frequently Asked Questions (FAQ) About Dividend Investing
Dividend Investing Misconceptions
Long Term Dividend Growth Investing
Dividend Stocks For Long Term Wealth Accumulation

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:

Yrs Div Increase
5 year DG
Fwd P/E
Exxon Mobil
Philip Morris Intl
Baxter International
Lockheed Martin

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

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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

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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

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