Thursday, October 29, 2009
I definitely understand the frustration for those readers. Most investors typically want to be told what to buy, when to buy it and how much they would make when selling. This strategy always works in get rich quick books, but it seldom generates any profit in the real world. The reason why so many investors lose money on a consistent basis is because they fail to educate themselves and instead end up following gurus which don’t even trade the ideas they are pitching to their followers.
The value of a stock analysis is that it should give investors ideas about what they want to see in a stock, versus what they don’t want to see in a stock. A prime example is my analysis of Paychex (PAYX), which is overvalued relative to its competitor Automatic Data Processing (ADP). In addition to being overvalued, Paychex currently distributed most of its earnings out as dividends, which is clearly unsustainable in the long run. Thus, the relatively higher dividends yield of 4% on PAYX versus 3.3% for ADP is not enough to compensate the risk of a potential dividend cut.
Another reason why a neutral stock analysis is beneficial is that it provides investors with some insight into a company which could be temporarily overpriced. Since entry price matters to some extent, it would be unwise to pay top dollar for stocks, when there are companies with similar characteristics that are priced attractively. An investor, who does his or her homework early in the game, would be well prepared from reading the analysis to enter a position on dips, should the stock fall on general market weakness or on negative news.
The urge for constant action and the inability to wait for the best entry setups might be the difference between making money and losing money in the long run. Jesse Livermore, a famous trader from the 1920’s is known for his saying that “The big money is made by sitting, not thinking. Men who can both be right and sit tight are uncommon”
I completely agree with this assertion. Investors who purchased stocks in the late 1990’s when dividend yields were at their lowest have suffered inferior returns over the past decade. Other investors who finally saw some gains in their portfolios in 2009 might have been quick to take a profit too early, thus missing out on the majority of the rally off the March 2009 lows.
Even if you purchased great stocks such as Johnson & Johnson (JNJ) or Procter & Gamble (PG) while their yields were at multi year lows, you would have seen no capital growth at best, although your dividend income would be higher than it was a decade ago.
At the end of the day what truly matters is that investors develop a sound strategy that fits their personality and go with it. The strategy should incorporate entry and exit rules, diversification and hopefully some sort of position sizing methods such as dollar cost averaging.
This blog post was included in the Carnival of Personal Finance #230 – New Site Edition
Full Disclosure: Long ADP, JNJ and PG
-Paychex (PAYX) Dividend Stock Analysis
-Automatic Data Processing (ADP) Dividend Stock Analysis
-Emotionless Dividend Investing
-Are High Dividend Stocks worth it?
Wednesday, January 14, 2009
Most investors who are close to or in retirement look for dividend stocks as a source of their retirement income. I believe that this is a great investment strategy, as long as these investors don’t chase high-yielding stocks. With the average market yields at 3%, stocks that yield more than 10% should not be automatically embraced in ones income portfolio, but examined more closely than usual. There are several reasons why a stock is yielding over 10%, one of them could be that the stock price has been in a severe down trend, which has increased the current yield on the stock.
Every dividend investor should be focusing not only on dividend income, but also evaluating the safety of their principal. If the high-yielding stock is paying a 10% current yield, but most of it is a return of capital, then chances are that the dividend payment will not be maintained in the future as the company’s capital base shrinks. Furthermore if a stock used to yield 3% but due to a decrease in its stock price is yielding 12%, the market might be sending a message that the current dividend payment is in danger of a cut. Financial companies like Bank of America (BAC) and Citigroup (C) in 2008 are a prime example of this scenario, as their current yields rose to 8%-10% because their stocks fell sharply in response to the softening of the general economy. Investors who purchased these stocks were hit on two fronts – the share prices dipped lower and the dividends were cut, which decreased yields on cost significantly. In other words if you are chasing a 30% dividend yield, then make sure that you don’t lose a lot in capital gains in the process. My experience with American Capital Strategies (ACAS) was a very good example of chasing a high-yield stock and getting burned in the process.
Before you invest your hard earned money in a dividend stock, always try to gauge how safe the dividend is, by looking at the dividend payout ratio and the dividend in relation to the cash flows per share. A high dividend payout ratio would tell you in most situations that the probability of any further dividend increases is greatly diminished. For most of the dividend aristocrats a dividend payout ratio of 50% or below indicates a healthy relation between the distributions and earnings, which also provides the dividend investor with a margin of safety. Lower dividend payout ratios also provide for more room to support for future dividend increases. There are however certain stocks which pay out more than 50% of their payout ratios to shareholders such as utilities, Canadian royalty trusts, Master limited Partnerships, oil tanker stocks as well as real estate investment trusts. Many investors, focusing on current income are buying onto these stocks in order to generate higher yields on their investments. The reason why these investments produce above average yields in most circumstances is because they also return capital as part of their distribution to stockholders. This is similar to you selling off a portion of your dividend holdings each year, and claiming the proceeds from this exercise a distribution to you. As dividend investors your primary goal is to generate income from earnings, which could be increased over time in order to beat the eroding power of inflation.
Investors shouldn’t focus exclusively on pass through entities such as Canadian Royalty trusts like PGH, PWE, HTE and MLP’s such as KMP and TPP as their investments could easily lose money if there are changes in the tax codes, which could negatively affect their portfolios. For example prior to 2006 many retired Canadians owned income trusts, which were taxed very favorably and paid out very handsome yields. In 2006 however the Canadian government announced that it was changing this corporate structure in 2011, sending trusts shares along with their distributions much lower.
Now I do believe that creating a diversified portfolio of income producing investments could include oil tankers, Canadian royalty trusts, master limited partnerships and real estate investment trusts. The goal of your retirement portfolio should be to not to overweight these investments with high current yield, but unstable dividend payments. In 2008 overweighting of shipping stocks such as DSX or FRO would have lead to decreases in dividend income as these stocks either cut severely or suspended their payments to shareholders.
I also believe that dividend investors should be tracking their yield on cost more closely than current yield. Yield on cost tracks the dividend yield on your original investment. If you bought a stock like JNJ, PG, MO one or two decades ago, you would be making a pretty decent yield on cost nowadays, which is close to what certain high yielding investments generate today.
Wednesday, August 6, 2008
Diversification is important, because it generally insures investors up to a certain point that they won’t lose all of their money at the same time. In general it is not a good idea to put all of your eggs in one basket. In terms of diversification, I am trying to own anywhere from 30 to 100 dividend paying stocks, which generate an ever increasing dividend income stream for me. The stocks should fit the criteria which I mentioned in the previous articles that I wrote. I will be trying to get a representative sample of as many sectors as possible; I will however try to own dividend stocks which are representative for the ten sectors that comprise the S&P 500 index. These sectors include Consumer Discretionary, Consumer Staples, Energy, Financials, Health Care, Industrials, Information Technology, Materials, Telecom and Utilities. Financials, Telecom and Utilities are stocks which traditionally have paid solid dividends. I will try to not be overly concentrated on specific sectors and instead try to be as equally weighted sector wise as possible.
Another important sector to look into is real-estate. Luckily there are plenty of REIT’s out there to satisfy the dividend investor’s appetite. I am also looking into getting some timber exposure, by purchasing shares in timber REIT’s like PCL, RYN, and POPE.
My portfolio will not be diversified without adding some foreign stock exposure. At this time this has been my weak point. It is difficult to find foreign companies which have increased their dividends consistently for more than 10 years. In addition, not all foreign dividend achievers are readily available to buy in the US. There are other taxation issues, which could potentially turn foreign stock investment into a complicated matter.
Another matter to look into is that most dividend paying stocks are established large cap corporations. Thus further diversifying into small and mid caps will be a tougher challenge.
Last but not least, a 20-25% exposure to fixed income could smooth the equity curve of my portfolio and reduce volatility. I wouldn’t start contributing to fixed income until I have ten years to retirement however. Even a modest exposure to bonds would have been helpful if you were invested in US stocks at the onset of the Great Depression or in Japanese stocks at the end of the 1980’s.
Next Week, I will discuss the last part of my dividend growth plan - Money Management.
- Determining Withdrawal Rates Using Historical Data
- Diversification Matters
- Diversification and portfolio allocation
- Can money grow on trees?
The goal of every dividend investor is to generate dividend income that is larger than their annual expenses. This coveted goal is called th...
Dividend growth stocks are the gift that keeps on giving . I like the fact that most of the work in selecting good dividend growth stocks is...
I have been a dividend growth investor for over 7-8 years now. The reason why I have somewhere between 85% - 90% of my networth in dividend ...
As a dividend investor, my main goal is to attain financial independence when dividend income exceeds expenses by an adequate margin of saf...
I love it when the stock market goes on sale, like it has been so far in the past two - three weeks. For aspiring dividend growth investors,...
How do you define success? To me, success is the freedom to do my own thing, and the ability to reach my goals. Given the fact that I am a f...
There are many risks to investing . One of the major risks that could ruin a portfolio’s chances of generating adequate dividends are p...
One of the biggest sins in investing, is investing money without a clear plan or strategy to accomplish specific goals . This investing sin...
Before I begin my message, I wanted to wish all my readers a Happy 4th of July. And I wanted to thank all of those military members for keep...
I am a fan of diversification as a tool to reduce risk. I diversify by buying at least 30 – 40 securities, representative of as many sectors...