Showing posts with label retirement. Show all posts
Showing posts with label retirement. Show all posts

Friday, March 28, 2014

Dividend Stocks for Consistent Cash Income

I was recently away from home for a two week period. During the time, I did not have the opportunity to check email or look at my dividend stock portfolio. The first thing I did after coming back was log on to my brokerage accounts. I noticed that everything had gone smoothly and I had more in cash than before. This should hardly come as a surprise to most readers – dividend investing is a low key, low activity process. It does not involve staring at a computer screen for 8 hours a day nor does my portfolio require tinkering every day, week or month. Most of the companies I tend to purchase are held as long term investments. Heck, even if I don't do anything with my dividend for a couple of years, I highly doubt my portfolio income will be affected.

I am mostly a buy and hold dividend investor. I tend to purchase companies, which have a quality product or service that is valued by customers, and which have been able to deliver dividend increases for at least one decade. Most of these companies, such as McDonald’s (MCD) or PepsiCo (PEP) tend to remain in the same lines of business for years, as they have the expertise and know-how to keep existing activities and also continuously improve in order to stay competitive. Even five or ten years from now, both companies would still be performing essentially the same things they are doing today. These strong brands are synonymous for quality and consistency of product/service, which is why consumers are willing to pay up. This translates into strong pricing power that enables companies to remain profitable, and pass on cost increases to customers, while retaining and even increasing profitability. Most such companies also tend to sell their products on a global scale, which ensures that they are not overly dependent on a single marketplace. Because these companies tend to have a stable, predictable business models, and because they have a diversified income streams coming from countries around the world, they tend to deliver dependable earnings and thus afford to pay dependable dividends to shareholders.

By owning companies with consistent earnings, I tend to generate consistent dividends every quarter. I typically let distributions accumulate in cash and do not automatically reinvest them. However, once amount f cash reaches $1,000, I tend to initiate or add to stock positions. I only tend to reinvest dividends in companies that are currently attractively valued, and whose prospects appear bullish. In other words, if my analysis indicates that a company has a decent chance of increasing earnings and dividends over time, and it is attractively priced at the moment, I would consider allocating any excess cash I have. This excess cash could be from dividends I received, and need to reinvest, or from new contributions. I do not automatically reinvest dividends, because I do not want to invest in companies which are overvalued at the moment, even if they have great long-term prospects. The frustrations of millions of US investors over the past decade, also referred to as the lost decade for US stocks, were primarily caused by excessive valuations in 2000. Even some solid companies such as Johnson & Johnson (JNJ) or Coca-Cola (KO) were overvalued in 1999 - 2000, which led to poor total returns over the next decade, despite the fact that their underlying businesses were growing.

The positive factor for owning quality dividend growth companies is that they tend to generate solid increases in dividend income, coupled with solid total returns. Another positive is the ability to compound income and total returns over time. Companies such as Johnson & Johnson (JNJ), Phillips Morris International (PM) and Casey’s (CASY) have been able to create strategies for increasing earnings, and then executing them. This has led to higher earnings and trickled down into higher distributions. As a result, investors who meticulously reinvested distributions at attractive valuations were rewarded by the amount of reinvestment plus the increase in distribution. As a result, they had effectively managed to turbo-charge their dividend compounding. The fact that earnings are growing, also makes the underlying businesses that dividend investors have put their hard earned money in, even more valuable. As other investors realize the extra value for the dividend paying company, they tends to deliver solid capital gains in the process as well. This icing on the cake also protects the purchasing value of the investment portfolio against inflation.

Full Disclosure: Long  MCD, PEP, KO, JNJ, CASY, PM

Relevant Articles:

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Check the Complete Article Archive

Tuesday, March 25, 2014

Should dividend investors invest in index funds?

Index funds are perfect for most people who don’t want to bother about managing their finances and retirement. If your goal is to accumulate a certain amount of net worth in the future, and do not want to spend any time learning about investing, index funds could be your best solution. Therefore, index funds are great for 80% - 90% of the population out there, particularly if coupled with the tax advantages of 401 (k), Roth and Regular IRA’s etc. I own index funds in my 401 (K), because I cannot buy anything else there.

However, if your goal is to generate income in retirement, index funds might not be most optimal use of your resources. If your goal is to generate a positive stream of income that is not dependent on market fluctuations and grows faster than inflation (dividends), then index funds like the S&P 500 might not be for you. Dividend investing is probably practiced by less than five percent of the investing population, although it should be higher. Of course, do not take my word for that, as this percentage might be even lower than that. But this article is written for the dividend investor, who is willing to do some work, and not let their retirement in the hands of Wall Street.

With dividend growth investing, you put a portfolio of 30 - 40 equally weighted individual securities, from as many sectors that make sense, which are attractively valued at the moment. After screening for your entry criteria, you construct your portfolio, and sit on it, while receiving a rising stream of dividend income. You monitor your portfolio regularly, and only sell after a dividend cut or a crazy overvaluation. I have been doing this since 2008, and have experienced one cut in 2008, two in 2009, one in 2010 and none between 2011 and 2014. The proceeds from the sale of the stock which cut dividends is put to work in another company that fits your entry criteria. Typically, dividends are either spent or reinvested into more quality dividend paying stocks in the accumulation phase, in order to compound capital faster. The reason why relying on dividend income for retirement is superior to index investing is because dividends are more stable than capital gains, and are always positive. Therefore, if stock prices fall and stay down, the dividend payments will provide positive reinforcement to the investor, who would be motivated to keep holding and ignore market fluctuations. Otherwise, investors could panic during a market correction, and probably sell at the worst time possible. In fact, many investors do sell at the worst times possible. It is very difficult for the ordinary uninformed investor to see their portfolio being down 30% - 40% - 50%, and them losing several years worth of contributions in one bad year for stocks. Therefore, a lot of investors sell in order to stop the pain and stop their nest egg from dwindling down even further.

In addition, with dividend stocks, you are a buy and hold investor with a long-term view. You are not switching money from one company to another. Therefore, you are reducing reinvestment risk due to transactions, and have a much lower chance of generating lower returns that come out of frequent portfolio churning.

One reason against index funds, is that they include a lot of companies which do not pay ANY dividends. Therefore, the yields on index funds are very low, and not sufficient to live off of today. That’s why in order to live off this nest egg in retirement, you need to sell of a chunk of it every single year. This leaves you with a shrinking asset base, which is relying on continued growth in prices. Without the increase in stock prices, you are shrinking your asset base even further. If you retired at the end of 1999, you would have experienced stagnating stock prices, and as a result, you would have “eaten” more than half of your portfolio by now. I would not want to face the stress of eating into my capital when I retire. If I have $1,000,000, and I sell $40,000 worth of securities each year, I would be out of money in 25 years, assuming no inflation and no stock price growth. If the first five or ten years produce no increase in stock prices, then I face a high risk of running out of money. The last few years of living in such conditions would likely be horrible, as I would be counting every penny twice, and stressing over, while counting the days until I have to get a Wal-Mart job as a greeter out of necessity. The thing is that noone can tell you in advance whether the year you retire with index funds will be similar to 1972 or to 2000.

There are many flaws with index funds, particularly those on S&P 500, which make them poor choices for the enterprising dividend investor. The first is that there is a lot of turnover every single year, which is not good for wealth building. In fact, the turnover is approximately 3% – 5% per year on average. This means that every year anywhere between 15 and more than 25 companies are added and replaced by the benchmark, incurring fees for the investor. Buying and selling of stocks is the reason many investors underperform their benchmarks. For indexes like S&P 500, this frequency of asset turnover has lead to underperforming a purely passive portfolio of stocks. Did you know that the original 500 stocks of S&P 500 from 1957 outperformed the S&P 500 index by 1% point for 50 years? My previous article on the topic discusses research done to prove this.

The second flaw is that index funds are weighted based on float and market capitalization. This is to serve the mutual fund industry, not the investor. If you are a big shot mutual fund, and you want to raise 100 billion from investors, you cannot follow a passive strategy that requires you to put money equally between 500 companies, because for some the total amount of stock available to purchase might be less than $200 million. Therefore, some companies are ignored, at the expense of focusing on the biggest. In reality, the equal weighted S&P 500 has done better than the market cap weighted S&P 500 over the past decade.

The third flaw is that I do not know what criteria the index committee uses to include stocks in the S&P 500. Sometimes, they (just like any normal investor) follow the crowd into irrational exuberance and doing stupid things. For example, back in 1999, a lot of old economy stocks were thrown out of the index, and substituted for red hot technology stocks such as Yahoo! I would let you figure out for yourself how that worked out. The other sin of the S&P index committee is that it didn’t include Warren Buffett’s Berkshire Hathaway in the index until 2010. With my strategy, I can select the securities that fit my criteria, and live or die by their performance, as I am the one in charge of capital allocation in the family.

The fourth flaw with index investing that they are not a magic panacea for sure stock market profits. An investor who doesn’t know anything about investing, and is passively saving in index funds, can still lose money. They can lose money if they panic at the wrong times such as in 2008 – 2009 and sell everything. They can also lose money if they put money to work without taking valuation into account. The ordinary investor can find a way lose money even with idiot-proof index funds. In fact, according to Morningstar, most investors in the Vanguard 500 index fund have underperformed the index by 2% per year over the past 15 years. The investor also needs to focus on valuation at the time of investment. You should not just blindly put your money in the market to work, without taking valuation into account. For anyone who bought S&P 500 index funds in the late 1990s, they were simply chasing market returns. This was not a smart decision, and the subsequent decade of low returns proved that ignoring entry valuation at the time of investment is not a good strategy.

The other thing is that while index funds have rock bottom expenses, they could still add up over time. For example, if you have a portfolio worth $100,000, you will end up paying $100/year in management fees. If your portfolio is worth $500,000, you will be paying $500/year for life.

In contrast, if you built a portfolio of 40 individual dividend paying stocks, and paid a $5/commission for each trade, you would pay $200 in total. If you never sell, you would never have to incur commission expenses again. Therefore, with a $100K portfolio, you are better off cost wise in 2 years. For the larger portfolios you are better off in individually selected stocks on your own, rather than index funds. That is one of the reasons why people who have several million in equities always pick their own securities, rather than rely on index funds. Why pay someone else thousands of dollars in fees per year for passive investments, when you can simply create a portfolio of the largest blue chip stocks, and do nothing after that?

Over the past decade, more and more investors are beginning to embrace passive index investing strategies. I am just wondering to myself, what if everyone is in index funds one day? I wonder what the consequences and inefficiencies that could arise from this phenomenon of people believe you do not need to know what you own, as long as it is an index fund.

If at one point everyone is invested in index funds, this could create all sorts of inefficiencies in the market. For example, if a company asks shareholders to vote on certain issues that could be otherwise profitable, noone would vote, since conventional efficient market theory says all information is already priced into the stock. As a result, index fund managers might not even bother voting, as they won’t believe their vote counts. Next, since these fund managers might not vote, because they probably haven’t done any research to know enough about the companies they hold for investors in the first place. Therefore, corporate managers at those large companies would face few consequences from angry shareholders. I think that one of the reasons why CEO’s are earning such high compensations is because ownership is being delegated to mutual funds, and not individual shareholders. If Warren Buffett owned 30% of Berkshire Hathaway, and he let his son be the CEO, you could be 100% sure that he would fire Howard on the spot if he paid himself an exorbitant amount of compensation while not furthering shareholders’ interests. This is the reason why as dividend investors, it pays to have your interests aligned with management, especially when management has an ownership stake.

In conclusion, there are a few main ideas that enterprising dividend investors should take from this article.

The first idea is to buy and hold, and not engage in active trading. If you slowly built a portfolio of 30 blue chip stocks, from as many sectors that made sense, and you HELD ON, for several decades, you should do very well for yourself.

The second idea is also to educate yourself about money and investing AS MUCH AS POSSIBLE. The main idea is that you are the one responsible for your retirement future. You are the one whose retirement is at stake, and the only one who cares about succeeding. Therefore, you should be personally involved in the process, educate yourself and determine the best way to achieve your goals. Whether you end up buying dividend paying stocks, index funds, or daytrade internet stocks online, you are the person who will benefit or  lose from your actions. Therefore, do not outsource your retirement goals and dreams to a third party, whose only goal is to generate a commission or annual fees from you. Take your dream in your own hands, and get at it!

Full Disclosure: Long S&P 500 Mutual Fund

Relevant Articles:

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Monday, February 3, 2014

How to retire in 10 years with dividend stocks

The goal of every dividend investor is to generate a sufficient stream of passive dividend income, that would adequately cover their expenses. In order to achieve this goal however, investors need to select a strategy and fine-tune it over time to reflect current market conditions. In most of my articles I tend to focus on investing that would generate dividends for several decades to come. But how would someone who wants to retire in one decade afford to retire? Follow the guidelines in this article, and you might end up being one of the lucky ones who can afford to quit the rat race in a decade.

The first guideline is to contribute regularly to your dividend portfolio. This is important, because it allows our investor to dollar cost average their way over many years. This would provide them with the opportunity to build their portfolio brick by brick, without purchasing everything as a lump sum. Many articles on retirement focus on lump sum investing, which is not relevant to most future retirees.

The second guideline is to focus on dividend growth stocks, which are companies that regularly raise distributions. Since our dividend investor is likely to live off distributions for decades to come, they need to overcome the risk of inflation. As a result, they need to invest in stocks that can afford to regularly increase dividends, thus ensuring an inflation adjusted stream of income. Luckily, David Fish has the dividend champions list, which can be accessed from here. Investors can use this list as a starting point to identify dividend growth stocks, and apply their screening criteria.

The third guideline is to buy quality dividend stocks at attractive valuations. This is the step where the savings added to the brokerage account need to be invested. Investors should develop a set of standard screening criteria, in order to narrow down the list of dividend champions or achievers to a more manageable level. I typically look for companies yielding more than 2.50%, which have raised dividends for at least ten years in a row and trade at less than 20 times earnings. I then further avoid companies with high dividend payout ratios, depending on their industry and business form. After I do this, I research each stock in detail, in order to determine if it has what it takes to keep raising earnings and dividends over time. This is the most subjective part of the process. However, if you create a properly diversified portfolio of income stocks as outlined in the next step, you have a very good chance of success, even if you picked average companies.

The fourth rule is to focus on creating a diversified income portfolio, in order to reduce risk. In order to protect yourself, your goal is to have your income stream come from as many companies as possible. Leave the task of outperforming the market each year to the people who want to manage other people’s money or who are trying to sell you expensive newsletters. Your goal is to create an income stream that grows over time, which will support you in your retirement. As a result, in order to have a defensible income stream, you need to own at least 30 individual income stocks representative from as many industries as possible. Ideally, you would own three stocks from each of the ten sectors identified by Standard and Poor's, which comprise the S&P 500 index. In reality however, it might be difficult to achieve this strict diversification. However, since you are building your portfolio over a long period of time, you will likely be able to purchase quality stocks from different sectors, which would be priced right at different times over the next decade.

The fifth rule is to reinvest dividends selectively in these quality income stocks over the next decade. Until you reach your target dividend income, you need to use the power of dividend growth, new capital contributions and dividends received to plow back into your portfolio and turbocharge your dividend income. I typically avoid reinvesting dividends automatically. Instead, I wait for my dividends to accumulate, and then either add to an existing position, or initiate a new position in an attractively valued stock. While some might say I am missing out on compounding my income while waiting for my dividends to accumulate and buy a stock, I disagree. Re-investing dividends in an overvalued stock is a much worse offense than simply patiently accumulating cash in my book, and deploying it in the best values at the moment. This is another tool that will increase your odds of growing your dividend income stream faster.

Now that I outlined a list of few basic guidelines to follow, I will show how an individual can retire in ten years. Let’s assume that our individual manages to save $1,000/month for the next 120 months (10 years). The first month they only manage to save $1000. Let us also assume that our investor invests his or her hard earned money in dividend stocks yielding 4%, that grow distributions by 6%/year. Let's also assume that share prices grow by 6%/year as well (Such linear growth in share prices does not work in reality, but is only used for the model) If the distributions are paid monthly, and are reinvested back in stocks yielding 4% and growing distributions at 6%, our investor will generate $659/month after 10 years. Now granted, they only saved $1000/month for ten years. However, if they saved $2,000/month instead, their dividend income will rise to $1,309/month in 10 years. If your dividend crossover point is around $1,300, then after ten years of meticulously saving and investing $2,000/month, you will be able to retire. The table below shows how investing $2,000/month in dividend paying stocks that yield 4% and grow dividends by 6%/year, can result in monthly incomes exceeding $1,300/month in 10 years, and $2,000/month in 13 years.

As you can see, the second column shows number of shares purchased with the $2000 savings every month, plus the amount of dividends received as well. After the first year, the $2000 buys less than 2000 shares, because the share price goes up in lockstep with the dividend growth.

This spreadsheet is a guideline on the forces that will help someone reach financial independence. Your dividend crossover point will be dependent the amount you can save, amounts you need, returns you can generate, and time to retirement. By carefully managing those variable, the retiree will be able to devise a proper plan that will help them accomplish their ultimate goals of attaining freedom over their time.

Relevant Articles:

Complete List of Articles on Dividend Growth Investor Website
What are your dividend investing goals?
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Dividend Growth Investing is a Perfect Strategy for Young Investors
Dividend Growth Strategy for Retirement Income

Wednesday, January 15, 2014

My Dividend Goals for 2014 and after

With the end of 2013, many dividend investors are reviewing the year that passed, and are updating their 2014 goals. As I am reviewing results from my portfolio, I am trying to understand if I am on track to reach my goals.

The three inputs that will help me achieve my goals are organic dividends growth, reinvestment yield and new capital to invest. In my book, organic dividend growth is merely a result of corporations approving increases in distributions to shareholders. I strive for a 6% in annual dividend growth on average. Since I am in the accumulation phase of my dividend investing journey I am also reinvesting dividends into more income producing securities. I believe that if my portfolio keeps growing distributions by 6 – 7% per year, and I reinvest this cashflow back into more dividend paying stocks yielding 3- 4% today, I can essentially grow total dividend income by approximately 10% per year.

This of course assumes that I no longer put any new capital to work in dividend paying stocks. The biggest change I implemented in 2013 was to reduce the amount of contributions to my taxable accounts to the minimum. This was because I am starting to max out tax-deferred accounts such as 401 (k), Sep IRA and Roth IRA, in order to cut down on taxes today, and create a vehicle where I would generate dividend income that won’t be taxed for at least 30 – 40 years. When you put money in taxable accounts, you can withdraw dividends from one account and easily pool them into another account. Unfortunately, with tax-deferred accounts, the money generated in one account has to stay there. I am doing this, because my largest expense in my budget is taxes. This includes Federal, State and FICA taxes.

My taxable accounts would likely generate a sufficient stream of income to reach my dividend crossover point within five years. This would be as a result of organic dividend growth, dividend reinvestment and fresh additions of investable funds. I do believe that I need to be generating more in dividends than what my regular monthly expenses are, just to be on the safe side. Because I would be earning more than what my typical monthly expenses would be, I would be paying taxes on the buffer income I won't be using. Therefore, I have added the assets that would generate this dividend income buffer in tax-deferred accounts. I would have to jump through hoops in order to access these funds, which is why I would only tap them in the case of extreme circumstances. There is a high likelihood that these funds would not need to be used ever, but could provide a potential buffer in case I am wrong in my calculations. Plus, the money would compound tax-free for decades, before the tax person gets their share, if I do not need to use them.

Now that I provided some high-level background on the status of accounts, I am going to go over my goals for the next few years. As I had mentioned before, I plan on becoming FI by 2018. After looking at the numbers, it looks as if I am on track to reach this goal. I am currently able to cover approximately 60%-65% of expenses with dividend income. This is a slight improvement from 50% – 60% that I was able to cover in early 2013. Using a conservative 10% growth in total dividend income, I come up with the following calculations:

Expenses Covered by Dividends

The table shows percentage of monthly expenses that are covered by dividend income at year end. I have simply compounded the percentage of expenses covered by dividends by 10%/annum. It looks like I am on track right now to accomplish my goals. I prefer to discuss goals in terms of the longer-term goal, rather simply focus on isolated annual goals. I think that for 2014 I would strive for approximately 70% in dividend income coverage, but this is meaningless without understanding how this goal fits in the grand scheme of things.

The percentages in the table do not include dividends generated in tax-deferred accounts. I expect that most of my future contributions will be in tax-deferred accounts, which would hold the excess dividend income, that would be part of my safety net. Some portions of income will make their way to taxable accounts, which might increase the percentage of expenses covered by dividends. However, in order to be conservative in my assumptions, I am not going to change these estimates in the table above.

I am also not putting down exact dollar figures, because reasonable expenditures vary from individual to individual. For example, for a single individual living in the Midwest that owns their residence, they can probably get by on say $1,500/month. However, if you are a married couple that lives in New York City or San Francisco, you would likely need at least $4,000 - $5,000/month merely to get by. The goal of this article is not to debate whether a certain dollar figure is reasonable or not, but to discuss my thought process in getting to a reasonable goal within a reasonable time. After all, these are my numbers, and they make sense for me - your numbers are going to be much different.

Therefore, in order to get to a place, you need to determine what your goal is. Write it down, and then try to determine how to get to that goal. I figured out early that I would achieve my goal with my diversified portfolio of dividend growth stocks, which are companies that regularly boost distributions for shareholders. I then determined the monthly amount I plan to invest each month, and also determined reasonable assumptions about returns. Based on these assumptions, I then figured out the amount of time I would need in order to get there.

It is also important to have a plan B and even plan C in action, in case your assumptions don’t turn out as expected. The value of a job income cannot be overlooked. For example, a source of $100 in monthly income is equivalent to $30,000 - $40,000 invested at 3%- 4%. This should be something you enjoy however, and are passionate about. So if you enjoy doing taxes and learning how much others make – you might be a tax preparer between January and April every year. It is up to you to figure out what you can do. However, I am not going to tell how to spend your time in retirement, so I am going to end the discussion here.

One obstacle to my plans could include situations where I lose my primary job, and am unable to find another one after that. This could damage my ability to make future contributions, and would also prevent me from reinvesting distributions, as I would be using them for my day to day expenses. Another obstacle that could prevent me from achieving my goals include situations where I can find fewer securities that fit my entry criteria. After a relentless increase in 2013, it is getting to a point where quality dividend companies are tougher to find. I do not envy the dividend investor who is just about to start putting their hard earned money to work today.

However, all hope is not lost, as I do find quality at decent prices today. The types of companies that look priced fairly include:

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 increased dividends for 38 years in a row. Over the past five years, it has managed to raise them at a rate of 13.90%/year. Currently, the stock trades at a P/E of 17.30 and yields 3.40%. Check my analysis of McDonald'’s for more information.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend machine has increased dividends for 5 years in a row. Over the past five years, it has managed to increase quarterly dividends by 15.40%/year. Currently, the stock trades at a P/E of 15.70 and yields 4.60%. Check my analysis of Philip Morris International for more information.

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion has increased dividends for 26 years in a row. Over the past five years, it has managed to raise them at a rate of 9%/year. Currently, the stock trades at a P/E of 9.90 and yields 3.30%. Check my analysis of Chevron for more information.

Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has increased dividends for 46 years in a row. Over the past five years, it has managed to raise them at a rate of 21.40%/year. Currently, the stock trades at a P/E of 16.70 and yields 2.70%. Check my analysis of Target for more information.

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide.This dividend champion has increased dividends for 39 years in a row. Over the past five years, it has managed to raise them at a rate of 14.20%/year. Currently, the stock trades at a P/E of 15 and yields 2.40%. Check my analysis of Wal-Mart for more information.

Full Disclosure: Long MCD, PM, CVX, TGT, WMT

Relevant Articles:

Complete List of Articles on Dividend Growth Investor
The Security I Like Best: Philip Morris International
Dividend Investing Goals for 2013
My dividend crossover point
My Retirement Strategy for Tax-Free Income

Wednesday, June 26, 2013

Dividend Growth Investing is a Perfect Strategy for Young Investors

Imagine your perfect day. You wake up when you are rested, without the need of any alarm clocks. You then do some working out , followed by having a nice healthy breakfast. You then read at your leisure, have a lunch later in the day to beat the 11:30 – 1 pm crowds, and then review your brokerage accounts. You notice dividends from several companies are deposited today, and you decide to transfer them to your checking account. You check for any major items concerning your portfolio holdings, and spend a few hours researching a new dividend stock.

After that you get more time to concentrate on your activities, be it volunteering at the local homeless shelter, mentoring high school students, learning a new language or simply catching up on some good books. Later that day, you might decide to enjoy a few with your mates/gals. This dream is brought to you by dividend investing.

This is my retirement dream in a nutshell. The reason I started Dividend Growth Investor blog in 2008, is to write down ideas on how to make it happen. I believe that dividend growth investing works for all investors, regardless of their age. However, I do realize that older investors might have a preference for higher yielding stocks, while youngsters like myself can afford to build portfolios across the yield spectrum.

One of the most common misconceptions about dividend investing however is that it is not a good strategy for building your nest egg, and therefore it is not suitable for younger investors. Being a youngster myself, I (not surprisingly) disagree.

Younger investors are typically told to take a lot of risks early on, because they have time to recuperate those losses. I find this saying to be very dangerous for young investors. The problem is that taking risk is important, but it should not be mean gambling. Investors should only be taking on large risks when they have a strategy with positive expectancy of a positive return, while risk is minimized. If you invest in penny stocks, social media stocks, or if you bought dot-coms during the tech boom of the late 1990s, you took huge risks but you were likely making concentrated gambles. There is a cost to gambling, because losing your entire nest egg of $10,000 at the age of 24 means you will be poorer by $800,000 by age 70. This calculation assumes a 10% annual return for 46 years.

In contrast, with a typical dividend growth strategy, you get a slow and steady approach that will lead to a monthly passive income that will pay your expenses in retirement. Starting out early will be beneficial, because you would gain the necessary experience through trial and error, and find out the nuances that work out for you. This would make you successful, and ensure you maintain your success in investing. A big part of investment success is not losing too much in your investment career.

With this dividend strategy, we are focusing not on net worth per se, but on target annual dividend income. If your goal is to have a net worth of $1 million dollars, but you end up investing it in a relatively illiquid asset such as a personal residence, you might not be able to retire entirely on it. In some parts of the US, you might have to pay $20 - $30 thousand in annual property taxes plus paying for upkeep, maintenance etc. If instead you had a rental property generating $4,000 in monthly income or a portfolio of dividend stocks generating a similar amount, you might be set for life.

I believe that a new investor who does not have a lot of money today but who plans on accumulating their “financial nut” over the next years will be perfectly able to utilize dividend growth investing. With this strategy investors turbocharge the dividend income growth of their portfolios by putting money to work every month in stocks that regularly boost dividends, and then reinvesting those dividends selectively.

Since 2008, I have been on a mission to build up my portfolio income. Every month, I save an amount of money that I deposit in my brokerage account. I scan the market for investment opportunities all the time, followed by analyzing prospective investments. I identify dividend stocks for further analysis either by running my screening criteria against the dividend champions or contenders lists, by looking at weekly list of dividend increases as well as through interactions with other investors and the general method of my inquiry into business.

I do a complete stock analysis of each company I find interesting, in order to gauge whether the company in focus has any competitive advantages, pricing power and whether there are any catalysts for further expansion in revenues and profitability going forward. I focus on companies that can grow earnings over time, which will provide the fuel for future dividend increases. A rising earnings stream is also positively correlated with an increase in stock prices. You can have your cake and eat it too with dividend growth stocks.

My goal is to acquire the quality companies identified for purchase at attractive valuations. Entry price does matter to an extent, because a lower price provides a higher margin of safety in the investment and is equivalent to a higher dividend income. Of course, if you plan on holding stocks for 20 – 30 years however, it would not really matter whether you purchased Johnson & Johnson (JNJ) at $70/share or $75/share. If you overpay today however, it might mean that your returns in the first five years might be below average, until the growing earnings result in a valuation compression that would make the stock attractively valued today.

For my personal portfolio, I try to generate annual dividend growth in the 6-7% range on aggregate. My portfolios also yield approximately 3.50% – 4%. I achieve these aggregate figures by stacking three different types of dividend growth stocks, for maximum results. So far, I am able to cover approximately 50% of my expenses from my dividend income.

A few good picks include:

Coca-Cola (KO) engages in the manufacture, marketing, and sale of nonalcoholic beverages worldwide. This dividend champion has increased distributions for 51 years in a row. Over the past five years, Coca-Cola grew distributions at a rate of 8.40%/year. Currently, the stock is trading above the 20 times earnings limit I have set for myself, but yields a very respectable 2.80%. Check my analysis of Coca-Cola.

Phillip Morris International (PM) manufactures and sells cigarettes and other tobacco products. The company has managed to grow distributions by 13.10%/year since the spin-off from parent Altria Group (MO) in 2008. I like the economics of the tobacco business, without the liability stemming from doing business in one country. PMI's revenues are generated outside the US, and therefore are not dependent on a single country's onerous laws on smoking. Currently, the stock is trading at 16.60 times earnings and yields 3.90%. Check my analysis of PMI.

Kinder Morgan Inc (KMI) is the general partner of Kinder Morgan Partners (KMP) and El Paso Pipeline Partners (EPB). It also owns limited partnership interests in KMP and EPB.  The most important asset is the incentive distribution rights structure, which provide for a 50% share of any future distirbutions growth over a certain threshold for KMP and EPB. Given the growth projections for energy assets in the US, and Kinder Morgan in particular, this stock can achieve high single digit dividend growth for at least the next five years. Currently it is yielding a very attractive 4.20%.

Procter & Gamble (PG) engages in the manufacture and sale of a range of branded consumer packaged goods. This dividend king has increased distributions for 57 years in a row. Over the past five years, Procter & Gamble has managed to boost distributions at a rate of 12.20%/year. Currently, the stock is trading at 17.20 times earnings and yields a very respectable 3.10%. Check my analysis of Procter & Gamble.

Let’s see how a portfolio stacks, where a young dividend investor puts $3000/month in 4% yielders that grow at 6%/year.

After five years with this approach, you would be earning $750 in monthly dividend income. Ten years after starting this strategy you will be earnings $2,000 in monthly dividend income. Fifteen years after beginning your dividend investment journey, you will be making almost $4,000 in monthly dividend income. This slow and steady approach is very boring, and it is not as exciting as tripling your money in Tesla (TSLA) in less than a month. However, more investors who focus on long-term wealth accumulation potential of dividend growth stocks will be better off than investors who gamble on the next big growth stock.

An investor with a vision will look beyond the 3%- 4% current yields today, but look at the potential for higher distributions over time. An investor that starts small at a young age, builds a diversified portfolio of income producing securities with growing distributions when valuations are right, reinvests these rising distributions into more stock and continuously adds to his portfolio, will achieve wealth at a relatively young age.

Full Disclosure: Long KMI, KO, PM, PG, JNJ, KMR

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- Carnival of Personal Finance #421

Monday, June 24, 2013

Your Retirement Income is on Sale!

Everyone loves a good sale! When you purchase quality merchandise at 50% off, or at everyday low prices, it is considered a bargain and a smart move. When stock prices decline however, investors all of a sudden lose their common sense to become fearful. Lower prices on quality stocks causes investors to shun buying stocks. Higher prices on the other hand, excite everyone.

Stocks have finally began sliding down, and I am starting to get excited. I would love for stocks to get down even further from here. As someone in the accumulation stage of the dividend machine building process, I welcome any price weaknesses with open arms, as it translates into higher entry yields.

The amateurs are starting to get nervous however. They need positive reassurance through rising prices. If they don’t get rising prices, they get scared, and start selling everything. These investors view stocks like lottery ticket substitutes. Many dividend investors, myself included, started their investing journey treating stocks like lottery tickets in their early days. After a while however, it all starts to sync in that stocks are ownership pieces of real businesses, and not just some paper certificates or kilobytes on a computer screen. Success if determined based upon the growth in the underlying business, not because of meaningless short-term stock price fluctuations.

At the end of the day, smart dividend investors view stocks as partial ownership shares of real businesses. They do their research in uncovering those businesses, and then try to buy existing owners out at bargain prices. They can then sit back, monitor their business interests, and collect dividends one check at a time. After all, if you owned an apartment building next to a college that is always occupied, you won’t give a damn if its quoted valued fell by 5% - 10%- 20% in one single day. As long as you can rent your building out, you should do just fine by ignoring “quoted values”.

And what a great time it is to be a collector of business profits, through generous dividend distributions. Corporate balance sheets are flush with cash, more people are going back to work, and that housing market is coming back up. It is even better, when the price of your dividend stream is getting cheaper by the dozen. Just a month ago, everyone was complaining that stocks are overextended, and quality REITs such as Realty Income (O) yielded only 4%. This caused me to ask myself, whether we were in a REIT bubble. Since then, the stock has gone down over 26%, and is yielding a cool 5.30%.

The chicken littles however are scared that the Federal Reserve will stop pumping $85 billion into the economy every single month. However, they seem to be forgetting that the economy seems to be recovering. Most importantly, they seem to be forgetting that most profits in investing are made by the long-term buying and holding, not flipping stocks.

I keep hearing from amateur investors of the world, that the improving economy and the ending of Qualitative Easing by the FED will lead to higher interest rates. Those rising interest rates will be bad for dividend stocks. I usually ignore such talk, not because I am smug, but because I try to look 20 -30 years down the road. I cannot imagine a scenario, where US businesses will not be better off in 20 – 30 years. Businesses will have better productivity, access to more markets, and would have made more in profits. Chances are that we would have new products that few are probably even dreaming of right now. I assume that these products would likely improve lives significantly. I wake up every day, trying to achieve something for myself and my family – I imagine that millions of other people in the US and the Globe are trying hard to achieve just that. Some of these people would be the ones to invent the products mentioned above, that will improve our lives.

In addition, rising interest rates are bad for all stocks, not just dividend stocks. If I had to choose between owning some highly speculative Chinese internet stocks or some blue chip dividend paying stocks that pay me rising dividends every year, I would always go with the dividend stocks. Chances are that the mature dividend stocks will have access to credit at much better terms when things get tough, while the hot growth Chinese internet stocks will get clobbered and many might have to resort to cooking the books to get credit. Again, the goal is to try to select the companies that have what it takes to be here in 20 -30 years, and then try to buy their stock at attractive valuations. You can also call these qualities competitive advantages, wide moats or strong brands. Trying to outguess the economic cycle is a fools game. Even people whose primary job is forecasting macroeconomic trends have trouble getting it right. Your job is again to invest for the next 20 – 30 years, which would cover several economic cycles, and several periods of interest rate fluctuations. In those 20 -30 years, stocks would likely drop by half at least once.

One of the smartest people in the world, who became a billionaire because of his intelligence, once said:

"If you are not willing to hold stocks though 50% loss, you should not be in stocks."

Let that sink in. This person is Charlie Munger, the long-standing business partner of Warren Buffett. If Buffett had chickened out in 1974, when the price of Berkshire Hathaway (BRK.B) had fallen down by 50%, and put everything in Treasuries, he would have never become a billionaire.

When shares of Aflac (AFL) dropped from $25 to $10/share in 2008 - 2009, it was a pretty scary experience. I held on, bought some more, and have been adding to the position and collecting dividends ever since. I am welcoming drops in prices, especially if it would bring companies such as Coca-Cola (KO) to trade at 15 - 16 times earnings. Given forward earnings of $2.14/share for 2013, this would translate into $32.10 to $34.34/share.

Some quality companies like Phillip Morris International (PM) are trading at 16.80 times earnings, yield 3.90%, while having a sustainable distribution. The company is expecting to grow earnings by 9 - 12%/year for the foreseeable future, fueled by its expanding growing operations. Check my analysis of PMI.

Other companies such as Wal-Mart Stores (WMT) are trading at 14.50 times earnings and yield over 2.50%. Wal-Mart Stores has been able to increase dividends for 39 years in a row.Over the past decade, the worlds largest retailer has managed to boost distributions by 18.10%/year. Check my analysis of Wal-Mart.

So back to our Realty Income story mentioned above. If you had $500,000 in May 2013, and you invested the whole stash in realty Income (O), you would have only been able to generate $20.000 in annual dividend income. If you bought Realty Income today, you would be able to make over $26.000. I don’t know about you, but the drop in stock prices is making me feel richer. If I were a rational dividend investor, I would actually hope for lower prices from here. If you get a cash machine that spits out an ever rising stream of dividend income, then wouldn't you want to buy a piece of it at the lowest prices possible?

After all, it would make the cost of your retirement much lower.

Full Disclosure: Long O, KO, AFL, PM, KO

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Thursday, April 18, 2013

The right time to sell dividend stocks

With the market hitting fresh 17 month highs, investors have to look hard in order to find attractively valued opportunities. Plenty of stocks such as Aflac (AFL), Emerson Electric (EMR), 3M (MMM) and Realty Income (O) ,which in early 2009 rewarded enterprising dividend investors with their highest yields in a decade, are now yielding much less. Many stocks are also trading at rich valuations, which suggests that investors these days are willing to pay a premium for future growth.

The rapid increase in prices since March 2009 lows has many dividend investors wondering whether they should lock in some or all of their gains today. Investors who were able to purchase stocks in 2008 and 2009 might be sitting at gains, which seem equal to the dividend payments they could expect from a stock for several years to come. The issue with this thinking is that dividends typically increase over time on average while cash in the bank typically loses its purchasing power over time. As a result the investor who takes profits today might lose on any increases in dividends as well as on any future price gains. They would also have to find a decent vehicle to park their cash, which is getting harder and harder to find these days.

Because of the reasons stated above I would not consider selling even if my position went up 1000%. It would not be a wise idea to sell a stock which was purchased as a long term holding and its business hasn’t changed much. What is important is that the original yield on cost that has been locked with the purchase in 2008 or 2009 is there to stay, as long as the dividend is at least maintained. I would only consider selling when the dividend is cut. If a stock you purchased had a current yield of 8%, your yield on cost of is 8%. The nice part about this is that you keep receiving 8% on your original cost as long as the dividend is maintained. Then it doesn't really matter if the stock is currently yielding 1% or 2% - you still earn 8% on your cost. If the dividend payment is increased then your yield on cost rises as well. Companies like Johnson & Johnson (JNJ) or Abbott Labs (ABT) for example have low current yields of 3%, but their growing dividend payments produce substantial yields on cost over time.

If you were thinking of selling a stock which generates great yield on cost, you should remember that currently the market is overvalued. But the market could keep getting overvalued for a far longer period than you or I could remain sane. Retirees need income, and in the current low interest environment dividend stocks seem to be the perfect vehicle for an inflation adjusted source of income in retirement.

Back in the late 1980s Procter & Gamble (PG) yielded less than 3% for the first time in decades, which was much lower than the 4% average yield that investors received in the mid 1980s. In early 1991 the stock traded at 10.50, yielded 2.40%, and paid 6.25 cents/quarter. Although bonds yielded at least three times what P&G yielded at the time, they couldn’t provide rising income payments and the possibility for high capital gains as well. By early 1994 Procter & Gamble stock increased to $14, after a 2 to 1 stock split, paid 8.25 cents/quarter and yielded 2.20%. In early 1999 Procter & Gamble traded at $46.50 and had split 2:1 in 1997. The company paid out 14.25 cents/share but yielded only 1.30%. The yield on cost for the early 1991 investor was a more comfortable 5.50%. Fast forward to 2010 and Procter & Gamble is trading close to $64 and yielding 2.80%. The yield on cost on the original 1991 purchase is 16.80%. This example goes on to show that selling Procter & Gamble (PG) when it became overvalued, was not a very good idea, because the company kept generating higher earnings and kept increasing its dividend payment. While investors could have found other stocks to reinvest Procter & Gamble (PG) dividends or allocate any new cash, they would have been well off simply holding on to Procter & Gamble (PG) and other dividend raisers despite them being overvalued for extended periods of time.

Right now Procter & Gamble (PG) looks like it could again stay below 3% for the foreseeable future. This time I am planning on adding to my position around $59 ,even though it is not exactly trading at a 3% yield.

Full Disclosure: Long ABT, AFL, EMR, JNJ, MMM, O, PG

Note to Readers: This article was originally published on March 24, 2010. The basic ideas behind it however are still valid, three years later.

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Tuesday, April 2, 2013

The Four Percent Rule is Dependent on Dividend Yields

I recently read a very interesting article from author Dave Van Knapp, related to the four percent rule. Dave analyzed research from Morningstar, which claimed that the four percent rule is no longer relevant, and should be replaced with a three percent rule. In this argument, I am going to discuss the root causes behind this issue, as well as the surprising reasons behind the real factors behind the four percent rule that made it truly successful.

The following chart below shows the dividend yield in the S&P 500 (SPY) between 1926 and 2011. All data used was obtained from Prof. Schiller’s website.

The following chart shows the current yield on Ten-Year US Treasuries between 1926 and 2011:

This chart, shows the average annual yield of a portfolio where 50% invested in S&P 500 and the remainder is put in a US Ten-Year bond.

The next chart shows the growth in dividend payments of the S&P 500. I used the S&P 500 as a proxy for dividend stocks, given the fact that data was widely available for the index, and it is an adequate proxy for dividend stocks.

Annual dividend returns are less volatile than annual price returns. It is extremely difficult to forecast if a stock is going to return a positive price gain in a given year or a negative one. However, it is much easier to forecast whether a company will be able to deliver a dividend return to its shareholders over the course of a year. For example, I am 99% certain that Wal-Mart Stores (WMT), McDonald's (MCD) and Coca-Cola (KO) would still be paying a dividend over the next 12 months. Chances are also that these companies would raise dividends through April 1, 2014 at least once. I believe that the reason why the four percent rule was successful was not because stocks tended to increase in value over time, but because the income generated from an equally weighted stock and bond portfolio is a reliable source of spending money for retirees.

It is easier to begin retirement if you invested at times when stocks were attractively valued. When stocks are cheap, they have low P/E ratios and relatively high dividend yields. A sustainable dividend payment, which more than covers investors expenses, provides for an adequate margin of safety to cover these expenses.
Based on the data, it could be argued that the four percent rule has traditionally been based on the stability of stock and bond yields and the positive dividend growth that investing in a basket of blue chip common stocks can deliver over time. Back in the early 1990’s, when William Bengen conducted his research, dividend yields were close to 4%, while yields on 30 year US Treasuries were anywhere between 7 – 8%. For the large part of the 1926 - 1994 study period, the average yield of a portfolio that consisted of 50% equity and 50% fixed income exposure was 4.87%. The average yield was less than 4% in only 24 out 69 years observed.

It is particularly interesting that in a traditional dividend portfolio, the goal is to generate a growing stream of distributions. A portfolio could yield 4% today, but over time and given a 6% dividend growth rate, it could double the yield on cost to 8% in 12 years and to 16% in 24 years. In the traditional portfolio described in Bengen’s research, an investor starts out by withdrawing an amount equivalent to 4% of the initial portfolio value every year, and then adjusts it every year with inflation. I see some similarities between the two approaches, and find that Bengen incidentally might have been following portfolio yield on cost, that many dividend growth investors tend to closely monitor.

Given the steep declines in bond and dividend yields over the past 20 years, the new research now claims that the four percent rule should be a three percent rule. Not surprisingly, an allocation to stocks and bonds could easily yield 3% in today’s environment. This further strengthens the argument that that the original four percent rule was based on relying on the stable dividend and bond interest factor that investors would have received.

Full Disclosure: Long WMT, KO, MCD

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Wednesday, November 7, 2012

Why am I obsessed with dividend growth stocks?

I have an obsession with dividend stocks. I log-on to my brokerage accounts every morning, in order to check the amount, timing and source of any dividends deposited. On certain days, such as the 15th of some months, the amount of dividends received is much higher than my salary. To me dividends represent financial freedom from a 9 to 5 (or typically later) job.

Dividends are an integral part of my retirement strategy. The point at which I will be able to retire will be when distributions exceed my monthly expenses by a sufficient margin of safety at the crossover point. I do not blindly invest in dividend stocks however. I follow a multi-step process, in order to ensure that unnecessary risks are not taken along the way.

A long time ago, employees used to slave away for 3 – 4 decades, until they received the golden watch at their retirement party. Typically starting at the age of 55, retirees were able to draw upon their company’s defined benefit plan. A few years later, they were able to receive Social Security checks, and live comfortably for the rest of their lives. A few decades ago however, corporations started cutting retirement benefits, and instead offering optional defined contributions plans, such as 401K’s. There is much speculation that the age for receiving social security benefits will be increased going forward, and that the amount of the benefit might be reduced in the meantime. This means that employees should be relying on themselves for funding of their needs in retirement.

Many retirees are typically sold on traditional asset drawdown schemes such as the four percent rule. This rule was popularized by CFP William Bengen in his research studies. According to this strategy, investors would purchase bond and stock index funds, allocate them in their portfolios according to their risk preferences. Investors will then sell a portion of their portfolios each year, in order to pay for their lifestyle, while rebalancing their portfolios and paying their financial planners and mutual fund managers sizeable fees in the process. The issue with this strategy comes when retirees are experiencing prolonged flat or bear markets. People who retired in 1999 – 2000 or in 2007 have been selling off portions of their portfolios, while the investments in their portfolios have remained flat or declined in value. If the market keeps being flat for another decade, these people will certainly run out of money and enjoy a much lower standard of living in the process. To me, selling off a portion of my assets each year is akin to cutting the tree branch you are sitting on.

This is one of the primary reasons why I am sticking to a strategy, where my portfolio throws off a decent amount of cash every month, quarter or year. This way, I maintain ownership in the companies I hold, without risking selling stocks for income during flat or bear markets. No matter what the markets do, as long as I have selected fundamentally strong companies, my dividend checks will keep coming in the mail.

In order to ensure that my portfolio will generate a rising stream of dividends every year during my planned retirement, I need to follow several sound principles around diversification, entry criteria and stock analysis.

Diversification is important, because it ensures that I do not have all of my eggs in one basket. In my portfolio, I attempt to hold at least 30 individual securities, which are representative of as many sectors as practical. That way, if all the companies in a certain sector cut dividends all at once, the impact on my overall dividend income will be negligible.

Entry Criteria at which stocks are purchased is important as well. I am currently dollar cost averaging my way into attractively priced stocks every single month. I try not to pay over 20 times earnings, an attempt to buy companies that yield at least 2.50% these days. Once a stock I own sells at more than 20 times earnings or less than a 2.50% yield, I will hold on but would not add to the position. In addition, I purchase securities which have sustainable dividend payments, and which have established histories of consistent dividend increases.

Diversification and entry criteria are closely interwoven with my overall analysis of a security. There are always at least 15- 20 attractively priced dividend stocks to purchase each month, which is why I need to do a little work before determining which stocks to add. I would need to also analyze each company in detail, in order to determine whether it can provide dividend growth in the future. This is achieved by studying the business, reading financial statements, visiting locations, talking to suppliers and customers and staying up to date on major developments. While I am enjoying the rising stream of dividend checks, I also want to see my dividend stocks deliver capital gains over the long run as well.

I take a conservative view of dividend investing, because I do not want to learn how to greet customers in my late 70s or early 80s. Some companies which I have recently met my entry criteria include:

McDonald’'s Corporation (MCD) franchises and operates McDonald's restaurants in the global restaurant industry. The company has raised dividends for 36 years in a row. Over the past decade, this dividend champion has managed to boost distributions by 27.40% per year. McDonald’'s currently trades at 16.40 times earnings and yields 3.50%. (analysis)

Aflac Incorporated (AFL), through its subsidiary, American Family Life Assurance Company of Columbus, provides supplemental health and life insurance. The company has raised dividends for 30 years in a row. Over the past decade, this dividend champion has managed to boost distributions by 20.40% per year. Aflac currently trades at 8.30 times earnings and yields 2.80%. (analysis)

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. The company has raised dividends for 25 years in a row. Over the past decade, this dividend champion has managed to boost distributions by 8.80% per year. Chevron currently trades at 8.90 times earnings and yields 3.30%. (analysis)

Air Products and Chemicals, Inc. (APD) provides atmospheric gases, process and specialty gases, performance materials, equipment, and services worldwide. The company has raised dividends for 30 years in a row. Over the past decade, this dividend champion has managed to boost distributions by 11.10% per year. Air Products and Chemicals currently trades at 14.40 times earnings and yields 3.30%. (analysis)

Walgreen Co. (WAG), together with its subsidiaries, operates a chain of drugstores in the United States. The company has raised dividends for 37 years in a row. Over the past decade, this dividend champion has managed to boost distributions by 18.90% per year. Walgreen currently trades at 14.40 times earnings and yields 3.20%. (analysis)

Full Disclosure: Long AFL, CVX, APD, WAG, MCD

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Wednesday, September 5, 2012

How to retire with dividend stocks

Dividend investing is a long term process. Investors should buy stocks with the intention of holding them forever, as long as the business fundamentals are still intact. The companies that are best suited for long term buy and hold investors have strong brands, strong competitive advantages, rising earnings and pay their shareholders to hold them. These stocks pay shareholders by sharing a portion of their earnings every year in the form of dividend, which is increased every year. Stocks that regularly raise dividends produce an income stream which keeps up with inflation, and could easily be spent, without having to dip into principal or reinvest a portion of it back in order to maintain purchasing power of income. Investors in fixed income on the other hand have to reinvest a portion of their interest income every year, in order to maintain the purchasing power of their income, unless they want to dip into principal.

Once investors have set their sights on dividend stocks, they should patiently accumulate positions in their best ideas. A company that pays 2%-3% today is generally ignored by most dividend investors. However, if this stock manages to double distributions at least every decade, they would generate a very respectable income stream when their investor decides to retire. The truth is that these yield-chasing dividend investors “need” a stock yielding 6%-8% only because they have not saved enough money for retirement. Most often these investors buy securities without analyzing whether the dividend is secure. Not all high yielding stocks are bad of course. Buying a stock just because it has a high current yield however, without analyzing it in detail, is a sure recipe for disaster.

We have all heard about the power of compounding. A $1000 investment, which generates 12% in annual total returns, will be worth $16,000 in 24 years. An investor who buys dividend stocks and reinvests distributions for decades, will be able to accumulate a sizeable portfolio by the time they are ready to retire. However, if those dividend stocks also regularly increased these distributions, the investor would enjoy a turbocharged power of compounding in their wealth.

The process of dividend investing will not get you rich quick overnight. However, the slow and steady approach provides attractive long term returns on capital, while minimizing the frequency of mistakes that more active traders make. Investing $1000/month in a portfolio of dividend stocks yielding 3% today, which has a dividend growth of 12% per year, would generate over $26,300 in annual dividend income in 24 years. If dividends are reinvested, chances are that this investment would generate much more than $39,600 per year in 24 years. As a result, for every dollar that you save in your 20s and put in dividend stocks, you would generate one dollar in dividend income in your 50s or 60s.

Market downturns are particularly helpful to investors who plan on living off dividends in retirement, because they provide an ideal opportunity to purchase world class dividend stocks at a discount.

Chevron Corporation (CVX), engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. It operates in two segments, Upstream and Downstream. This dividend champion has raised distributions for 25 years in a row. The company has also managed to boost distributions by 8.80% per year over the past decade. Yield: 3.20% (analysis)

Kimberly-Clark Corporation (KMB), engages in the manufacture and marketing of health care products worldwide. The company operates in four segments: Personal Care, Consumer Tissue, K-C Professional & Other, and Health Care. This dividend champion has raised distributions for 40 years in a row. The company has also managed to boost distributions by 9.70% per year over the past decade. Yield: 3.50% (analysis)

United Technologies Corporation (UTX) provides technology products and services to the building systems and aerospace industries worldwide. This dividend achiever has raised distributions for 19 years in a row. The company has also managed to boost distributions by 15.30% per year over the past decade. Yield: 2.70% (analysis)

PepsiCo, Inc. (PEP) engages in the manufacture, marketing, and sale of foods, snacks, and carbonated and non-carbonated beverages worldwide. This dividend aristocrat has raised distributions for 40 years in a row. The company has also managed to boost distributions by 13.30% per year over the past decade. Yield: 2.90% (analysis)

The Clorox Company (CLX) manufactures and markets consumer and institutional products worldwide. The company operates in four segments: Cleaning, Lifestyle, Household, and International. This dividend aristocrat has raised distributions for years in a row. The company has also managed to boost distributions by % per year over the past decade. Yield: 3.50% (analysis)

Air Products and Chemicals, Inc. (APD) provides atmospheric gases, process and specialty gases, performance materials, equipment, and services worldwide. This dividend aristocrat has raised distributions for 30 years in a row. The company has also managed to boost distributions by 11.10% per year over the past decade. Yield: 3.10% (analysis)

Walgreen Co. (WAG), together with its subsidiaries, operates a chain of drugstores in the United States. This dividend aristocrat has raised distributions for 37 years in a row. The company has also managed to boost distributions by 18.90% per year over the past decade. Yield: 3.10% (analysis)

The truth is that investors do not need a nest egg of $1 million to retire. They do need however to have saved and invested regularly in quality dividend stocks, purchased at attractive valuations over their investing career.

Full Disclosure: Long All Stocks listed above

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