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

Wednesday, July 16, 2014

Dividend Investors Will Make Money Even if the Stock Market Closed for Ten Years

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. Warren Buffett

Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. Warren Buffett

In 1914, the New York Stock Exchange closed for five months. In 2001, the NYSE, Nasdaq and AMEX were closed for a week. Active stock traders did not make any money during those periods. Dividend investors kept receiving their dividend checks, without interruption.

Investors can buy and sell their stock in an instant. This ability to quickly cash out makes stock investing a preferable option for many investors. Compare this to real estate or a private business, where it might take months in order to buy and sell an asset.

Sometimes however this could be a curse as well. While stocks are a very liquid investment, sometimes investors end up being too focused on short-term price fluctuations, while ignoring fundamentals. During bull markets, investors bid up share prices to unsustainable levels. During bear markets, investors who see their portfolio values collapsing panic and sell at the wrong times. Those investors become too emotional, which creates opportunities for the enterprising dividend investors. The emotional investors tend to forget that stocks are not some lottery tickets or numbers blinking on a computer screen, but ownership pieces of real businesses. In a perfectly rational world, the value of business depends on its current and future estimated earnings powers. This is why when entire businesses are sold to a private buyer, the price paid is usually close to the intrinsic value. However, due to the emotional state of Mr Market, the ownership pieces that are exchanged between stock market participants are frequently mispriced.

Dividend investors know that dividend stocks represent ownership stakes in real businesses. As a long-term investor, your success is dependent on the success of the business. If the business manages to grow earnings per share, it would be worth more and would also be able to distribute more in dividend income.

Dividend investors who embrace a buy and hold mentality have an inherently psychological advantage over the average investor. Dividend investors generate a return on investment every time they receive a dividend payment. As a result, many retirees who are living off dividends, concern themselves with the company’s ability to grow earnings to pay higher distributions, than the stock price of the stock. Astute dividend investors focus on fundamentals, understanding the company’s operations and valuing the business as if it were a privately owned corporation.

Dividend investors are in essence much different than the rest of participants, who rapidly exchange little pieces of ownership between each other, in an effort to outwit each other. Dividend investors see stocks as partial ownership pieces of real businesses. They understand that their ultimate success in investment is based on the price they paid and on the success of the business itself. If you own a restaurant along with 10 other partners, you care about making sure the business succeeds, and stays relevant for as long as possible. The goal is to make sure that repeat business is earned, customers are happy, and profit margins are healthy, while trying to constantly increase profits. The advantage of dividend investors is that they focus on the fundamentals of the business, how it earns money, and whether this business has the potential to earn more money in the future. Then they try to purchase that business at an attractive valuation, which takes into consideration a range of potential outcomes, and provide an entry price range which would generate a satisfactory return on investment. If you are the partial owner of a McDonald's franchise, you earn profits whether the stock market is open or closed. In fact, if you have found the right business at the right price, it is highly likely that you will hold this business forever.

This is how I view ownership of high quality companies such as Coca-Cola (KO), Johnson & Johnson (JNJ) and Kinder Morgan Inc (KMI). Those are real businesses, that provide real goods or services to clients, and which generate profits to be distributed to me as the partial share-owner. I expect to hold those businesses forever, and expect to earn ever increasing dividends over time from those ownership stakes. I see the rapid trading as pure madness, which actually doesn't really affect me. Whether I pay $37 for Coca-Cola shares or $37.10/share is irrelevant to me. Let the high-frequency computers make that money. The real money is made by identifying a quality company,  buying it at an attractive price, and then sitting on it for decades. In the meantime, the business will be earning more and more in profits almost every year, and pay you an amount of dividends that will likely exceed the purchase price paid by a factor of a few times the purchase price.  Time is the ally of the long-term, buy and hold dividend investor. The initial results are slow, but eventually, the compounding ends up snowballing into mind-boggling yields on cost and capital appreciation returns.

This is why I spend so much time screening the list of dividend champions and dividend achievers, and then researching companies one at a time. I am looking for companies with strong competitive advantages, strong brands, that would allow those companies to have the potential to be around in 20 years, and still earn more per share over time. For example, if you are a part owner of the local water utility, you know that this business will be around in the next 20 - 30 years, because it would be impossible for someone else to compete with you, due to regulation and cost to set-up and maintain the system. If you are a part owner in a company that provides a unique product or serves, which is largely unregulated, it essentially has a monopoly that could mint profits to the shareholder for decades. A prime example of that is Coca-Cola, which has a strong distribution network throughout the world, is associated in consumers' minds with positive emotions, has over 500 brands globally that quench the thirst of people in 200 countries to the tune of 1.9 billion servings per day. If you believe this business has the staying power to be around in 20 years, then you can make projections on earnings, revenues and dividends with a much larger degree of comfort. You want a business which will not change too rapidly. People will get thirsty 30 years from now. If you have the distribution scale that covers 200 countries, and a portfolio of 500 branded drinks, chances are that consumers will use your products. This is why Buffett invests in quality companies with durable competitive advantages, operated by honest and able managers, which have attractive returns on capital and which are available at attractive prices. If you find such a company, the goal of the dividend investor is to hold on to it for decades, and let the power of compounding do the heavy lifting for them.

In contrast, while I might know that Apple will be around in 20 years, I am not so sure how much profitable the enterprise will be, due to the rapid changes in technology. Sony was another great consumer technology franchise, which has not done so well as of the past decade. Will Apple follow the steps of Sony? I don't know, and chances are that few investors really have the necessary knowledge to make an educated bet today. This is why I am sticking to companies I understand, and focus on their fundamentals for the next 20 - 30 years. As a long term buy and hold dividend investor, my goal is to live off the dividends from my collection of quality enterprises. Therefore, my success will be determined on the success of the businesses I invest in, not on stock price fluctuations. The stock market is only helpful to me as a tool where I find sellers of quality businesses, not as a place to instruct me on how to make my investments.

Full Disclosure: Long KMI, JNJ, KO. One share of BRK.B

Relevant Articles:

Coca-Cola: A wide-moat dividend growth stock to buy and hold
Maintaining Moats in times of Technological Changes
Seven Sleep Well at Night Dividend Stocks
How to analyze investment opportunities?
Let dividends do the heavy lifting for your retirement

Wednesday, July 9, 2014

Look abroad for higher dividend yields

US stocks these days are offering much lower yields than the rest of the world. For example, S&P 500 yields less than 2%, while UK stock indices are yielding more than that. Given the fact that foreign companies are paying more generous dividends that US ones, should dividend investors venture abroad?

Before investors decide to invest in foreign stocks, they need to understand the risks and peculiar characteristics of foreign dividend paying stocks.

In general, most foreign dividend paying companies pay fluctuating dividends each year. Foreign companies are quick to cut dividends if earnings fall even by a small amount, since they target a particular dividend payout ratio, rather than a particular level of dividend payments. US investors who are used to the stability of dividend payments that most American firms exhibit might be disappointed by this feature. Fluctuating dividends make it particularly difficult to live off your investments, and as a result it is best that these companies are avoided.

Adding to the injury, most foreign companies tend to distribute cash to shareholders once or twice per year at best. Many multinationals such as Nestle (NSRGY) for example pay distributions once per year. As a result, investors who like to reinvest dividends have only one instance/year to compound their profits. As a dividend investor, I have found that having the ability to reinvest the same annual dividend in four quarterly installments allows for faster compounding than having the dividend compound just once per year. For the companies that pay dividends twice annually, they tend to split distributions into interim and final payments. The interim payments typically represent 40% of the total annual dividend, while the final payment represents 60% of the total annual dividend. As a result, many US services such as Yahoo!Finance, routinely miscalculate the dividend yields of companies such as UK based company Diageo (DEO), or Vodafone (VOD).

Another factor to consider before purchasing foreign shares is taxes. Many countries such as Canada, France, Switzerland and Netherlands, to name a few, impose taxes on dividends paid out to US investors. These taxes are typically around 15% for Canadian stocks held by US investors for example. While US investors can claim a credit for any taxes withheld at a foreign source in taxable accounts, they cannot do that in tax-deffered ones such as ROTH IRA’s. In addition, some foreign companies such as Unilever have dual class shares with similar rights that trade both in London and Amsterdam. Purchasing the Netherland based ADRs for Unilever N.V. (UN) could lead to tax withholdings, whereas purchasing the United Kingdom based ADR’s for Unilever PLC (UL) could pose no such problems. US dividend taxes would still be due of course, but there is less paperwork trying to claim foreign taxes withheld on dividends.

Another factor to consider includes transaction costs. Many US investors tend to purchase American Depositary Receipts (ADRs) on foreign listed shares. As a result, they end up paying US capital gains taxes and US commissions. If you dare to venture abroad however, you would have to deal with finding the right broker, paying taxes abroad and paying commissions which are probably much higher than the ones in USA.

In general, many foreign companies also report results under IFRS, which is a different accounting standard than the US GAAP. Other factors to consider include the fact that many foreign companies listed in the US are typically global businesses, and therefore would trade similarly with their US competitors. In other words, during the financial crisis of 2007 – 2009, many stocks lost almost half of their values. As a result, venturing out abroad might not have delivered the diversification benefits that international investing is supposed to deliver. However, by expanding the time-frame to look at performance of foreign shares before and after the crisis, one could note a few differences. Because of the global nature of business these days, I avoid international over diversification by purchasing shares of US based multinationals.

There are a few lists with dividend growth stocks, which could aid investors in their search for dividend paying companies with dependable and rising distributions. These include the international dividend achievers index, which lists companies traded in US, which have boosted distributions for at least 5 years in a row. Another interesting benchmark is the Europe Dividend Aristocrats index, which lists European companies which have raised distributions for over 10 years in a row.

Some foreign companies that fit in this criteria include:

Diageo (DEO), which produces, distills, brews, bottles, packages, and distributes spirits, beer, wine, and ready to drink beverages. The company has managed to increase dividends for at least 15 years in a row. Currently, the stock is selling for 19.70 times forward earnings and yields 2.70%. Check my analysis of Diageo.

Nestle (NSRGY), which provides nutrition, health, and wellness products worldwide. The company has managed to increase dividends for 18 years in a row. Currently, the stock is selling for 18.60 times forward earnings and yields 3.10%. Check my analysis of Nestle.

Novartis (NVS), which is a multinational company specializing in the research, development, manufacturing and marketing of a range of healthcare products led by pharmaceuticals. The company has managed to increase dividends for 17 years in a row. Currently, the stock is selling for 17.50 times forward earnings and yields 3%. Check my analysis of Novartis.

Unilever (UL), which is a consumer goods company operating in Asia, Africa, the Middle East, Turkey, Russia, Ukraine, Belarus, Europe, and the Americas. The company has managed to increase dividends for at least 19 years in a row. Currently, the stock is selling for 20.20 times forward earnings and yields 3.50%. Check my analysis of Unilever.

BHP Billiton (BBL), which operates as a diversified natural resources company worldwide. The company has managed to increase dividends 15 years in a row. Currently, the stock is selling for 16.80 times forward earnings and yields 3.50%. Check my analysis of BHP Billiton.

Those companies are a little pricey today, but are good long-term holdings for long-term investors. If prices decrease from here, it would be nice to have those company on a watchlist.

Full Disclosure: Long NSRGY, UL, VOD and DEO

Relevant Articles:

International Over Diversification
Best International Dividend Stocks
International Dividend Stocks – Pros and Cons
Nine Quality Dividend Stocks Purchased for the Roth IRA
How to retire in 10 years with dividend stocks

Wednesday, July 2, 2014

Can everyone achieve financial independence with Dividend Paying Stocks?

The goal of every dividend investor is to create a portfolio that makes enough dividend income to live off. In order to reach this goal, investors need three ingredients: regular savings, quality dividend stocks and time.
The first step in your journey as a dividend investor is to spend less than what you earn. Unless you are counting on receiving a big lump sum from an inheritance or winning the lottery, living within your means and savings are the primary sources of investable cash.

The next step is to choose quality stocks, which have a history of consistent dividend increases. The best place to start is the list of dividend champions and the list of dividend contenders maintained by David Fish. In order to reduce the number of stocks to a more manageable list, they can create a set of rules for screening dividend investments. A screen I use includes the following parameters:

1) Valuation – P/E less than 20
2) Consecutive years of dividend increases – at least 10
3) Ten year dividend growth of at least 6%
4) Dividend Yield exceeding 2%
5) Payout ratio of less than 60% for common stocks. For MLPs and REITs look at the DCF payout or FFO Payout ratios.

Once the screening criteria are utilized, and the list of potential candidates is generated, it is time to thoroughly research every single income investment. Researching entails reading the annual report, press releases, slides from analyst conferences, analyst reports and keeping up with major developments. The goal of this exercise is to evaluate whether the company can increase profits over time. While this sounds like a major time commitment on the surface, the reality is that few companies change so much over the course of a year. As a result, once our investor spends a large block of time to gain an understanding of the business, any additional information that is material to a business would only take less than a few hours per quarter.

Another crucially important component of investing is time. Even if you purchased the best dividend stock in town, at the best price possible, an investor could still be exposed to meaningless noise, that might lead them to trade in and out of stocks. This activity could be bad for your pocketbook, since time in the market is more important than timing the market. Most investors that lose money are those who frequently trade, and never really end up grasping the power of compounding for those patient enough to let the seeds of their capital mushroom over time. Those who make money are those who think like long-term business owners. Time is an important ally for good businesses, and for the patient investors who hold on to those quality businesses. If the business manages to grow earnings and pay rising dividends, this can compound your money until you reach your financial goals. Things could change over time, and as a result people need to create mechanisms for dealing with change. In order to ensure the successful passive income compounding of the dividend portfolio over time, one needs to diversify, reinvest dividends and sell losers.

Diversification is an important tool in the arsenal of the successful income investor, because it protects them against the proverbial bad apple that can take a serious bite out of your dividend income at the worst possible moment. I often encourage investors to build a diversified income producing portfolio consisting of at least 30 - 40 individual companies, which are representative of as many sectors that make sense. As a result, even if one bad apple cuts or eliminates distributions, the total dividend income would not be affected by as much. In addition, once the dividend cutter is sold, the proceeds could be used to purchase another cheap company in the sector. By avoiding the major losses that could seriously derail the investment portfolio, the investor would have all the odds in his or her favor that would allow them to compound their profits.

Investors can either compound their dividend income by reinvesting automatically in the firms that generated the income in the first place or by taking the cash distributions and reinvesting in another stock once the proceeds exceed their minimum lot size. Investors need to add new capital or accumulated cash dividends to the companies that are attractively valued. However, they should not commit more than 5% – 6% of their portfolio to a single security. If the top security is one you are already overweight in, invest your funds in the next most attractively valued stock that has a portfolio weight with room to grow. For example, I have frequently purchased companies like Johnson & Johnson (JNJ), Chevron (CVX) and Phillip Morris International (PM), which is why they are overweight in my portfolio. Because of that, any new money I add would have to be allocated to other quality investment opportunities available at good valuations.

An investor, who follows these simple principles, should be able to achieve financial independence at some point in the future. The end result is directly correlated with the level of effort and resources committed to achieving it.

Full Disclosure: Long JNJ, CVX, PM

Relevant Articles:

Why Dividend Growth Stocks Rock?
Dividend Champions - The Best List for Dividend Investors
How long does it take to manage a dividend portfolio?
How to think like a long term dividend investor
Replacing dividend stocks sold

Monday, June 23, 2014

Multi-Generational Dividend investing

You have spent your whole life accumulating your nest egg. Building a long term dividend portfolio takes a lot of time, effort and a little bit of skill or luck. Once the dividend machine is set up properly however, and starts throwing off a sufficient stream of income, investors would have to spend less than 10 hours/week on managing investments. This is not a huge time commitment, but it provides investors with the ability to make changes if stories do not work out as expected. Investors, who looked after their income portfolios in 2007-2009 bear market, would have been able to dispose of their securities in a timely manner after they cut or eliminated dividend payments.

The question is however what happens if the individual/s who built the portfolio from scratch cannot afford to manage the investments anymore. This could be due to several reasons including death, incapacitation or other gruesome events. As dividend investors, we tend to focus on selecting companies that would generate income for decades, but do not spend a lot of effort on who would be the next one in the family to maintain and manage the portfolio. Selecting a beneficiary for your online brokerage accounts is just a small step in the process. Writing a will which lists all online accounts is another small step that should be done, in order to avoid having inheritors scramble to locate assets after an unfortunate event.

These unfortunately still do not answer the question of whom and how the income portfolio would be managed. There are several potential options, each coming with its own set of risks.

-The first is to just hold on stocks, don’t do anything , except for maybe sell after dividend cuts. I have noticed that many companies tend to raise dividends for long periods of time, and then freeze them, only to continue raising them again. Kellogg (K) is a prime example of this, as it ended a four decade streak of annual dividend raises in 2000, only to start boosting distributions again nine years ago. One piece of research I find particularly telling is the work that Jeremy Siegel has done on the performance of the original S&P 500 companies in 1957. He found that a portfolio of these companies, where investors did absolutely nothing, except for reinvest dividends and reinvest cash proceeds from acquisitions in the portfolios, would slightly outperform over the next 50 years.

- The second thing to do is to educate family/close ones, in order to ensure they can manage investments without a considerable input from outside help. The goal is to make family members motivated enough so that they can manage money and are interested in making it last for several generations. If family members are not motivated, chances are the amounts of money will be spent quickly, leaving little behind in a few short years after the original accumulator is no longer in charge. As a result, creating a trust fund where only the income could be spent might be the best solution. This would require some help from an attorney, in order to set up the trust properly, and outline bylaws and trustee responsibilities.

- The third option is to hire someone to manage investments and focus on implementing your strategy. This could cost a lot, particularly if the wrong type of an advisor is selected. In addition, there has to be a process for selecting advisers in the future, since many would end up retiring on their own. You also need to decide how to avoid the future Madoff’s of the world.

- There is a fourth option, where one could simply place the money in mutual funds, and probably be just fine with that. However, going back to step two, if the beneficiaries are not properly trained to think about money, they can blow through the funds in no time. Alternatively, someone who has a large nest inherited nest egg and doesn't know a lot about investments can panic during the next bear market and sell. Thus the beneficiary could potentially undo decades worth of patient compounding by the original capital accumulator.

Overall, I believe that a relatively well diversified portfolio, consisting of several stocks from each sector should do well over time, even if managed passively. I believe in the living off dividends method, since this is a sustainable way to ensure that a nest egg can produce income to live off for decades. This is what has ensured success for charitable organizations and trust funds for decades. Examples of companies to include per each sector includes:

Sector
Name
Ticker
Yrs increase
10 yr DG
Fwd P/E
Yield

Information Technology
IBM
IBM
19
19.40%
     10.21
2.40%
Financials
Aflac
AFL
31
16.80%
       9.95
2.40%
Energy
Chevron
CVX
27
10.55%
     11.86
3.50%
Healthcare
Johnson & Johnson
JNJ
52
10.84%
     17.44
2.70%
Consumer Staples
Procter & Gamble
PG
58
10.59%
     18.96
3.20%
Consumer Discretionary
McDonald's
MCD
38
22.80%
     17.48
3.20%
Real Estate
Realty Income
O
20
5.99%
N/A
5.10%
Telecommunications
AT&T
T
30
4.88%
     13.17
5.30%
Industrials
United Tech
UTX
20
14.48%
     17.05
2.00%

For my money, I plan on placing them in trusts that would distribute dividends only to beneficiaries for decades to come. The only decisions that would be done by a trustee would be about selling companies that cut or eliminated dividends, or distribute proceeds from companies that are acquired for cash by someone else.

What are you doing to ensure longevity of your nest egg, beyond your own generation?

Full Disclosure: Long K, IBM, AFL, CVX, JNJ, PG, MCD, O, UTX

Relevant Articles:

Living off dividends in retirement
Four Percent Rule for Dividend Investing in Retirement
Why Dividend Growth Stocks Rock?
A dividend portfolio for the long-term
How much money do you really need to retire with dividend paying stocks?

Wednesday, June 18, 2014

Investors Should Look for Organic Dividend Growth

The goal of every dividend investor is to have an active plan in service that will allow them to reach the dividend crossover point. This occurs when dividend income exceeds annual expenses for the first time. In order to achieve this, investors can rely on new contributions, the compounding power of dividend reinvestment and on dividend growth from their positions. Over time, these three powerful forces will be able to propel the passive income of our investor until they reach their goal. However, I think that investors need to also asses their portfolios at least once – twice per year at the very least.

Investors need to continually stress test their portfolio assumptions, in order to gauge whether their dividend machine can live up to its full potential in retirement. Investors need to understand if their portfolio would have produced increased income even if no new funds were added or if no dividends were reinvested. This is a very important step in dividend investing for retirement that would ensure that income is growing over time. Growing income is important, in order to maintain purchasing power of your dividend stream. For example, even if inflation was a low 3% per year, your purchasing power declines by 20% in year 7, 40% by year 17 and over 50% by year 24.

My expectation is that my dividend portfolio will deliver a six percent annual dividend increase, without adding any new money. For example, if I had a portfolio yielding 3% today valued at $100,000 I would generate $3,000 in annual income. If I add $6,000 to the portfolio in stocks whose average yield is 3%, I would have increased my dividend income by 6% to $3,180. Without new money, this income stream would lose purchasing power over time, which is a dangerous proposition in retirement. However, if the original stocks this this portfolio yielded 3% but also grew distributions by 6%/year, the distribution would be $3,180 without having to add $6,000 to the portfolio. As you can see, if all things were equal, organic dividend growth could be very valuable weapon in your quest for financial independence, because the internal compounding results in lower needs for capital to be placed in-service into your dividend machine.

In my income portfolio, I always look at my holdings at the end of the year, and then ignore any additions or deletions I made since the beginning of the year. I assume that I didn't add any funds and I also assume I put all dividends received in my checking account. I took a look at my starting portfolios at the end of 2008, 2009, 2010, and 2011 to come up with the following organic dividend growth rates:


2009
2010
2011
2012
2013
Dividend Growth
-0.97%
6.74%
7.50%
7.11%
8.70%

I was building out my portfolio throughout 2008, which is the only reason why an organic dividend growth rate was not calculated for that year. In comparison, the dividend income assuming dividend reinvestment and new money addition was much higher.The cuts in General Electric (GE) and State Street (STT) really prevented me from achieving organic dividend growth in 2009. Since I reinvested the funds from the stocks I sold however, my total dividend income increased in 2009, even before accounting for purchases I made.

To summarize, I believe it is important to invest in companies that regularly increase dividends for their shareholders out of the earnings growth their business generates. This results in an increase in dividend income that is much cheaper for the dividend investor, and doesn't require constant reinvestment of dividends in order to keep up purchasing power or increase income.

Full Disclosure: None

Relevant Articles:

How to Generate an 11% Yield on Cost in 6 Years
Reinvest Dividends Selectively
Replacing dividend stocks sold
The Sweet Spot of Dividend Investing
Dividend Investing vs Trading

Wednesday, June 4, 2014

Focus on High Yielders with Growing Distributions

In a previous article, I mentioned that as a long term dividend investor, I do not try to pursue a strategy of active dividend investing. As I gain more experience however, I tend to closely scrutinize companies which are not performing up to my requirements. In general, these companies tend to have a higher yield, slower or nonexistent distributions growth, and have neutral business growth outlooks at best. I have previously simply held on to such companies, and reinvested distributions elsewhere. But recently, I have began reconsidering whether my income portfolio would be better off disposing of these potential high yield traps.

Many dividend investors focus on dividend yield in their starting analysis of potential income investments. In general, the higher the yield, the higher the dividend income that the investor would receive. This could be even more common for investors who have not saved a sufficient amount of money, which is why they are searching for any type of a shortcut, in order to get them to the desired level of income in retirement.

The main risk with such a strategy is that by focusing exclusively on the yield or the desired level of income, the retired investor could end up overlooking certain factors, which could be devastating for their retirement. If the dividend paying company cannot support the distribution payments, chances are that it would cut or eliminate it. This would cause severe drops in income, along with decrease in the stock price, as fewer investors would be willing to purchase an asset with limited or no income potential.

In my process of looking at dividend stocks, I look for several things, before I even decide to analyze a stock. I look for a trend of consistent dividend increases, a dividend payment that is adequately covered from earnings or cash flows as well as attractive valuation. After I uncover a stock that fits these loosely defined quantitative criteria, I tend to analyze qualitative factors, in order to guesstimate whether the company would be able to generate higher earnings per share over time. Each company is different, but some of the most common drivers behind future growth include expanding the business in new territories, introducing new products, acquiring competitors, reengineering the business in order to attract new clients. Another important set of drivers include having products or services, where the number of customers is expected to increase, and where the quality of the company’s offering helps it maintain pricing power.

For example, the low interest rate environment has made many retirees switch to dividend paying stocks. The primary outcome of this hunger for yield is that many companies in the utilities and real estate investment trust arenas have been bid up by investors. As a result, their yields are at multi-decade lows. One example includes Consolidated Edison (ED), a regulated utility that supplies electricity and steam power to millions of customers New York City. The company has boosted dividends for 40 years in a row. However, in 2012 it yielded less than 3.80%. In addition, it had only been increasing distributions by less than 1% per year over the past 17 years. At this rate, the purchasing power of your dividend income stream has been ravaged by the eroding power of inflation. I analyzed the stock and noticed that going forward, because of the unfavorable regulatory environment for utilities in New York, the company could not count even on decent earnings growth to support a higher dividend growth rate. As a result, back in 2012 I decided to sell the stock and purchase units of ONEOK Partners (OKS), which have the capacity to deliver much higher distribution growth over time, had sustainable distributions and as an added bonus yielded more. I only kept a few shares in another legacy account, for which it was not cost-beneficial to sell.

In previous articles I had mentioned that I want to hold a diversified portfolio of stocks coming from as many sectors that make sense. In general, the more I study historical dividend stock information, the more I realize that utilities are great only for current income for a period for 5 -10 years. Utilities in general tend to have poor dividend growth rates, which are typically overlooked by yield hungry income investors. In addition, many utilities tend to cut dividends every couple of decades or so, after which they start raising distributions again. Many utilities do provide with the added income stability during a period of economic turmoil, such as the one observed during the 2007 – 2009 financial crisis. However some like Ameren (AEE) did cut distributions during that tumultuous time.

Utilities of course are not the only sector that dividend investors should scrutinize closely, in their quest for rising dividend incomes. Some companies that I used to own, such as Cincinnati Financial (CINF) have had a hard time covering distributions in recent years, and have raised distributions only by nominal amounts for the past six years or so. While having a long streak of consecutive dividend increases is impressive, and speaks a ton about the company’s dedication to rewarding long-term shareholders with a rising stream of cash each year, I do prefer to see substance. In other words, I would much rather hold a slightly lower yielding stock, with a shorter streak of dividend increases, which however has the potential to generate higher earnings and dividends growth. This is a preferred investment in comparison to a higher yielding, but lower growth company such as Cincinnati Financial (CINF) or Consolidated Edison (ED). As a result of my dissatisfaction with Cincinnati Financial, I replaced the stock with shares in five Canadian banks in early 2013.

To summarize, while it is important to thoroughly analyze stocks before purchasing them, it is also important to not get married to positions. Buy and hold investing does not mean buy and forget – regular monitoring of positions is a must for the serious dividend investor. This would ensure the longevity of the dividend income stream by identifying potential troublemakers well in advance, and replacing them with opportunities with better prospects.

Full Disclosure: Long ED, OKS

Relevant Articles:

Active Dividend Growth Investing
Margin of Safety in Dividends
Utility dividends for current income
High Dividend Utility Stocks – Are they a trap for dividend investors?
Spring Cleaning My Dividend Portfolio

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