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

Wednesday, August 20, 2014

How to Invest Like Warren Buffett

Warren Buffett is the most successful stock investor in the world. He made his first $20 million dollars by running a hedge-fund like investment partnership in the 1950’s and 1960’s. However, if he hadn’t changed his investing habits from being a pure value investor to being influenced by Charlie Munger and Phillip Fisher, he would not have been as successful as he is today. Buffett’s earlier cigar-butt investments produced large gains initially, but then he had to do more research in order to find more value investments, and reinvest his money. What he learned from See’s Candies, Berkshire’s Insurance Operations and Newspapers however, shaped the way Buffett invests. By using his investing acumen to identify these superb businesses, his company managed to earn a recurring stream of profits for years to come.

The best lesson that Warren learned happened when he purchased See’s Candies for 25 million dollars in the 1970’s. The business had a strong brand, which was synonymous with quality, and had a loyal customer base. The strong competitive advantages of the business helped it maintain pricing power, and slowly boost prices to consumers over time. When competitors tried to emulate its packaging in order to steal market share, they were sued by See’s and promptly had to stop doing that. At the same time the business did not need to reinvest a substantial portion of earnings in order to increase sales over time. As a result, the business has generated over a billion dollars for the forty years that Berkshire Hathaway (BRK.B) has owned it. In effect, the business has paid for itself almost 50 times over.

The other businesses that Buffett purchased included newspaper and insurance companies. At the time, newspapers had strong competitive advantages in metropolitan areas, which allowed them to serve as the only local exchange of information, services and goods in a given city. All of these businesses were flush with cash, and were spitting excess free cash flows every quarter. They also had strong competitive advantages, and didn’t need all of their profits to be reinvested back in the business in order for it to grow. Unlike the cigar-butt investments that Buffett made earlier in his career, the companies with competitive advantages managed to deliver returns for years to come, rather than deliver a one-time return and then nothing.

Buffett then used the free cash flows from these businesses to purchase more income streams that generated more excess cash flows. This is very similar to what dividend investors in the accumulation phase are doing. They design a dividend portfolio, and then use dividends received in order to purchase more shares of other attractively valued companies. As a result, I have long argued that Buffett is a closet dividend investor. If you read his letters to shareholders closely, one would notice that he keeps reiterating how Berkshire Hathaway’s investments keep producing excess cashflows of staggering amounts every month.

In fact, dividend investors can essentially emulate Buffett’s style by creating their own mini-Berkshire’s using dividend growth stocks purchased at attractive valuations. Some of the most widely-held dividend stocks to serve this purpose 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. The company has a 10 year average dividend growth rate of 22.80%/annum. Currently, the stock is selling for 17 times forward earnings and yields 3.20%. Check my analysis of McDonald's.

Wal-Mart Stores Inc. (WMT) operates retail stores in various formats worldwide. This dividend champion has increased dividends for 41 years in a row. The company has a 10 year average dividend growth rate of 18%/annum. Currently, the stock is selling for 14.80 times forward earnings and yields 2.50%. Check my analysis of Wal-Mart Stores.

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend stock has increased dividends for 6 years in a row. The company has a five year average dividend growth rate of 14%/annum. Currently, the stock is selling for 16.50 times forward earnings and yields 4.10%. Check my analysis of PMI.

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. This dividend achiever has increased dividends for 19 years in a row. The company has a 10 year average dividend growth rate of 19.40%/annum. Currently, the stock is selling for 10.60 times forward earnings and yields 2.40%. Check my analysis of IBM.

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has increased dividends for 32 years in a row. The company has a 10 year average dividend growth rate of 9.60%/annum. Currently, the stock is selling for 12.80 times forward earnings and yields 2.70%. Check my analysis of Exxon Mobil.

Full Disclosure: Long MCD, KO, WMT, PM, IBM and 1 share of BRK.B

Relevant Articles:

What Attracted Warren Buffett to IBM?
Warren Buffett is now working for me
Why Warren Buffett purchased Exxon Mobil stock?
Warren Buffett Investing Resource Page
How Warren Buffett built his fortune

Wednesday, August 13, 2014

Dividend Investing for Financial Independence

There are millions of Baby-Boomers in the US. Every day, thousands of them retire from the workforce. Most will rely on a mix of social security, company pensions and personal assets for income in their golden years. Fewer employers are offering traditional pensions these days however, and the future of the Social Security system is not as sound as it once was. Depending on who you listen to, Social Security system would either run out of money in 35 years or will be able to continue paying benefits, albeit at a deeply reduced rate. For many investors outside the Baby Boomer generation, the realization is that they would have to provide for their own retirement, and not rely on employers or the government.

The tools that there investors can leverage in order to reach their financial independence goals include time, compounding, capital and smart investing.

One investment strategy that can provide for your own investing is investing in dividend paying stocks. By creating a portfolio that consists of dividend paying stocks, an investor generates income that is paid to them at predictable intervals of time. Having a stream of income deposited in your brokerage account every month or every quarter makes budgeting much easier, and living off dividends a no brainer solution.

I view every dollar I can save as a dollar that can generate income for life. Let’s assume that this dollar is invested in a dividend stock that yields 4%, grows distributions and stock price by 6% annually. After ten years, this dollar will generate 7.16 cents in income, which will increase to 12.80 cents by year 20. In 30 years, this dollar will be generating almost 23 cents in annual income. If distributions are reinvested however, the dollar will be generating 10 cents, 26.70 cents and 71 cents in the next 10, 20 and 30 year periods. One cannot retire on a single dollar alone, but if you keep adding dollars to your investment portfolio and let them compound through dividend reinvestment, our investor can afford to generate enough income to retire.

These dollars need to be invested by designing and creating a diversified dividend portfolio that consists of at least 30 individual stocks. The portfolio should have representation from as many industries that make sense at the time of implementation. This portfolio should focus on dividend growth stocks, which are companies that have a history of regular dividend increases. A company that regularly increases dividends essentially provides investors with a stream of income that keeps its purchasing power over time. Compared to interest income, dividend income looks like a clear winner for preserving purchasing power from inflation.

The element of time is another crucial element in achieving financial independence with dividend paying stocks. Depending on the amount of capital invested initially, as well as the amount of capital added each month, a portfolio would require differing amounts of time to compound before a sustainable amount of income is generated. The portfolio would need more time to compound investment dollars in order to reach the target monthly dividend income if the amount of capital added is not high enough. However, if the amount of capital added to it is large enough, the time needed to reach the monthly income targets would be greatly reduced.

For example, let’s assume that an investor puts $1000/month in the stocks yielding 4% today and achieving a 6% annual dividend growth. If dividends are reinvested, the portfolio will generate over $7,900 in annual dividend income in ten years. However, if our investor put away $2000/month in income stocks with the same characteristics as above, they would be achieving $7,900 in annual dividend income only after 72 months.



Besides diversification and power of compounding, another crucially important factor to building a successful dividend portfolio is stock valuation. Just like a house is composed of many bricks, placed one by one, a portfolio is comprised of many individual stocks which are the building blocks that provide support behind the portfolio. If one or a few companies in a concentrated sector bet crumbles during a recession, it could potentially destroy the whole structure. Having a strong foundation would protect investors’ income portfolios in the event of dividend cuts or eliminations as a result of unfavorable business conditions. Each dividend stock in a portfolio should thus have to be carefully chosen, and should be purchased only at attractive valuations. Purchasing shares when they are cheap maximizes price gains and dividend income for shareholders over time. This further turbocharges the compounding in income stream growth over time. I typically look for companies that have raised dividends for over 10 years, that trade at less than 20 times earnings, have a dividend payout ratio of less than 60% and which yield at least 2.50%. For Master Limited Partnerships and Real Estate Investment Trusts however, the only differences related to how I calculate payout ratios and what minimum yield requirements I selected.

A few companies which are attractively valued today include:

SYMBOL
P/E
DPR
10 yr DG
YIELD
PRICE
DIV/SHARE
EPS

ADM
19.69
48%
12%
2.10%
49.04
0.96
2.01
AFL
9.35
23%
17%
2.30%
59.19
1.48
6.46
BMS
18.19
53%
6%
2.60%
39.84
1.08
2.05

CB
10.8
24%
9%
2.10%
88.34
2
8.36
CVX
12.21
42%
11%
3.20%
127.86
4.28
10.27
EFSI
11.76
37%
7%
3.60%
22.95
0.72
1.97

GPC
19.19
51%
6%
2.60%
84.24
2.3
4.49
HP
16.17
39%
23%
2.40%
103.23
2.75
7.09

JNJ
18.69
54%
11%
2.70%
101.08
2.8
5.23
MCD
16.94
59%
23%
3.20%
93.55
3.24
5.5
MMM
19.85
50%
7%
2.40%
140.85
3.42
6.9
ORI
8.98
36%
7%
4.30%
14.39
0.73
2.04

SRCE
12.68
32%
7%
2.30%
29.25
0.72
2.28

TMP
12.23
46%
6%
3.30%
44.36
1.6
3.51

TROW
18.08
43%
16%
2.10%
78.11
1.76
4.11

UGI
16.67
41%
7%
2.40%
49.02
1.18
2.85

WEYS
16.75
47%
15%
2.80%
27.08
0.76
1.61

WMT
15.42
40%
18%
2.50%
74.67
1.92
4.84
XOM
12.72
38%
10%
2.70%
99.74
2.76
7.34


Full Disclosure: Long ADM, AFL, CB, CVX, JNJ, MCD, MMM, WMT, XOM

Relevant Articles:

My dividend crossover point
Can everyone achieve financial independence with Dividend Paying Stocks?
Margin of Safety in Financial Independence
How to stay motivated on your road to financial independence
Achieve Financial Independence with Dividend Paying Stocks

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