Thursday, October 17, 2019

What is intrinsic value?

The value of a business to a buyer in a going private transaction is its intrinsic value. In other words, if a business is acquired by another entity, the amount exchanged for that business is its intrinsic value.

Quite often, investors confuse price and value. The price of a business is readily available throughout the day on the internet. On the other hand, the value of the business to an acquirer is not quite easy to determine. It takes some analysis, before coming up with an estimate of the intrinsic value in a going private transaction.

The price of the shares will fluctuate above and below the intrinsic value of the business, driven by the fear and greed of market participants. The market price is just based on the amounts that stock investors are willing to pay. The price is just their guesstimate of intrinsic value, but these opinions vary widely from day to day. In fact, these opinions vary more than the changes in a company’s intrinsic value. It is interesting to observe that even for large and mature large cap companies there is a large gap from year to year between the high and low prices investors are willing to pay for a security. This is why Warren Buffett and Ben Graham refer to the stock market as a manic-depressive individual.

For example, Johnson & Johnson (JNJ) has traded between $121 and $149 over the past 12 months. I would think that this is a high variation, driven by short-term news. I do not believe that the intrinsic value fluctuated that much over the past twelve months. This is why I prefer to look at dividends, since they are not the opinion of stock traders, like share prices. Dividends are the only direct link between company’s fundamental performance and investor returns. While everyone these days seems to believe that dividends are useless because share prices are adjusted downwards on the ex-dividend date, I disagree. I have long argued that dividends unlock value, as evidenced by special dividend announcements. Dividends accrue to share prices in between ex-dividend dates. And since dividends are directly linked to fundamentals, they are more stable and predictable than share prices.

Another way to unlock the true value of an enterprise is when it is acquired by someone else.

This was very evident with Versum Materials, which is a company whose stock I owned. The company was acquired for $53/share in cash in early October.

The company was a spin-off from Air Products & Chemicals (APD) in 2016. The stock fluctuated in price between a low of $22 in 2016 to a high of $53 in 2017, before dropping down to $25/share in late 2018.

Versum Materials initiated a quarterly dividend of 5 cents/share in 2017. It then raised it to 6 cents/share in 2018, before raising it again to 8 cents/share in late 2018 after two quarters. Shareholders received 15 cents/share in 2017, 24 cents/share in 2018 and 24 cents/share in 2019.

The company earned $1.93/share in 2016, $1.77/share in 2017 and $1.80/share in 2018.

In January 2019, the company was in talks to merge with Entegris, which resulted in an increase in the share price to almost $40/share.

By February 2019, Versum received an offer by Merck of Germany for $48/share. The company rejected it. Ultimately, Merck of Germany ( not to be confused with Merck (MRK), although both companies were connected before WWII)) had some wiggle room and managed to win Versum for $53/share. The intrinsic value of Versum was therefore $53/share.

It is interesting to note how shares fluctuated, but never really exceeded the intrinsic value. Anyone who ever purchased shares in Versum, and never sold, made money. Investors who held on to their shares after the spin-off from Air Products & Chemicals made money too.

I have seen examples where companies share prices sold above their intrinsic values. When these companies were acquired, many investors lost money on the transaction. This was evident with the acquisition of Whole Foods by Amazon in 2017. My conclusion was that you should not overpay for securities, hoping for future growth. That’s because if the stock is acquired, you may not be able to participate in the future growth of the enterprise. It is also possible that the rich valuation today is driven by opinion of future growth, which is a little too optimistic.  So investors should try to avoid overpaying for future growth.

The other lesson is to hold on to your spin-offs. And to trade as little as possible. In the age of zero-commission investing, it is easy to tinker too much with your portfolio.

Relevant Articles:

Price is what you pay, value is what you get
Does Paying a Dividend Reduce a Company’s Value?
Dividend income is more stable than capital gains
Financial Independence Is Easier to Model with Dividends

Monday, October 14, 2019

Four Dividend Paying Companies For Further Research

For this week’s review of notable dividend increases, I have included four companies which raised distributions last week. Each company has a ten-year track record of annual dividend increases. I believe that each of these companies is worth researching further. I find at least a few of them to be attractively valued today too.

My reviews include comparisons of the recent dividend increases relative to the ten-year average. I also look at the trends in earnings per share, coupled with a view of valuation. These are a derivative of my screening criteria.

The companies in today’s review include:

A. O. Smith Corporation (AOS) manufactures and markets residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products in North America, China, Europe, and India. It operates through two segments, North America and Rest of World.

A.O. Smith raised its quarterly dividend by 9% to 24 cents/share. This marked the 26th consecutive annual dividend increase for this dividend champion. Over the past decade, the company has managed to grow distributions at an annualized rate of 19.90%.

Earnings per share have increased from 59 cents/share in 2009 to an estimated $2.36/share in 2019. Currently A.O. Smith is fully valued at 20.30 times forward earnings and offers a dividend yield of 2%.

Thor Industries, Inc. (THO) designs, manufactures, and sells recreational vehicles (RVs), and related parts and accessories primarily in the United States, Canada, and Europe. It operates in three segments: North American Towable Recreational Vehicles, North American Motorized Recreational Vehicles, and European Recreational Vehicles.

Thor Industries raised its quarterly dividend by 2.50% to 40 cents/share. This is a far cry from the annualized dividend growth of 18.30% over the past decade.

The company earned $2.07/share in 2010, and is expected to generate $5.62/share in 2019.
The stock looks attractively valued at 9.60 times forward earnings. Thor Industries yields 3%. The slow recent rate of dividend increases is giving me pause before putting this stock on my list for further research. I would imagine the RV market is fairly cyclical in nature, and the performance during 2006 – 2010 confirms my thesis. However, this company has managed to grow earnings in the long-run, which is pretty impressive.

Eaton Vance Corp. (EV) engages in the creation, marketing, and management of investment funds in the United States. It also provides investment management and counseling services to institutions and individuals. Further, the company operates as an adviser and distributor of investment companies and separate accounts.

Eaton Vance raised its quarterly dividend by 7.10% to 37.50 cents/share. The increase marks the 39th consecutive fiscal year that this dividend champion has raised its regular quarterly dividend. During the past decade, this dividend champion has managed to grow distributions at an annualized rate of 7.80%.

Eaton Vance earned $1.07/share in 2009. The company is expected to generate $3.39/share in 2019.
Currently, the stock is attractively valued at 12.80 times earnings and offers a dividend yield of 3.45%. Check my analysis of Eaton Vance for more information about the company.

Enterprise Products Partners L.P. (EPD) provides midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, petrochemicals, and refined products. The company operates through four segments: NGL Pipelines & Services, Crude Oil Pipelines & Services, Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services.

Enterprise Products Partners raised its quarterly distributions to 44.25 cents/unit. This distribution is 2.30% higher than the distribution paid during the third quarter of last year. The rate of annual distributions growth has slowed down from the ten-year average of 5.30%. Enterprise Products Partners is a dividend achiever with a 21 year track record of annual dividend increases.

Enterprise Products Partners is one of the best managed pipeline companies in the US. It yields 6.40% today, but issues K-1 tax forms during tax time since it is a partnership. This factor complicates return filings at the federal and state levels for investors, which is why it is not suitable for everyone.

Relevant Articles:

Twenty-Four Attractively Valued Dividend Champions for Further Research
Dividend Aristocrats List for 2019
2019 Dividend Champions List
November 2018 Dividend Champions List

Thursday, October 10, 2019

The Initial Grind Is The Hardest

I started my website almost twelve years ago. During that time I shared my process of looking for and analyzing companies. I discussed my strategy in detail, delved into topics such as building and monitoring a portfolio. I have discussed resources I use, books I have read, and investors who have inspired me.

Last year, I decided to put all of this information to practical use in real time, and launch a premium newsletter where I show investors how I am building a dividend portfolio from scratch. After investing in this portfolio for 16 months, I have learned a few lessons that are applicable to almost anyone investing in dividend growth stocks.

The goal of this dividend portfolio is to generate $1,000 in monthly dividend income after investing $1,000/month for a certain period of time. I try to allocate the money each month in ten attractively valued companies. It is exciting to launch a new portfolio from scratch, and watch it grow by applying my principles in real time. But investing is a long-term process. This project will go on for at least a decade. As such it is more of a marathon than a sprint.

I have invested $15,579.29 so far in 49 companies through September 30th. The portfolio is projected to generate $482.44 in annual dividend income. This comes out to $40 in monthly dividend income, and takes us to around 4% of our long-term dividend goal. The forward dividend income has steadily increased since launching of the newsletter in July 2018. I expect this trend to continue, driven by new investments, dividend reinvestment and dividend growth.

Currently, the impact of new capital contributions drives most of the gains in forward dividend income. The rate of dividend growth is not as significant, given the small relative capital and dividend base. After a few years of investing however, the impact of dividend growth will be much more powerful than the impact of new contributions. This is why when investing, I need to play a long-term game, and focus on companies that can grow earnings and dividends 5 - 10 - 20 years down the road. In an uncertain world, I need to focus on companies with business models that can endure most calamities. Yet, I also need to be diversified, in order to protect against tail risks.

The portfolio has had 41 dividend increases since the launch of the newsletter. We haven't had any dividend cuts yet. If we do have a dividend cut, I will sell the security with a cut one second after the announcement, and buy something else with the proceeds. I may reconsider a dividend cutter after I have sold it, once it starts growing dividends again. I have had two dividend freezes, which is when companies keep dividends unchanged. I will continue holding, but not sell.

The amounts of dividend income quoted today are low. However, this is just the beginning. Plus, I believe that what I am presenting to you is a strategy/system for achieving long-term financial goals and objectives. This is the type of investment program I have followed in my personal portfolio for over a decade.

By following a consistent program of making regular new investments, reinvesting dividends selectively and patiently holding on to those shares, we have created a virtuous cycle which increases chances of financial success. Best of all, investing is a scalable activity. The same amount of effort is needed to invest $1,000 or $10,000 or $100,000.

The initial grind is always the hardest part of investing. When you buy $1,000 worth of shares, and you generate $30- $40 in annual dividend income, it is easy to get discouraged.

For those rare individuals like you and me however, that first $30 - $40 in annual dividend income is pretty exhilarating. You get your a-ha moment when you see that passive dividend income as your stepping stone towards your eventual financial independence. Once you make the investment, you realize that money is working hard for you, so that you don’t have you. You see each dollar invested as a dollar that will grow dividend income for you, without any additional effort. Similar to building a house brick by brick, you see the process of building a dividend portfolio through the lens of each individual purchase.

You realize that with every single investment you make, you are buying your financial freedom.

After several years of investing, the amounts of dividend income start getting noticeable.

After several years of patiently buying quality blue chip companies, reinvesting the dividends and holding those shares for the long term, the dividend income starts getting some real traction. This is the point where the powerful force of compounding starts to overtake the monthly amounts that are added to the portfolio.

To summarize, the system for building wealth and passive income is really simple:
  • Buy quality dividend growth stocks every month 
  • Hold those shares for as long as the dividends are not cut 
  • Reinvest dividends selectively 
  • Maintain a diversified portfolio 
  • Be a patient buy and hold investor

Investors with a long-term outlook, who won't despise the days of small beginnings, and who patiently accumulate assets stand a chance to reach their financial goals and objectives.

Relevant Articles:

Use these tools within your control to get rich
What drives future investment returns?
Estimating future Dividend Growth
The value of dividend growth in retirement planning

Tuesday, October 8, 2019

Four Dividend Growth Stocks Rewarding Shareholders With A Raise

I have long subscribed to the theory that buy and hold means buy and monitor. Dividend investors should continue monitoring their holdings after an initial investment. They should also monitor the dividend investing universe fin order to keep informed of notable company developments. It is helpful to observe dividend growth in action, in order to identify new companies for further research.

I review divided growth actions by companies each week as part of my review process. It is helpful to observe the rate of changes in annual dividend increases for companies I own and companies I may consider owning under the right conditions ( valuation/fundamentals etc)

As part of this weeks review, I focused my attention on the companies that have managed to grow dividends for at least a decade. A long track record of annual dividend increases is a way to identify quality companies for further research.

I also reviewed each company by focusing on the rate of dividend increases relative to the ten year average. I also reviewed trends in earnings per share, in order to determine the likelihood of future dividend growth. Investors can expect dividend growth only from companies that can grow earnings over time. It is also important to look at valuation, since even the best companies in the world are not worth overpaying for. I look at valuation in conjunction with growth, and payout ratios. After all, a company with a P/E ratio of 10 and a dividend yield of 4% will not grow as fast as a company with a P/E of 25 and a dividend yield of 1%.

The companies for today’s review include:

American Financial Group, Inc. (AFG) is an insurance holding company, which provides property and casualty insurance products in the United States. The company operates through three segments: Property and Casualty Insurance, Annuity, and Other.

The company increased its dividend by 12.50% to 45 cents/share. This marked the 14th consecutive annual dividend increase for this dividend achiever. During the past decade, it has managed to grow distributions at an annualized rate of 11.20%.

Between 2009 and 2018, American Financial Group managed to grow earnings from $4.45 to $5.85/share.The company is expected to generate $8.65/share in 2019.

The stock looks fairly valued at 12.10 times forward earnings and yields 1.70%.

Bank OZK (OZK) provides retail and commercial banking services to businesses, individuals, and non-profit and governmental entities.

Bank OZK increased its quarterly dividend to 25 cents/share. This is a 4.17% increase over the last quarterly dividend and a 19% increase over the dividend paid during the same time last year. The bank is a dividend achiever with a 23-year history of annual dividend increases. During the past decade, it has managed to grow distributions at an annualized rate of 20.30%.

Between 2009 and 2018, the bank managed to grow earnings from 55 cents/share to $3.24/share.
The company is expected to generate $3.33/share in 2019.

Right now it is attractively valued at 7.90 times forward earnings and offers a dividend yield of 3.80%.

RPM International Inc. (RPM) manufactures and sells specialty chemicals for the industrial, specialty, and consumer markets worldwide.

The company raised its quarterly dividend to 36 cents/share. This represents a 2.90% increase over the last quarterly payment, and a 12.50% increase over the distribution paid during the same time last year.

This action marks RPM’s 46th consecutive year of increased cash dividends paid to its stockholders. Over the past decade, this dividend champion has managed to grow distributions at an annualized rate of 5.50%.

Between 2010 and 2019, RPM has managed to grow earnings from $1.39/share to $2.01/share.
The company is expected to generate $3.39/share in 2019.

The stock is fully valued at 20.20 times forward earnings and offers a dividend yield of 2.10%

Northwest Natural Holding Company (NWN) provides regulated natural gas distribution services to residential, commercial, and industrial customers in Oregon and Southwest Washington.

The Board of Directors of Northwest Natural Holding Company increased the quarterly dividend to 47.75 cents per share on the Company's common stock. This marks the 64th consecutive annual dividend increase for this dividend king. This is a half a percent raise in the quarterly dividend.

During the past decade, this dividend king has managed to grow distributions at an annualized rate of 2.20%.

Between 2009 and 2018, earnings per share dropped from $2.83/share to $2.24/share. The company is expected to generate $2.39/share in 2019.

The stock is overvalued at close to 29.30 times forward earnings. The stock yields 2.70%, but has a very high payout ratio, no earnings growth and the likelihood of dividend growth stopping in a few years is high.

Thank you for reading!

Relevant Articles:

Six Dividend Growth Stocks Rewarding Shareholders With a Raise
Record Dividend Payments in the US For A Decade
My Portfolio Monitoring Process In a Nutshell
Altria Group Joins The Dividend Kings List

Thursday, October 3, 2019

Stock Investing is Commission Free in the US

As an investor, there are a few things you can control. You can control how much you save, what strategy you have to achieve your goals, your temperament and your ability to keep investment costs low. In this article I will discuss how easy it is today to keep investment costs low. As low as zero actually, using a commission free broker. There seem to be plenty of them these days, and the numbers are only getting bigger from here.

I have long been a fan of commission free brokers. I used broker Zecco extensively a decade ago, until it started charging commissions and merged with Tradeking. There have been a few other brokers charging zero commissions, namely Robinhood and Merrill Edge. Merrill Edge does have some hoops to jump through in order to qualify for 30 to 100 commission free trades, but in my opinion these were not to tough to accomplish, provided you had the assets and bank and broker accounts needed.

Over the past five years, I have been a big fan of Robinhood brokerage, which charges no commissions to buy or sell stock ( there is a small fee to sell, but this is a regulatory fee that is simply passed though). Robinhood has disrupted the world of online stockbrokers, since it offered commission free trading long before it was the norm with stocks and ETFs. I have seen a lot of negative publicity against Robinhood, mostly because it generates revenues by selling order flow. After using Robinhood for five years, I can attest that my order fills have been quick and the price I received has been comparable to prices I get from other brokers. The difference is that with other brokers, I paid a commission and the broker also earned money by selling my order flow. With Robinhood, I paid nothing in commissions and my entry price was comparable. Most negative publicity ignored the fact that other brokers also received money for order flows and shorting stock, and also charged fees to transact on top of it.

Last week, Interactive Brokers announced that it was launching an Interactive Brokers Lite account. This is a commission free account, which had no inactivity fees. The account is scheduled to be launched this month, but I have not heard specific on the timing. The account would offer commission free trading, which is a pretty good deal for investors, used to paying $5 - $10/trade. Interactive Brokers is already a great broker for dividend investors, as it allows direct access to the stock market at a very low fee of 35 cents/trade to $1/trade. Depending on the order you place, you may also end up being paid to add liquidity to the stock market. That’s a fee that most other brokers tend to pocket for themselves.

The nice thing is that Interactive Brokers is open to non-US based investors. So if you are based in Canada or the UK or another country, it means that you can potentially invest in US listed securities by paying no commission. That’s a game changer.

Interactive Brokers opened the floodgates with their announcement. Within a few days, Charles Schwab decided to offer commission free stock investing for stocks and ETFs, starting October 7th. Prior to that Schwab charged $4.95/trade. There are no account minimums, but the nice thing is that they have great customer service and local branches to visit. This is open to US investors only however. Schwab already had a list of commission free ETFs it was offering. However, ETFs carry a small but ongoing annual fee to investors. They will still charge a commission to buy or sell options.

Next, we had TD Ameritrade decide to offer commission free stock and ETF investing as well. TD Ameritrade has a list of commission free etf’s as well. However, it charged $6.95/trade to buy or sell stocks. They will still charge a commission to buy or sell options, similar to Schwab, Interactive Brokers and Etrade. Robinhood doesn't charge for options trading.

Finally, just a few hours ago, we also had Etrade join the party of zero-commission stock trades. Etrade had a line-up of commission free ETFs already. However, Etrade has some hidden fees related to selling ETFs within 90 days, and some fees if you have a reverse stock split, a company is acquired for example. I have been charged those fees, and had some of them waived, but I am just throwing this out there - be cautious and always read the fine print.

It is interesting that Interactive Brokers set off the chain reaction with their announcement last week. Ironically, the IBKR Lite account is not ready to be opened yet. However, for Schwab, TD Ameritrade and Etrade, you can open an account and invest commission free starting on October 7th at the very latest.

There are a couple smaller brokers offering commission free trading since last year. The first one is Firstrade, which offers free stock and ETF trading. The broker also offers different account types, such as IRA. Robinhood didn’t offer these types of accounts. Firstrade is also open to investors from a few countries outside the US – China, Taiwan, Hong Kong, Macau, Japan, Mexico, New Zealand, Singapore, Korea, Republic of (South) and Israel.

Another commission free option was M1Finance, which lets you build your own portfolio without paying a commission. It also allows investors to build portfolios with partial shares, but is more geared towards investors who buy the same securities. It is easy to set up a portfolio with the same 10 or 20 or 100 securities and equally weight it. If you want to buy the same securities every so often, and just do rebalancing between the two, M1Finance sounds like a perfect broker. However if you buy 10 companies this month, and then want to buy ten different companies next month as so on, it is impossible to execute using M1 Finance. They do offer different types of IRA accounts as well however.

A commission free broker which is not really advertised as such is Motif Investing. It lets you buy partial shares in equities commission free, provided that you schedule your order for the open at the next day. It is very easy to create an equally weighted portfolio by putting $10 in 50 companies. The other thing to consider is that there is an inactivity fee provided you do not make a paid transaction within a certain time period OR you do not keep a certain amount of investments in your portfolio. If you keep more than $10,000 at Motif, this is not a problem however.

Overall, I wanted to share that it has never been easier or cheaper to buy individual stocks in the US. While plenty of brokers offer commission free ETF trading already, this was still a limited list of what you can and cannot invest in. With commission free stock investing, you do not need to check if your investment is pre-approved by someone else – you can just buy it and not pay a commission.
However, you always need to review the commission and fee schedules for your brokers, even if they claim to be commission free. That’s because some brokers have some “gotcha” clauses that you need to be aware of. A few notorious examples include inactivity fees, or fees if your account balance falls below a certain dollar amount. In general, you want to avoid these.

Some brokers charge you for a security reorganization, which is a broad term that could apply to stock splits, reverse stock splits, spin-offs to name just a few corporate events that are expensive.
You can also expect to be charged a fee if you hold certain instruments, namely ETFs or mutual funds for less than 30 or 90 days.

Finally, if you plan to close your account and move securities to another broker, you can expect to be charged a fee. If you close a retirement account, you will likely be charged a fee as well.

When you keep investing costs low, this means that you keep more money working hard for you. This goes on for commissions, but should also be something to think about in terms of minimizing taxes. This could be easily achieved in the US by opening a Roth IRA account, and doing more of your investing through it. Everyone’s tax situation is different however, so you need to consult with a tax adviser, because of different limitations and opportunities. If your adjusted gross income is below a certain amount, you are not going to pay taxes on certain amounts of dividends and capital gains. Again, you need to consult with a tax professional to see how this applies to your situation ( or research it on your own).

The best thing to come out of this exercise is that investors are winning in the end. Plus, there is more emphasis on cost than ever before. This goes beyond commissions, taxes and fees however. I believe that the days of paying an adviser 1% to assemble a portfolio for you are also coming to an end. This may be bad for asset managers.

Thank you for reading!

Relevant Articles:

Robinhood Offers Free Stock Trading for Dividend Investors
The Best Broker for Dividend Investors: Interactive Brokers
Merrill Edge Offers Commission Free Trades for Dividend Investors
Roth IRA’s for Dividend Investors
Best Brokerage Accounts for Dividend Investors

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