Thursday, October 18, 2018

Eaton Vance (EV) Dividend Stock Analysis

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.

Last week the company raised its quarterly dividend by 12.90% to 35 cents/share. This marked the 38th consecutive dividend increase for this dividend champion.

Eaton Vance has delivered a 9.10% annualized total return over the past decade.

Eaton Vance has managed to grow dividends at an annualized rate of 8.50% over the past decade.

The company has managed to grow earnings at a rate of 8.60%/year over the past decade. this was helped by the fact that it managed to reduce the number of shares outstanding by 14% over the past decade. The rate of dividend growth has tracked the growth in earnings per share over our study period. The company earned $1.06/share in 2007, and managed to grow it to $2.42/share by 2017. Analysts expect that Eaton Vance will earn $3.21/share in 2018.

The company has been able to grow revenues by growing assets under management. Assets have increased by attracting new client inflows, acquiring assets through acquisitions and through price appreciation. Market appreciation is a strong long-term tailwind, which can grow assets under management and related fees over time. If customers add money to the base on a net basis, assets grow even further.

Good relative performance is rewarded with client inflows. In general, clients have tended not to move assets out once they have been invested. Inertia can be a powerful force. But you cannot blame them for staying – there is an opportunity cost associated with switching investment products and strategies. For other strategies focusing on tax managed assets, retirement plan assets or closed-end-funds, you have a more sticky asset base that is less likely to leave.

The company is adapting to the changing needs of the customers by launching new products, which also attracts more money under management. The price to pay of course is that during bear markets, assets under management will likely decline, dragging down short-term results with it.

There is an element of scale with investment managers. It doesn’t take that much effort to run more money, but on the other side the cost gets spread over a larger base, resulting in higher profit margins.

There is a large amount of competition, and a pressure on fees. Passive investing funds are gaining in popularity during the strong bull market we have been experiencing. In total, passive investment funds have been generating inflows, while actively managed funds have generated outflows.

The dividend payout ratio is at 48% today, versus 48% in 2007. While there were some fluctuations along the way, it remained in a 37% - 59% range over the past decade.

Right now, I find Eaton Vance to be attractively valued at 14.40 times forward earnings. The stock yields a safe 3%, which is well covered by its earnings. In addition, earnings grow over time, which bodes well for future expected dividend growth.

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Monday, October 15, 2018

Your favorite businesses are on sale

Last week, there was a correction in the stock market. For some reason, be it higher interest rates, trade wars, or fears of future inflation, stock prices went down. Your guess as to why this happened is as good as mine. The reason why this happened is not required to be a successful investor however.

As a dividend growth investor, I see myself as a part owner of a business. As a result, my focus is on acquiring shares in those businesses at attractive valuations. I could not care less about stock price fluctuations, other than as an opportunity to acquire more ownership in the world’s best run businesses at attractive valuations.

I focus on dividends, because dividends are more stable and more predictable than share prices. I focus on companies that can generate stable earnings and reliable dividend payments. Only a select few companies have even managed to grow dividends for more than a decade. A long streak of consecutive dividend increases is one of my filters to search for quality. A strong balance sheet, and the ability to generate strong recurring cashflows is the secret sauce that allows long track records of annual dividend growth to occur. I focus on the companies that can grow earnings per share, reinvest a portion to grow the business, and send any excess cash flows to shareholders in the form of dividends. I want those businesses at good entry prices however.

The next step in the process is evaluating the fundamentals of these businesses. As I mentioned in my article on how I analyze dividend stocks, this involves looking for growing earnings to support the future dividend growth. Evaluating the safety of those dividend payments is paramount.

Since dividends are a direct link with the fundamental health of the business, they are a form of return that is usually more stable and reliable than capital gains. Share prices on the other hand are derived from the collective expectations of stock market participants. Sometimes they are overly excited about the prospect of a business, and are willing to pay a high multiple for every dollar of earnings. Other times, these participants are gloomy, and not willing to pay even a bargain price for these earnings. Stock prices are driven by the madness of the participants with short-term expectations. As investors, our goal is to capitalize on those who set prices in the short run, and buy our future retirement income on sale. Our goal is to select the best businesses in the world, and buy them at attractive valuations. Our job after that is to monitor our holdings, and sit tight, as we are showered with a rising stream of dividends over time.

Since my focus is to grow my dividend income over time, I can focus on the dividend income, its safety and its potential for future growth. I could not care less if stock prices go up or down in the short-run.

As a result of the decline in the past week, I am seeing several companies I am monitoring for my dividend growth portfolio newsletter become attractively valued today. I will share the selections I am making on October 28 with premium subscribers. If further weakness continues, the list of potential additions to the portfolio will increase. That is great news, because I like to build out diversified dividend portfolios, in order to ensure that I generate a retirement stream of income that is defensible and can grow above the rate of inflation.

For example, Johnson & Johnson (JNJ) is selling at $133/share today, versus $142.88 at the highs last month and $148/share in January. The company is still expected to earn $8.15/share, yet participants valued the shares at different multiples. The company is still expected to pay $3.60/share in dividends.

In another example, 3M (MMM) is selling at less than $198/share today, versus $216 in September and $260 in January. At the same time the stock is attractively valued today using forward earnings at $10.29/share. 3M is expected to pay $5.44/share in dividends.

During the financial crisis, Johnson & Johnson’s share price fell from a high of $72.76/share in September 2008 to a low of $46.25/share in March 2009. At the same time, earnings per share went up from $3.63/share in 2007 to $4.57/share in 2008. Johnson & Johnson earned $4.40/share in 2009. The company’s dividend payments between 2007 and 2009 were $1.62/share in 2007, $1.80/share in 2008 and $1.93/share in 2009. Investors owning JNJ shares who focused on the growing stream of dividends could have been able to ignore the fact that share prices are volatile. They could do this, because the company they invested in had solid fundamentals, and the dividend was well covered and poised to grow. The diversified portfolio of businesses under the Johnson & Johnson umbrella represented products that consumers use on an everyday basis, which meant that the demand will not decrease as much during a recession. Those with cash to invest, would have been ecstatic to buy ownership interests in a world class business such as Johnson & Johnson below $50/share, rather than pay over $72/share for the same shares.

It is very likely that at some point, we will be entering a bear market. Investors in the accumulating phase should be looking forward to bear markets, because they will be able to buy shares in their favorite businesses at better entry valuations. This would mean that shares on other world class businesses such as Visa (V) and Starbucks (SBUX) will be available for sale at less than 20 times earnings.

To summarize, lower entry prices should be welcomed by dividend investors in the accumulation phase. As a result of lower prices, they can purchase future dividend income at a discount. Investors in the retirement phase should ignore stock price volatility, and should focus on dividend income, which is more stable, reliable and predictable than share prices. When you are paid for owning shares, holding those shares through the ups and downs of the economic cycle is much easier. Either way, the most important thing is to stick to your dividend portfolio through thick or thin. The consistency of dividend payments makes it easier to stick to your portfolio, and add to it, even when share prices are tanking. The investor with a clear strategy to pursue dividend paying equities, will continue following their plan, and invest money regularly in the best values at the moment. This consistency and long-term focus is the secret sauce that will help them succeed and reach their long-term goals.

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Wednesday, October 10, 2018

How Long is Cardinal Health’s Record of Annual Dividend Increases?

According to the last list of Dividend Champions, Contenders and Challengers, compiled by the late David Fish, Cardinal Health (CAH) has managed to increase dividends for 21 years in a row. This track record is impressive, as there are only a couple of hundred companies in the US with this impressive record of annual dividend increases.

According to the Dividend Aristocrats Index however, which is maintained by Standard & Poor’s, Cardinal Health has managed to grow dividends for 30 years in a row.

This is an obvious disconnect. Just like with other disconnects, such as Altria and Abbott, I decided to research further in order to determine for myself the correct track record of annual dividend increases.This exercise was helpful in my monthly update process for the list of Dividend Champions that I post for my readers here.

The first step was to review press releases announcing dividend increases over the past decade, in an effort to determine what track record is being claimed by the company itself. Unfortunately, between 2007 and 2018, Cardinal Health has not stated what its track record of annual dividend increases really is.

The second step was to review the company’s dividend history using Cardinal Health’s Investor Relations website. I had to ensure I am properly adjusting for stock splits, stock dividends, and excluding one-time distributions. The dividend history was messy, as it appeared that dividends were being tracked by the company on an ex-dividend date basis, as opposed to how much actual cash per share was being distributed to shareholders.

For example, the company shows total dividends in 2017 as $1.8361/share.

Total dividends in 2017:

If you look closely, you can see that only three of those payments occurred in 2017, with the last one occurring in 2018. An investor was entitled to this dividend payment at the end of 2017, but didn’t receive it until January 2018.

A long-term investor in Cardinal Health would have received $1.8226 in total in 2017 for each share they owned. That is the cash amount they would have received in 2017 that would have been potentially taxable to the IRS.

Armed with this information, I calculated the annual dividend income based on two criteria.

The first one is based on actual cold hard cash collected in a calendar year per share of Cardinal Health. This method adjusted for stock splits and one-time dividend payments. Based on this method, Cardinal Health has raised dividends for 22 years in a row since 1996. The dividend payment in 1995 was the same as the dividend payment in 1996.

The second method is based on ex-dividend days, but still adjusted for splits and one-time distributions. Based on this method, Cardinal Health has raised dividends for 23 years in a row since 1995. The dividend payment in 1995 was the same as the dividend payment in 1994.

Today, we evaluated the dividend track record of Cardinal Health. We can see that the company has only been able to raise dividends for 22 years in a row, using calendar year cash payments. As a result, the company has correctly been excluded from the list of dividend champions today. Unfortunately, the company is included in the list of dividend aristocrats today. Based on my review of the history of the dividend aristocrats index, I have concluded that it is an incomplete list for dividend investors. Serious dividend investors should focus on the list of dividend champions, and ignore the dividend aristocrats. The real lesson to learn of course is that you should always do your homework, and try to do the work to reach your own conclusions.

Relevant Articles:

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Monday, October 8, 2018

My screening criteria for dividend growth stocks

Screening is part of my process for identifying quality dividend growth stocks. For over a decade, I have managed to apply my screening criteria against the universe of dividend growth stocks I am interested in. This helps to narrow down the list of companies I am looking at. I use these parameters as a cornerstone in my dividend growth newsletter as well. However, I also tweak them in order to identify quality companies for further research.

The criteria I use are listed below:

1) A P/E ratio below 20

I have a set limit where I am not willing to pay more than 20 times earnings for a company. A P/E ratio of 20 translates into an earnings yield of 5%. This helps me avoid getting excited about chasing future growth opportunities and buying shares that are overvalued. I want to avoid situations where I buy a stock at inflated growth expectations, which do not turn out as expected. I also use this P/E ratio as a way to compare between dividend stocks. If I overpay dearly for a stock, my long-term returns may be lower than the returns of a company with better entry valuations. Dividend investors instinctively understand valuation, because overpaying for a stock results in buying future income at an inflated price; whereas buying a stock at a better entry valuation results in purchasing a future stream of income at a discount. Of course, valuation is a tricky subject, where P/E ratios should be taken into consideration while also evaluating the growth expectations of the business.

2) A dividend payout ratio below 60%

A quality dividend company reinvests a portion of earnings back into the business, and distributes the excess earnings to shareholders. This criterion ensures that I focus on the dividend payments which are sustainable. I want to have a margin of safety in case earnings temporarily decline during a recession. This goes back to my objective to generate dividend income that I can count on throughout the economic cycle. By focusing on companies with lower payout ratios, I reduce the risk of dividend cuts during the next recession. I also look for a dividend payout ratio that is sustainable, while also looking for growing earnings over time.

3) A dividend streak of at least 10 years

I have found that companies that manage to grow dividends for at least a decade are likely to have the business model and the corporate culture that rewards long-term shareholders with more dividends over time. Many companies that have managed to grow dividends for less than a decade tend to have a more cyclical business model that results in dividend freezes or dividend cuts when the business environment becomes more challenging. This requirement helps me avoid companies that have managed to grow dividends simply by expanding their payout ratio, which ultimately results in a dividend freeze after a few years. Again, my goal is to find companies that can grow the dividend for years down the road.

4) A positive dividend growth over the past decade

I want to get a positive dividend growth over the past decade. I look at the most recent dividend increase, and compare it to the five year and ten year rates of annual dividend growth. In general, I want a company that is able to produce reliable dividend growth over time. This achievement is possible only when the underlying business is able to deliver long-term results for the shareholders. I am not placing a numeric amount for dividend growth, because of the trade-off between dividend yield and dividend growth. A company like Verizon or Con Edison will have slower rates of dividend growth, but will compensate with higher yields. On the other hand, companies like Visa may have lower current yields, but will more than compensate with higher dividend growth over time.

5) A history of earnings growth over the past decade

This is the last step in the screening process. It is intertwined with the stock analysis process I follow. I want to buy companies that can grow earnings per share over time. Rising earnings per share can lead to higher dividend payments over time. If a business earns more over time, it should also be more valuable as well. This earnings growth provides ample margin of safety if the stock market decides to value equities at 10 times earnings, which is down from a purchase price of 20 times earnings for example. The rising stream of earnings will eventually bail out the investor, while also pocketing higher dividends along the way. I also look at earnings because I want to avoid purchasing a company which won’t be able to grow dividends in the future, due to high payout ratios, and stagnant or declining earnings per share.

I ran a screen of attractively valued dividend champions back in July 2018. I am presenting it again today for illustrative purposes only.

My screening process has evolved over time. I used to have a minimum yield requirement, which I have subsequently dropped. My screening process will also change based on the environment in which I operate. For example, if stocks are depressed, I may focus on securities with a P/E below 15 for example. I may also ignore companies that sell at a P/E of 19 if the industry group historically sells at 10 or 15 times earnings for example. My dividend growth requirements also vary, because of the yield/growth trade-off. At the end of the day, it really is about understanding each business and acting appropriately. Long-term readers know that I like Altria (MO), despite the fact that the company has a dividend payout ratio of close to 80%. That’s because the company has showed the ability to pay and grow dividends and earnings, despite the high payout ratio.

I wanted to reiterate that screening is just the first part of the process of evaluating dividend growth stocks. I also wanted to reiterate that I look at those criteria in tandem, and not in isolation. I may find a stock that fits all criteria, and still not buy it, because I do not understand the business well enough or because I may find another company that has a better score. I have also found that I am willing to tweak the parameters I am looking for. When you develop a strategy from scratch, you know when it may be a good idea not to follow it precisely ( as if precision ever existed in investing).

The next step of the process is to evaluate the companies, one at a time, in order to gain and understanding of whether they can continue delivering solid dividend growth for my portfolio. This step somewhat overlaps with step five above. In the process of reviewing earnings, dividends, payout ratios, I review the companies and tend to discard the ones that don’t fit my requirements. I try to focus on the remaining companies that grow earnings and dividends, have a sufficient track record of annual dividend increases, while having a sustainable dividend payout ratio and are available at an attractive valuation today.

Relevant Articles:

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How to read my stock analysis reports

Thursday, October 4, 2018

Use these tools within your control to get rich

The ultimate goals of everyone reading this site is to retire wealthy and to stay retired. Financial independence provides flexibility, freedom and a lot of options in life for you. Getting there is usually the challenging part.

I have been on a quest to reach financial independence ever since I graduated college in 2007. I have spent at least a few hours per day, every day, for almost a decade now dreaming of, planning for and working towards my dividend crossover point. The dividend crossover point is the situation where my dividend income exceeds my expenses. While I am very close to this point today however, I also want to have some margin of safety in order to withstand any future shocks that might come my way.

In the process of thinking about how to reach financial independence, I have spoken to a lot of others who are working towards financial independence. I have come up with a list of a few tools that these people have used to get rich. These are tools that are within their control. While outcomes are never guaranteed in the uncertain world of long-term investing, taking maximum advantage of things within your control tilts the odds of success in your favor.

These levers are common sense, and are at a very high level, but I have found that they are super important. If you ignore those levers however, chances are that you may not reach your goals, even if you are a more talented stock picker than Warren Buffett.

I have found that the only levers within your control as an investor such as your savings, investing in something you understand, time you have, keeping costs low for taxes and commission/fees.

1) The most important thing for anyone that wants to attain financial freedom is savings. If you do not save money, you will never have the capital to invest your way to financial independence. As a matter of fact, under most situations, you have more control over your savings rate, than the returns you will earn as an investor. If you earn $50,000 per year, you can accumulate $10,000 in savings within one year if you save 20% of your income. In this case, your annual spending is $40,000/year. The $10,000 you saved will be sufficient to pay for your expenses for 3 months.

If you figure out a way to cut your expenses and to save 50% of your income, you will be able to save $25,000 in one year. This means that after one year of working and saving, you can take an year off. If you are like my friend Jacob from ERE, and you manage to save 80% of your income your spending would be $10,000/year. This means that after working for a whole year, you are accumulating enough money to last for 4 additional years. After five – six years of working and saving aggressively, you will be able to retire because you would have accumulated somewhere close to 20 – 24 times your annual expenses. And the best part is that all of this ignores investment returns. The point is not to focus on absolute dollars, but on the savings percentages. The point is that you have a higher level of control over how much you save, and this has a higher predictability of success when building wealth, than the returns on your investment. Unfortunately, future returns are unpredictable. Dividends are the more predictable component of future returns, which is why I am basing my retirement on dividend income.

This is why I have found it important to keep my costs low, in order to have a high savings rate and accumulate money faster. I have been lucky that I have essentially saved my entire after-tax salary for several years in a row. Besides keeping costs low, I have achieved that by trying to increase income as well. ( when you save a lot and invest in dividend paying stocks that pay dividends, you get more income)

2) The second important thing you have within your control is the type of investments you will put your money in. It is important to understand that despite a history of past returns, future returns are not guaranteed. You have no control over the amount and timing of future returns – the best you can do is to invest in something you understand and something that you will stick to no matter what. In my case, I invest in dividend paying stocks with long track records of regular annual dividend increases. Others have made money by investing in business, real estate, index funds, bonds etc. The important thing is to find the investment that works for you, and to stick to it.

I do this, because I have found that dividend income is more stable than capital gains. Plus, I want to only spend earnings in retirement, not my capital. With this type of investing, I am getting cash on a regular basis, which I can use to reinvest or spend. It is much easier to generate a return on my investment, and to stick to my investment plan, when I am paid cash every so often. If I invested in hot growth stocks, I would be subject to huge fluctuations that would impact how much I can spend in retirement. So I would be less likely to stick to my plan. Dividends are not guaranteed, but they are more stable and more reliable portion of total returns than capital gains. Investors who rely mostly on capital gains face huge risks because most of their returns will be dependent on the mood of Mr Market who may decide to value companies at anywhere from 5 to 100 times earnings. If you expect to sell stocks to fund your expenses, you would be in a lot of trouble if you sell at 5 times earnings because you will be eating up your capital quickly. In addition, you will be in a lot of trouble if Mr Market decides that the company for which you paid 25 - 30 times earnings and which grows your share of its income is now worth 10 - 15 times earnings. This is precisely what happened between 1968 and 1981 for US stocks as represented by S&P 500 – the P/E ratio contracted from 18.20 to 8.10, while earnings per share increased from $5.72 to $15.18. As a result, S&P 500 barely went up in nominal terms from $103.86 to $122.55 over the same 13 year period. Almost the entire equity returns over that period were derived from dividends, which increased from $3.04 to $6.83. (source).

3) The third important tool at your disposal is your ability to compound your investments over time. You have some control over the amount of time you will let your investments compound. Over time, a dollar invested today, that compounds at 10%/year should double in value every seven years or so. This means that in 28 – 30 years, the investor should have roughly $16 for each dollar invested at 10%. Of course, if the investor doesn’t allow their investments to compound, they would be worse off. Many investors are sold on the idea of long-term compounding. Unfortunately, a large portion end up trading far too often for various reasons. One reason is fear during a bear market. Another is the desire to take a quick profit, without letting compounding do its heavy lifting for them. I have observed people panic and sell everything when things sound difficult. Another reason for selling is the attempt to time the markets or the attempts to replace one perfectly good holding for a mediocre one.

In most situations, the investor would have been better off simply holding tight to the original investment. For the past 8 - 9 years of writing on my site, I have seen someone mention that stocks are at a high level almost every single month. Like this successful investor, who believed that stocks were expensive in 2009. Almost no one can sell at the top and buy at the bottom – so don’t bother timing the market. Most investors who claim that they have avoided bear markets do so, because they are often in cash. Therefore, they miss most of the downside, but they also miss most of the upside as well. A third reason for frequent trading is because the investor is told that some other group of stocks/strategies/ has done better recently, which somehow is a good reason to sell their original holdings. Again, your portfolio is like a bar of soap – the more you handle it, the smaller it gets. The best thing you can do is find a strategy you are comfortable with, and then stick to it. There aren’t any “perfect” strategies out there, so if you keep chasing strategies you are shooting yourself in the foot. As a matter of fact, you would likely do better for yourself if you buy long-term US treasuries yielding 3% and hold to maturity, than chase hot strategies/sectors/investments. So find a strategy, and stick to it through thick or thin.

4) The other important factor to remember is to keep investment costs low. What does that mean? It means to keep commissions low. When I started out, I paid a zero commission for investments. I then switched to other brokers and tried to never pay more than 0.50%. But this is too high – there are low cost brokers today, which charge little for commissions. Try to keep costs as low as possible, because that way you have the maximum amount of dollars working for you.

It also means to make sure to minimize the tax bite on your investment income as well. I used to have an acquaintance who chose to pay tens of thousands of dollars more in taxes every year than they had to. They did this because they didn’t want to learn about taxes. This was really surprising to me, because this person claimed to be super frugal. Once I really spend time to learn how to minimize the impact of taxes on my investments, the rate of net worth and dividend income growth increased significantly. I have calculated that a person who maximizes tax-deferred accounts effectively in the accumulation phase could potentially shave 2 -3 years for every ten years of saving and investing.

In order to keep costs low, the amount of fees you pay to an adviser should be eliminated. Most investment advisers out there do not know that much more than you do. If you decide to educate yourself on basic finance, you will likely know as much as most investment advisers ( most of whom are salespersons). It makes no sense to pay someone an annual fee of 1% - 2% per year on your investment portfolio. The long – term cost of 1% - 2% fee compounds over time to a stratospheric proportion. It makes no sense to have someone who doesn’t know that much charge you 1% - 2%/year merely for holding on to your investments ( because that’s what they are doing).

Thank you for reading!

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