Wednesday, February 20, 2013

Dividend Stocks for Young Investors

One of the most prevalent myths about dividend stocks is that they are mostly for retired investors. The slow growing, unexciting businesses which tend to grow at predictable rates, are not seen to be sexy enough for young investors. This misconception can cost you millions of dollars in missed opportunities.

Dividend growth stocks are the perfect investment vehicles for investors in all ages. The fact that these companies are established and mature should not steer you away from investing in them. The reasonable growth means that these companies are trading at more attractive valuations in comparison with high-flyer technology companies such as Netflix (NFLX) or Blackberry (BBRY). This means that share prices will not decrease substantially when the economy experiences its next recession. In addition, the strong amounts of cash flow that these companies consistently generate, lead to stable and rising dividend checks, coupled with good market like total returns.

After all, companies such as International Business Machines (IBM), Exxon-Mobil (XOM), Coca Cola (KO), Kellogg (K) and Procter & Gamble (JNJ) have been established companies for many decades. Investors in these companies have managed to not only enjoy a rising stream of dividend incomes but strong total returns as well. The true powerful force behind such stocks is their long term wealth building potential. The products and services that they create fill in a basic need in the marketplace. There are no rapid shifts in consumer needs for products such as cornflakes, soda or fast food. As a result, companies with strong brands who capture consumers attention, are able to essentially build a long-term relationship with customers, which could span for generations.

One of the major advantages that younger investors in their 20s and 30s have is time. Investors in their 40s and 50s, who are just about to begin their retirement journeys, are more focused on current income and have less time to enjoy the long term compounding of their net worth. The time that young investors have, is an important asset, as it will allow them to compound their capital for several decades, which will result in more comfortable retirements.

One important similarity between older and younger investors however is that they both have comparable goals of living off dividends. The only difference is that investors in their 20s or 30s will have an investing process that spans a time period that is twice the length of retired income investors. The basic premise of purchasing wide-moat, dividend growth stocks with the potential to increase earnings over time is valid for both groups of investors. Both younger investors and retirees should also focus on companies which are attractively valued. Otherwise, long periods of time would be wasted waiting for the perfect growth stock to catch up.

Due to the longer time horizons that both younger and older investors currently have, the structure and composition of their portfolios 30 years from now will likely be much different than their starting portfolios today. Thus, investors have to be nimble and keep an open mind in selecting new potential additions to their portfolios. Our 20 something year old investor of today will likely be thinking about retiring 30 years from today. Our 50 something investor would hopefully be still enjoying life 30 years from now, while covering his expenses from his income stocks, and planning ahead to leave a substantial portion of their wealth to future generations or charity.

Another concerning thing that I observe with investors of all ages, is the concept of yield. Retired investors tend to focus exclusively on higher current yield, which could lead to dividend surprises down the road. Younger investors tend to focus on growth companies, while ignoring dividends whatsoever. The right path to follow should be to pick great companies, which can afford to grow earnings and dividends. It is very costly to impose your own living situation on the markets, rather than be nimble and embrace the markets. Older investors tend to focus on utilities, telecoms, REITs and MLPs. Any changes in current legislature will lead to cuts in MLPs and REITs distributions. Younger investors who focus exclusively on growth, will find that overpriced companies like Cerner (CERN), Netflix (NFLX) or Baidu (BIDU) can drop in price very quickly, when expected growth fails materialize.

The hidden truth behind dividend growth investing, is that investors of all ages and time-frames should mostly follow the same criteria for stock selection. After all, the goal of every investor is to select great stocks, which have the durable competitive advantages to increase earnings, which will lead to stock price gains and dividend increases. It so happens that these cash machines happen to leave a long trail of consistent dividend increases. The older investors could use the distributions to fund their retirements, whereas the younger investors could use the dividends to purchase more dividend stocks.

In other words, great companies such as PepsiCo (PEP), McDonald’s (MCD) or Procter & Gamble (PG) are good holdings for both younger and older investors today.

Full disclosure: Long PG, PEP, MCD, KO, K

Relevant Articles:

Dividend Investing Myths
Dividend Growth Stocks – The best kept secret on Wall Street
Why Dividend Growth Stocks Rock?
Strong Brands Grow Dividends
Living off dividends in retirement
- Carnival of Personal Finance

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