Monday, June 3, 2013

My Dividend Portfolio Looks Much Better than I Expected

Many of my stocks reached all-time-highs over the past few months. When I purchase my stocks, I usually expect a decent current yield in the 2% – 4%, followed by a P/E of 15 – 20, and a growth in earnings and dividends that averages at least 6%/annually. So far, it has averaged 7% - 10%. As a result, short-term fluctuations in the price of a company which I purchase for say $100/share today which yields 3% and trades at a P/E of 16 would not bother me too much. I would expect such company to realistically trade at about $200/share in a decade or so, still yield approximately 3% and trade at a P/E of about 16. Over that decade, it could trade as high as 25 times earnings and as low as 10 times earnings. The only difference is that its earnings and dividends have doubled over the period. My whole premise of the idea that I won’t sell even at a 1,000% gain is based on this mental model.

Of course, in real life, things never progress in a linear fashion. If you looked at P/E ratios of companies like Wal-Mart (WMT) or Coca-Cola (KO) over the past 10 - 15 years, you would not be surprised to see them over 30 in not one, but at least several occasions. Over the past four years, most of the companies I have usually added to were the likes of Colgate-Palmolive (CL), Johnson & Johnson (JNJ) & Kimberly-Clark (KMB). Right now many of these companies look very overvalued, which is pretty scary. I actually isolated the following companies, whose P/E ratios per Yahoo! Finance exceeded 20. I then excluded MLPs, REITs for whom earnings per share and P/E ratios do not provide comparable results.

Being the lover of annual reports, and digging around data, I went through this list searching for the answer of an obvious question. The question running through my mind was whether it still made sense for me to hold on to these companies. Now, I am not a die-hard buy and hold despite everything type of investor, and a crazy valuation could lead me to sell an otherwise fantastic company. This of course depends on each particular situation. However, I do believe that taking small profits on the few amazing ideas I might be lucky enough to stumble upon in my lifetime would probably be very detrimental to my finances. I could sit-out temporary overvaluations in securities, for which future growth could compensate me well for holding on during a moderate level of craziness. Craziness for a company like Brown-Forman (BF-B) could be a P/E above 30, whereas for a company like Con Edison (ED), craziness could be anything above 18 – 20 times earnings.

However, in my studies of investing, I have learned to dig for information. Most of the information on earnings per share from sources like Yahoo! Finance might be abnormally low, because certain one-time adjustments have reduced it. My next step would be to look at analyst estimates for the current year and the next one, coupled with digging around press releases from the company, in order to evaluate whether those estimates have any merit.

Just by looking at P/E ratios, the stocks in the table look very overvalued. However, if you look at forward earnings, only a couple of those look somewhat overvalued.

For example, looking at Johnson & Johnson (JNJ), it looks terribly overvalued at 23 times earnings. However, by applying forward EPS of $5.41/share, the stock looks much more reasonably priced. While not included on this table, Kimberly-Clark (KMB) looks expensive at 21.06 times earnings and EPS of $4.60. But based on 2013 forward earnings of $5.73/share, it looks cheap at 16.90 times forward earnings. Of course, if analysts are overly optimistic on this company and actual earnings are significantly less, then Johnson & Johnson would be overpriced today.

For those companies that still look overvalued, I am going another step. I estimate what the company is going to earn in a decade, then estimate the total in dividends I will receive over the next decade and then slap a P/E multiple for this time in 2023. My estimates are conservative in regards to growth, although not as conservative in regards to multiples.

For example, Brown-Forman (BF-B) is expected to earn $2.70 in 2013. I believe that by 2023, it could easily earn $6/share and trade at a P/E of 20. In addition, I would expect that Brown-Forman would pay its shareholders approximately $20 -$25/share over the next decade. This means that investors paying $70/share today, might end up doubling their money in a decade. This translates into a return of approximately 7%/year. Those of you reading this article in 2023 would likely use this article as an example of why people should never make predictions. Either way, it is my best case based upon widely available information on consumption on liquor worldwide, historical growth rates, and assumptions for the future revenues, earnings and dividends.

For Automated Data Processing (ADP), I like the fact that it offers business services such as payroll processing to small and medium sized businesses. These businesses outsource certain functions like payroll to ADP, which benefits from scale of transactions processing, constant improvement in technology and depreciation in technology equipment prices. But most importantly, ADP benefits from building and maintain relationships with businesses, which would be less likely to switch processors just to save a few bucks. Over the past decade, EPS grew by 5%/year. If we project this growth forward, this means ADP would likely earn $4.82/share in 2023, which at a P/E of 20 translates into $96.40/share. If dividends also grow at 5%/year, this means that an investor can expect to receive $23 in dividends over the next decade. This translates into a total return of about 6%/year. Check my analysis of ADP.

I purchased Visa (V) in 2011, because I liked the story about credit card processing business, the fact that there are only two major companies in the game, and the opportunity behind growth of cashless transactions worldwide. These were the reasons why I initiated a position in the stock despite the fact that the company has only been publicly traded since 2008. I expect Visa to either double or triple earnings per share over the next decade. This could translate in EPS ranging from $15 to $20 by 2023. At a P/E of 20, this translates into $300 - $400/share. I expect dividends to increase at the high end of these projections, and triple by 2023. Thus, I wouldn’t be surprised if Visa shareholders receive about $25 in dividends over the next decade, with annual dividends reaching $4/share that year.

The return assumptions for the three stocks above, ignore dividend reinvestment, which would likely increase the annual returns slightly.

Nucor (NUE) is the odd one out, as it is a cyclical stock. The demand for steel fluctuates with the cycles in the economy, meaning that profits and revenues are highest at the peak of the cycle, and very depressed at the trough. This is why cyclical companies usually appear overvalued when their stock prices are low, and cheap when their prices are high. During the last boom, Nucor earned $5.98/share in 2008. In addition, the company kept raising its regular dividend even during the lean years after that. The thing that appeals to me is the fact that during the boom years through 2007 – 2008, Nucor paid special dividends every quarter to shareholders. Management was smart enough to realize that this boom in profits would likely be a short term event, yet they still wanted to keep the streak of dividend increases going, and reward long-term shareholders as well. This is why if you simply look at trends in dividends per share, you might see a decrease in 2008. However, the regular dividend amount was never cut, but actually increased. If the US economy keeps expanding, we might see growth in earnings per share, and a lot of special dividends from Nucor. This is the one stock where I cannot provide a ten year guidance of earnings and dividends, but would likely hold on to either way. You get a stable and slowly rising dividend payment, plus a “lottery type” opportunity for special dividends when times are really good. Check my analysis of Nucor.

As a long-term investor, my holding period is in years for some stocks that don’t work out as well, to decades for the ones that keep delivering results over and over again. As such, it was helpful for me to go over my positions above. Overall, when I looked at what seemed to be the most overvalued stocks in my portfolios, I found out that there is nothing to be scared about. Some of the valuations were high either because of one-time events depressing earnings per share, and in those situations forward earnings per share showed a more reasonable valuation. In other scenarios, I reassessed the reason as to why I held on to certain stocks, and whether it still made sense to hold on to them.

Full Disclosure: Long D,V, NUE,TFX, BF-B,K,LOW,CL, EV, ADP, JNJ, YUM, ED, KMB,

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  1. Howdy mate,

    Have you shared with us how large your dividend portfolio is, its performance, and how many years you've been building it? It would help give us readers some perspective.



  2. Hi Sam,

    I am not a mutual fund, and I do not sell and investment product or service. This site is for entertainment purposes only. I would much rather investors read what I write, and hopefully learn something than simply giving them a result that doesn't mean anything.

    Since you asked however, below are my total returns since starting Dividend Growth Investor in 2008 to document my journey in dividend investing in 2008

    DGI TR S&P 500 TR
    2008 -11.76% -36.80%
    2009 23.35% 26.36%
    2010 18.75% 15.05%
    2011 14.32% 1.90%
    2012 12.99% 15.99%
    2013 14.13% 15.36%

    I honestly do not see what value tracking my performance monthly/daily or even annually provides, because this is noise in long-term data set, that doesn’t provide much in actionable insight. Will I stop using DGI because I underperformed YTD – not at all. I actually outperformed market this year till early May, when a few of my stocks started going down.

    DGI stocks perform their best when market is down or flat, and not as well in an up market. Now if 10 years down the road, I underperform S&P 500 by more than 1%/year, I might have room for concern. So I would say, give me 4 - 5 more years, before I can say with some level of certainty in my results to say whether the past 5.5 yrs I have been plain lucky . Of course, the caveat is that past performance is no guarantee for future results.

    However, how do you translate the concept of total returns into an income stream in retirement? I turned to dividend investing, which works great. I select a company with rising EPS, rising DPS, at what I think are attractive valuations, and then hold on to it for as long as possible. I diversify, reinvest dividends selectively , monitor regularly and am fine selling if something goes wrong. I like the fact that dividends as part of total returns are always positive, and yet you also have a shot of generating capital gains and meet or beat the market averages. I like having my cheesecake and eating it too.

    I think it is better to learn what my objectives are, what stocks I look for, holding period etc. My goal is to generate rising dividends. Using my process of not really paying much attention to performance vs market I have crushed it over the past 5 years, although this could likely not be the case going forward. Well-diversified portfolios of 30 stocks will very likely match returns of Dow, S&P 500 etc over time, which is what I would probably achieve. As a result, I would think I would do better in flat, slightly higher or declining markets, but do worse during rising markets. Of course, if you under perform by more than 1%/year for a period of say 5 - 10 years, you would likely be better off in index funds. After all, DGI takes more effort than indexing.

  3. Thanks for sharing your performance DGI. Can you share your portfolio size? With dividend growth investing I do think size matters b/c your goal is to live off the income. Hence, it would be great perspective to get an idea of the feasibility of living off the dividend income.

    Is there a reason you only started in 2008 instead of sooner? What were you doing with your capital beforehand?


  4. BTW, if you want more investors to read what you write, it's great to provide more perspective/context to the writing. It's what I've learned from my blogging experience. Check out my site sometime and the comments. It's taken 4 long years, but I think I've finally got the hang of blogging :)

  5. Hi Sam,

    Thanks for reading.

    Unfortunately, I do not want to discuss my net worth in public. I can only see the downside of it.

    Size matters for all types of strategies where you need to live off your nest egg. If you have no nest egg you can't retire, whether you use Index Funds, Real Estate, Fixed Income or Chinese Internet stocks. And, I prefer to focus on income, not portfolio size, which is secondary.

    I have refrained from discussing my personal situation, other than this:

    As for why I only have performance before 2008:


    For your last comment, I am not certain what you mean by perspective. I am always willing to learn how to make site more appealing to new/existing readers, so if you can clarify, that would be awesome.

    I have had this site since 2008, and I have a decent amount of readers. But this is not my full-time occupation ( if the quality of the posts didn't reveal that already ;-))

    I might incorporate some of your questions into a blog post, since I am assume a lot of readers have similar questions.

    If you would like to talk further, you can always email me at dividendgrowthinvestor at gmail dot com.

  6. Sounds good mate. It's all u to you.

    Let's hope the markets don't get too blitzed!

  7. I'm a big fan of the advice you give and I really appreciate it. A guy doesn't have to run a big mutual fund or be a certified anything to know what he's talking about. I love to read as much as I can about investing and pick up the best bits and pieces and adapt them into my own strategies.


Questions or comments? You can reach out to me at my website address name at gmail dot com.

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