Monday, June 24, 2013

Your Retirement Income is on Sale!

Everyone loves a good sale! When you purchase quality merchandise at 50% off, or at everyday low prices, it is considered a bargain and a smart move. When stock prices decline however, investors all of a sudden lose their common sense to become fearful. Lower prices on quality stocks causes investors to shun buying stocks. Higher prices on the other hand, excite everyone.

Stocks have finally began sliding down, and I am starting to get excited. I would love for stocks to get down even further from here. As someone in the accumulation stage of the dividend machine building process, I welcome any price weaknesses with open arms, as it translates into higher entry yields.

The amateurs are starting to get nervous however. They need positive reassurance through rising prices. If they don’t get rising prices, they get scared, and start selling everything. These investors view stocks like lottery ticket substitutes. Many dividend investors, myself included, started their investing journey treating stocks like lottery tickets in their early days. After a while however, it all starts to sync in that stocks are ownership pieces of real businesses, and not just some paper certificates or kilobytes on a computer screen. Success if determined based upon the growth in the underlying business, not because of meaningless short-term stock price fluctuations.

At the end of the day, smart dividend investors view stocks as partial ownership shares of real businesses. They do their research in uncovering those businesses, and then try to buy existing owners out at bargain prices. They can then sit back, monitor their business interests, and collect dividends one check at a time. After all, if you owned an apartment building next to a college that is always occupied, you won’t give a damn if its quoted valued fell by 5% - 10%- 20% in one single day. As long as you can rent your building out, you should do just fine by ignoring “quoted values”.

And what a great time it is to be a collector of business profits, through generous dividend distributions. Corporate balance sheets are flush with cash, more people are going back to work, and that housing market is coming back up. It is even better, when the price of your dividend stream is getting cheaper by the dozen. Just a month ago, everyone was complaining that stocks are overextended, and quality REITs such as Realty Income (O) yielded only 4%. This caused me to ask myself, whether we were in a REIT bubble. Since then, the stock has gone down over 26%, and is yielding a cool 5.30%.

The chicken littles however are scared that the Federal Reserve will stop pumping $85 billion into the economy every single month. However, they seem to be forgetting that the economy seems to be recovering. Most importantly, they seem to be forgetting that most profits in investing are made by the long-term buying and holding, not flipping stocks.

I keep hearing from amateur investors of the world, that the improving economy and the ending of Qualitative Easing by the FED will lead to higher interest rates. Those rising interest rates will be bad for dividend stocks. I usually ignore such talk, not because I am smug, but because I try to look 20 -30 years down the road. I cannot imagine a scenario, where US businesses will not be better off in 20 – 30 years. Businesses will have better productivity, access to more markets, and would have made more in profits. Chances are that we would have new products that few are probably even dreaming of right now. I assume that these products would likely improve lives significantly. I wake up every day, trying to achieve something for myself and my family – I imagine that millions of other people in the US and the Globe are trying hard to achieve just that. Some of these people would be the ones to invent the products mentioned above, that will improve our lives.

In addition, rising interest rates are bad for all stocks, not just dividend stocks. If I had to choose between owning some highly speculative Chinese internet stocks or some blue chip dividend paying stocks that pay me rising dividends every year, I would always go with the dividend stocks. Chances are that the mature dividend stocks will have access to credit at much better terms when things get tough, while the hot growth Chinese internet stocks will get clobbered and many might have to resort to cooking the books to get credit. Again, the goal is to try to select the companies that have what it takes to be here in 20 -30 years, and then try to buy their stock at attractive valuations. You can also call these qualities competitive advantages, wide moats or strong brands. Trying to outguess the economic cycle is a fools game. Even people whose primary job is forecasting macroeconomic trends have trouble getting it right. Your job is again to invest for the next 20 – 30 years, which would cover several economic cycles, and several periods of interest rate fluctuations. In those 20 -30 years, stocks would likely drop by half at least once.

One of the smartest people in the world, who became a billionaire because of his intelligence, once said:

"If you are not willing to hold stocks though 50% loss, you should not be in stocks."

Let that sink in. This person is Charlie Munger, the long-standing business partner of Warren Buffett. If Buffett had chickened out in 1974, when the price of Berkshire Hathaway (BRK.B) had fallen down by 50%, and put everything in Treasuries, he would have never become a billionaire.

When shares of Aflac (AFL) dropped from $25 to $10/share in 2008 - 2009, it was a pretty scary experience. I held on, bought some more, and have been adding to the position and collecting dividends ever since. I am welcoming drops in prices, especially if it would bring companies such as Coca-Cola (KO) to trade at 15 - 16 times earnings. Given forward earnings of $2.14/share for 2013, this would translate into $32.10 to $34.34/share.

Some quality companies like Phillip Morris International (PM) are trading at 16.80 times earnings, yield 3.90%, while having a sustainable distribution. The company is expecting to grow earnings by 9 - 12%/year for the foreseeable future, fueled by its expanding growing operations. Check my analysis of PMI.

Other companies such as Wal-Mart Stores (WMT) are trading at 14.50 times earnings and yield over 2.50%. Wal-Mart Stores has been able to increase dividends for 39 years in a row.Over the past decade, the worlds largest retailer has managed to boost distributions by 18.10%/year. Check my analysis of Wal-Mart.

So back to our Realty Income story mentioned above. If you had $500,000 in May 2013, and you invested the whole stash in realty Income (O), you would have only been able to generate $20.000 in annual dividend income. If you bought Realty Income today, you would be able to make over $26.000. I don’t know about you, but the drop in stock prices is making me feel richer. If I were a rational dividend investor, I would actually hope for lower prices from here. If you get a cash machine that spits out an ever rising stream of dividend income, then wouldn't you want to buy a piece of it at the lowest prices possible?

After all, it would make the cost of your retirement much lower.

Full Disclosure: Long O, KO, AFL, PM, KO

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