Tuesday, January 14, 2014

Two Dividend Machines I Purchased Last Week

Over the past week, I purchased shares in two quality dividend paying companies. I made those purchases in my Loyal3 account, which lets you buy stock in over 50 well-known companies without paying any commissions, with investment amounts as little as $10 per transaction and as much as $2,500 per transaction. I believe these companies to be good values today, and would be happy to add more over the next year, especially if we get the correction that every dividend investor is anxiously waiting for.

McDonald’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. This dividend champion has rewarded long-term investors with a dividend raise for 38 years in a row. Over the past decade, McDonald’s has raised dividends by 22.80%/year. Over the past five years however, dividend growth has slowed down to a more reasonable 13.90%/year. The company is expected to earn $5.56 in 2013 and $5.93 in 2014. Earnings growth seems to be slowing down to about 6 – 7%/year. I am not worried about temporary slowdowns in earnings and dividend growth, because these things are to be expected. Growth in dividends varies from year to year, and goes in cycles. When your investment timeframe is 30 years, you will see periods where dividend growth slows down. This scares off the weak and impatient holders, who sell. For example, in 2001 and 2002 dividend growth at McDonald’s slowed down to 5%/year. Since then, the annual dividend paid is up by a factor of 13.

However, even if the days of 6-7% growth are here to stay, all is not bad. This would likely mean slowing down of dividend growth to the rate of earnings growth. This is not bad for a company with annual sales of over $28 billion. Annual earnings growth at 7%, plus a healthy 3.40% dividend yield can compound capital at 10%/year for the patient investor with a long-term timeframe. The stock also trades at P/E of 17 times earnings. Check my analysis of McDonald’s for more detail on the company.

Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has managed to reward loyal shareholders with dividends raises for 46 years in a row. Over the past decade, Target has managed to boost distributions by 19.80%/year.

The year 2013 was a very challenging one of the retailer. First, its expansion into Canada did not go as smoothly as expected. I do believe this issue is a temporary one in nature, and the company would use the lessons learned in its further international expansion abroad. So far, most of its stores have been based in the US, so a large portion of future growth would likely come from international expansion. The second issue with Target in 2013 was the fact that 70 million customer credit and debit cards have been compromised in the November – December period. The biggest issue is that the real truth is slowly being uncovered, and not surprisingly the real impact is getting larger with any new discovery. Initially, the number of compromised accounts for 40 million, then debit cards were added to the list of compromised accounts. This could mean that the company might still not know the full impact of hacker breaches.

However, I believe that the best time to buy stock I when there is blood on the streets. Growth in earnings, dividends and share prices is never linear. Big companies stumble from time to time. If you assess the issues currently faced by a business and determine problems are temporary in mature, you might get interested in the company. Your next point is to determine if the price adequately compensates you for the risk you are taking. The thing is that unfortunately all retailers, whether brick and mortar or on the internet, are exposed to the problems that Target is experiencing. While the current breach is an issue, I believe it will pass in a few months, without destroying the brand that so many shoppers enjoy.

I am slowly moving my way into accumulating a decent position in the retailer, by adding a small amount every month into the stock in taxable accounts, and one or two small purchases in tax-deferred accounts. That way, if the stock continues going down in price, I would be able to average my cost basis down.

Currently, Target sells at 16.70 times earnings and yields a very sustainable 2.70%. Check my analysis of Target for more information on the company.

I have broken those transactions, and instead of putting the usual amount I put per each investment at a time, I am going to separate that into four purchases. Basically I am going to spread purchases over three – four months, in an effort to take advantage of any corrections. Particularly in Target’s case, I might be value hunting too early, as prices could easily fall into the low to mid $50s, especially if investors get particularly pessimistic about the company. Lower prices would be very welcome in general however. These were a partial lot purchases, as I am conserving resources in case my Coca-Cola (KO) January puts I sold are exercised. I also like to build my share positions slowly.

The bull market of 2009 – 2013 has trained investors to put money to work as soon as possible. Otherwise, they witnessed steep increases in prices for quality dividend stocks while waiting in cash, and had to pay those higher prices later in order to get a piece of the action. As a contrarian investor, I try to do the opposite of what everyone else is doing. As a result, I never chase rising prices, but try to rationally allocate my capital in the best values at the moment. I also try not to get excited too much even for the best dividend paying stocks. This could be expensive, as I would end up overpaying for the future stream of dividend payments. My goal is to buy future dividend income growth at reasonable prices today. If I get in on a 7 – 10% dividend growth at 2% and a P/E of 20, rather than at 3% at a P/E of 20, I will generate lower future dividend incomes over time.

Full Disclosure: Long MCD, TGT

Relevant Articles:

How to buy dividend stocks with as little as $10
Target Corporation (TGT) - A high growth, attractively valued stock
McDonald’s Corporation (MCD) Dividend Stock Analysis
How to buy when there is blood on the streets
Why do I own so many individual dividend paying stocks?

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