Wednesday, July 30, 2014

Dividend Investing Over the Past Seven Years Was Never Easy

Very often, I hear the following comment:

Well, the stock market has been going up non-stop in the past several years. Anyone who purchased stocks would have done very well. It was easy to buy stocks in the past five - six years, since they only went up. When stocks go down by 15%- 20%, all dividend investors will cry for their mommy and abandon their strategy

I take great offense with those comments. First, they show the lack of prep work made by the commenter, and second, they show that the commenter is subject to hindsight bias, where everything looks easy but only in retrospect. In reality, there was always a reason not to invest in dividend paying stocks during each of those past seven years that I dedicated to dividend growth investing.

There is never a perfect time to start investing in dividend stocks. There is always a reason not to invest in dividend stocks. The truth is that dividend investing was never easy.

I myself started investing in dividend paying stocks at the worst time possible, which was in late 2007 – early 2008 period. This was the worst time possible to start investing in stocks in general, let alone dividend paying ones. I also launched my site at the time, in order to write down my ideas, and make myself do the work required to form an opinion on quality dividend paying stocks.

Some of you remember the dark days from 2008 and 2009, when many companies crashed, stocks kept falling from their highs by over 50% and several prominent bank payers slashed dividends. Those were some pretty scary times, as evidenced by the fact that some companies accepted usurious interest rates on loans from Berkshire Hathaway (BRK.B), mostly because they needed the funds, but also because they wanted Buffett's stamp of approval to calm investors.

It was pretty scary to watch any news during that time, because I feared the whole economy would collapse.
Nevertheless, I kept putting money to work every month during that time. It is insane to think about it now, but some of the best blue chip dividend stocks like were available at fire-sale prices. For example, I was able to purchase shares of Altria (MO) at $15.11 and Chevron (CVX) at $64.35 in early 2009. Even as late as August - September 2009, one could buy companies like Phillip Morris International (PM) at $46.94/share.

Then in 2009, stocks started going up after hitting multi-year lows. That’s when we had fears of inflation, fears that there was a disconnect between stock prices and the real economy, unemployment was bad and stocks were too high. That’s when I kept adding to my portfolios, and were still able to find stable dividend paying companies, that were available at attractive prices.

In 2010, I was able to keep putting money in dividend paying stocks, every single month. I was doing much better income-wise starting in 2010, relative to 2007, 2008, or 2009, which is why I was able to put even more money to work in dividend paying stocks. In 2010, we had fears of a double-dip recession, the TARP plan was being ridiculed left and right, and everywhere I looked there was doom and gloom. In fact, this doom and gloom is everywhere, and has only recently started to fade away. The majority of individuals I have talked to since 2009 have been in disbelief whenever I would inform them that the recession has been over since 2009. What made it psychologically difficult to commit money to dividend paying stocks in 2010 as the fact that preferential tax rates on dividends and capital gains were set to expire that year. This was a fear a couple of years later, although congress finally managed to extend those breaks, while raising rates for highest earners.

The years 2011 and 2012 were characterized by double dip recessions in Europe, Greece defaulting on its debt, and more fears about debt ceilings, and tax rates. It was not an easy time to put $1000, $2000 to work in Aflac (AFL) or McDonald's (MCD) or Walgreen (WAG). It was also tough because some of the companies, like Johnson & Johnson had issues on their own, which made many investors want to sell their shares at $60. This is when I kept adding to the stock, which is one of my largest portfolio holdings today. When I look at old articles I have written between 2010 and 2012, they mention Johnson & Johnson quite frequently. Yet, many readers didn’t like that and complained about it. In retrospect, what looks like a no-brainer decision when Johnson & Johnson is at $105/share, looked like a very scary decision back in 2010 – 2012.

Between 2009 and early 2013, a common fear I heard from investors was that “stocks are too high”. Looking at my archives, I even wrote several articles which discussed the fact that there are always some quality companies that are selling at attractive valuations.

The reason why I kept putting money to work for me in my dividend portfolio is because I had goals and a dividend growth plan to achieve them. This plan was helpful in outlining the steps that need to be taken in order to achieve my goals. I didn’t have all the steps codified, but the message has been clearly repeated ad nauseum on this site for several years: invest in quality companies at attractive valuations, diversify, dollar cost average, reinvest dividend selectively, keep screening the list of dividend growth stocks regularly, keep learning more about companies, business and develop strategy. Ignore the noise.

The other factor that really made me stick through my strategy through thick and thin was the reinforcing power of cash dividends which I receive in my brokerage accounts. When you get a dividend check from the company you invested in, it further solidified the idea that I am investing in real businesses, and not in some lottery tickets. The first dividend checks were a small drop in the bucket initially. This stream has been increasing in size, frequency and intensity. The goal is that this stream will cover my expenses in a few years or so. When you receive a stream of income which grows faster than raises at your job, which comes from global business powerhouses with growing earnings, it is pretty easy to ignore the opinion of the stock market and keep at your plan.

There is always something to worry about. The way to be successful is to buy shares in good companies that you understand, and buy them at attractive prices. If you have a diversified portfolio of solid blue chips, purchased at attractive prices, with long histories of dividend growth, which have catalysts for further growth in earnings, you can’t go wrong if you are patient and have a long-term time frame. And by long-term, I don’t mean next week, I mean that you should be fine collecting dividends, even if they closed the stock market for 10 years.

In fact, the dividend haters often claim that dividend investors will get scared from a 20% decrease in stock prices. I am really hopeful that they are right and we do get a 20% drop. I promise to act scared, as long as I can get that 20% drop. Inside, I would be ecstatic, since I would be able to buy more future dividend income with less dollars. As someone in the accumulation phase, a bear market would definitely make it easier to achieve my goals faster.

To end up with the words of superinvestor Charlie Munger” If You Can’t Stomach 50% Declines In Your Investment You Will Get The Mediocre Returns You Deserve

Full Disclosure: Long MO, CVX, JNJ, AFL, MCD, WAG, PM

Relevant Articles:

Common Misconceptions about Dividend Growth Investing
Frequently Asked Questions (FAQ) About Dividend Investing
Dividend Investing Misconceptions
Long Term Dividend Growth Investing
Dividend Stocks For Long Term Wealth Accumulation

Monday, July 28, 2014

Dividend Yield or Dividend Growth:My Experience With Both

There is a ranging debate of whether someone should go with high yielding companies today, or they should go with lower yielding investments, which however offer the promise of increasing payouts at a faster clip. As I have discussed earlier, there is a tradeoff between dividend yield and dividend growth, with the decision of which path to take ultimately being dependent on the underlying unique characteristics that an investor has in his or her own opportunity set.

Nevertheless, I still get asked the following question. The question goes something like this: Why go for an investment that yields 3%, with the potential for a 7% in annual dividend growth, when someone can get an investment yielding 6% today? Even if all the expectations turn out to be correct, an investor would have to wait for a long ten years, before they collect a 6% yield on their cost. With the other investment, they would have been collecting that 6% yield for 10 years already.

I usually answer those questions with examples, which discuss the probabilities of different events happening. However, the reason why I usually go with the lower yielding stock is due to my experiences. Actually, one of my investing mistakes pretty much sums up why I do what I do.

I will tell you what the risks behind the thinking in the question asked above are, by discussing my experience with ONEOK Inc (OKE).

I bought shares of ONEOK Inc (OKE) in three separate transactions in 2010 – 2011 at the following price points - $25.31, $25.71 and $30.20. I liked the fact that shares were offered at a low P/E ratio, had adequate current yield, and offered the opportunity for growth. As a general partner in ONEOK Partners (OKS), there was plenty of opportunity for growth. And I think there still is. ONEOK Inc paid a quarterly dividend of approximately 21/cents per share.

In 2011, I decided that I wanted to earn more in distribution income right away, rather than wait for a few years. I also believed that the shares were too high. So I ended up selling all my shares at $36.18/share and purchasing shares of ONEOK Partners at $41.71/unit.

Since then, ONEOK Inc spun-off One Gas (OGS). Investors received one share of One Gas (OGS) stock for every four shares of ONEOK Inc (OKE). If I had stayed with ONEOK Inc, I would be earning a quarterly dividend of 56 cents/share from ONEOK shares as well as dividends from One Gas shares, where rate is 28 cents/quarter. This comes out to a total of 63 cents/quarter for shares that were bought at an average price of $27.07/share, or an yield on cost of 9.30%. Instead, I am earning an yield on cost of 7.10% by sticking to ONEOK Partners (OKS). If growth continues further, as it should, investors in ONEOK Inc will be generating even higher yields on cost, due to high distribution growth.

I violated two of my rules. One is never to sell, even if I had a 1000% gain on the investment.  The other rule is that activity is bad for your performance. According to research, 80% of the time the investor is better off staying with their original investment and not doing anything else. I also chased yield by replacing ONEOK Inc (OKE) with ONEOK Partners (OKS).

I also ended up paying taxes on a portion of the gains. The opportunity cost of the taxes I paid could be very high, because this is money that could have quietly compounded for decades for me and made me even wealthier in the future. It could have meant more money for the causes and people I care about when I die. Instead, I threw the money away and gave it to the government.

Overall, the investment in ONEOK Partners has been satisfactory. However, I made a few mistakes, and probably should not have sold the original shares purchased in ONEOK Inc. Once again, as Warren Buffett says, some of the largest mistakes he has made were mistakes of omission, not mistakes of commission. Other mistakes of omission I have made include watching Williams Companies (WMB) go from $32 to $36 in 2013, and not purchasing because I wanted to buy it cheaper. The company might still be a good investment, given the high forecasted growth in dividends. As a matter of fact I recently initiated a position in it, and I am hoping it drops from here.

I believe that smart people, learn from the mistakes of others. Hence, I hope that my smart readers will learn from those mistakes I made. The goal of every investor is to always be learning, and always be improving. If one stops learning and improving, they have a high chance of failing to reach their goals and objectives. The goal is to get a little smarter every single day, and removing ignorance one item at a time.

Relevant Articles:

The Tradeoff between Dividend Yield and Dividend Growth
Why I am replacing ConEdison (ED) with ONEOK Partners
ONEOK Partners (OKS) Dividend Stock Analysis
Seven Dividend Stocks I purchased for the long-term
Types of dividend growth stocks

Saturday, July 26, 2014

Best Dividend Investing Articles for July 2014

For your weekend reading enjoyment, I have highlighted a few interesting articles from the archives, which I find to be relevant today. The first five articles have been written and posted on this site, while the last five have been selected from other authors. I tend to post anywhere between three to four articles to my site every week. I usually try to write at least one or two articles that contain timeless information concerning dividend investing. This could include information about my strategy, or other pieces of information, which could be useful to dividend investors.
Below, I have highlighted a few articles posted on this site, which many readers have found interesting:

1) Seven Dividend Stocks I purchased for the long-term

I was able to identify seven dividend companies, and purchase them in my tax-deferred accounts. In the article, I discuss the names involved, brief information behind each company and why I purchased it. Since I am a stock picker, I believe that investors can find bargains during most times.
On a side note, I also sold some 2015 and 2016 puts on General Electric (GE), Wells Fargo (WFC) and Altria (MO) a few days ago. I am also close to selling some puts on General Mills (GIS) in the coming days.

2) Are you drowning in cash?

I discuss the issue that many investors and corporations have today. The issue is that they are drowning in cash. For the everyday dividend investor like me, I believe the best idea is to keep searching for values, and dollar cost average in those values every month. With a long-term horizon, I believe the power of compounding will provide good returns over time.

3) How to earn $900 in dividend income per minute

Warren Buffett's holding company Berkshire Hathaway is one of the largest shareholders in Coca-Cola (KO). Those 400 million shares effectively produce over $900 in dividend income every minute. Buffett likes receiving dividend income from his holdings, but prefers to allocate those funds himself into other income producing assrts.

4) Can everyone achieve financial independence with Dividend Paying Stocks?

In this article I go through the steps I take each month, in order to achieve my goal of financial independence one day. I believe that everyone can achieve the so called dividend crossover point, which is the point where dividend income exceeds expenses, if they apply themselves and keep learning about investments all the time. I do believe that success will be achieved by those who put in the time and do the work today, and let the snowball roll.

5) Five Dividend Machines With Growing Distributions

One of my ways to monitor dividend growth stocks is through regular monitoring of dividend increases. In this article that readers found interesting, I highlighted five dividend growth stocks, which recently announced increases in distributions.

I read a lot about companies, and also read a lot of interesting articles from all over the web. A few that I really enjoyed over the past months include:

1) A 0% Allocation to Fixed Income?

Dividend Mantra had a very interesting article on why he has no exposure to fixed income. Given the low returns on fixed income, the unfavorable taxation on interest, and the fact that interest barely keeps up with inflation, I share his views completely. I found particularly interesting the discussion how Social Security checks represent an asset that is similar to fixed income, which also provides inflation protection.

2) Why Dividends Matter?

Dividends4Life provides 11 compelling reasons as to why dividends do and should matter to investors. He also provides 11 dividend growth ideas for further research by investors. He is one of the most consistent dividend bloggers out there, and I have had the pleasure to interact with him over the past seven years.

3) 20 Dividend Champions To Buy Today

Chuck Carnevale provides a list of 20 dividend champions which are in value territory today. While everyone else has been worried sick about a correction, individual dividend investors like Chuck have been able to allocate their capital wisely in the best values that they see at the moment. This is what makes dividend growth investing appealing to investors like me who put money to work every month - even when the stock market is at elevated levels, there are always quality companies available at bargain prices.

4) Why Have Dividend Aristocrats Outperformed?

Sure Dividend provides some very interesting reasons on why Dividend Aristocrats have outperformed over the past decade. It is not surprising that when you have highly profitable businesses, which are the leaders in their industries, manage to keep growing earnings over time, have high returns on equity, and have the discipline to keep rewarding long-term shareholders with consistent increases in dividends, that you will generate market beating returns over time.

5) You Are Responsible For Your Investing Decisions

Dave Van Knapp, who is the author of The Top 40 Dividend Stocks of 2014, wrote an interesting article about personal responsibility in investing. Every investor has a duty to themselves to do proper due diligence, prior to purchasing any investment.

Thank you for reading Dividend Growth Investor site. I am also on Twitter, if you are interested in following me on another platform, where I post about recent trades I have made.

Full Disclosure: Long KO, one share of BRK.B and short puts on GE, MO and WFC

Friday, July 25, 2014

Should I invest in AT&T and Verizon for high dividend income?

Most readers are probably aware that it has been getting more difficult to find decent values in the current environment. When I ran my screens for valuation, I stumbled upon AT&T (T) and Verizon (VZ), which are telecom behemoths in the US.

AT&T (T) has increased dividends for 30 years in a row. In the past decade, it has managed to increase dividends by 4.90%/year. Between 1984 and 2014, the company has managed to increase dividends by 4.70%/year. The stock trades at 13.70 times forward earnings and yields 5.20%.  Check my previous analysis of AT&T.

Verizon (VZ) has increased dividends for 9 years in a row. In the past decade, dividends grew by 3%/year. Between 1983 and 2014, the company has managed to increase dividends by 3.50%/year. The stock trades at 14.40 times forward earnings and yields 4.30%.

The telecom industry in the US is very competitive. Companies like AT&T (T) compete with the likes of Verizon (VZ), Sprint and T-Mobile. In the past, almost all of the profits have been made by Verizon (VZ) and AT&T, at the expense of smaller competitors. An investment in AT&T and Verizon today would presume that the status quo would remain unchallenged, and that Sprint and T-Mobile would be kept weak forever. The service that telecom companies is essentially a commodity. Telecom companies are not utilities, because there is the possibility for switching the provider. Try moving to Saint Louis, Missouri, and then switching your gas, water or electric utility – you can’t. But anywhere in the US, you can switch to another wireless carrier, plus you have other alternatives and very low customer loyalty. There is nothing to stop a customer from switching to another carrier after their contract expires.

It also takes an enormous amount of capital to maintain and continuously upgrade a network that would cover 300 million people in dispersed area such as the US. Long gone are the days when telecom only meant providing voice calls between users in different locations. Now there are technologies such as 3G, 4G, LTE that require constant costly investment to upgrade network. Barriers to entry are steep of course, since it takes tens of billions of dollars to build a network. However, the main competitive advantages available to Verizon and AT&T are those of scale.

There is a risk of technological obsolescence, since new technologies are requiring that telecom companies engage in multi-billion dollars upgrades, merely to keep up with competitors. In addition, there are new technologies which could leverage existing network infrastructure but could be directly competing with telecom companies. For example, 20 – 30 years ago, the price of a long-distance call between New York and San Francisco would have been quite expensive. Today, I can call anyone in the world using Viber or WhatsApp for free, using wi-fi from a device that is connected to the internet.

Currently both AT&T and Verizon have the advantages of scale, which allows them to spread costs of upgrading and maintaining their network over larger pools of customers. This has allowed them to earn hefty profits, and pay the high dividends to shareholders. For example, if you want to advertise your service, it is much easier to outspend your competitor in advertising by spending twice as much as them when you have three to four times as much customers. On a per customer basis however, this advertising is still going to be cheaper.

Another advantage is the fact that in the traditional telecom model, it would be very difficult for someone to set up a new wireless network. This would take tens of billions of dollars to get the network equipment on tens of thousands of cell towers across the US, plus get valuable spectrum rights. Today however, it is quite possible that competing technology platforms might end up destroying value at the traditional telecom companies. Again, I am talking about WhatsApp and Viber. In addition, we do not know if the future doesn’t hold another technological breakthrough, which could replace the cellphone the same way the your landline has become obsolete.

AT&T has recently announced that it would be acquiring DirectTV (DTV). This could help it offer bundled services to customers at a greater scale. It could also pave the way for international expansion beyond TV for AT&T. AT&T could generate synergies from deal. Plus, DIRECTV could easily double earnings within five years $6 billion from current $3 billon. The company has grown through acquisitions in the past, which is why I believe integration risk to be low.

For both AT&T and Verizon, the dividend has not had a very good coverage out of earnings. I always require that there be a margin of safety in dividends when I analyze a dividend paying company. There is a high risk that the dividend be cut sometime in the next decade, given the competitive pressures, high payout ratios, constant requirement for new capital to invest, and commoditized type of service. If you add in the competitive pressures to the high payout ratio, one could see why I have not been excited about AT&T and Verizon as dividend growth stocks. The best probable scenario that I could see for AT&T and Verizon  income shareholders is that their dividend keeps up with the rate of inflation. Even during the past 25 years, the best that AT&T and Verizon could do was grow dividends by 3% - 4%/year. As a result, I would take a pass on both stocks. However, it could be a decent holding for someone who needs high current income for the next decade, and is fine that this income lose purchasing power over time.

An investor in a high yielding company company like AT&T could reinvest their dividends and grow dividends by the 5% dividend yield and the 1-2% organic dividend growth. This means that a holder of AT&T shares worth $30K will receive approximately $1,500 in annual dividend income, which would be then used to purchase 5% more shares. In the next year, the dividend will increase by 2% and the investor will earn the higher dividend on the increased amount of shares. If you rinse and repeat this exercise for 18 years, it is highly likely that the investor will be earning $5,000 in annual dividend income from this position. This is due to the power of reinvesting high dividends into more shares of a high dividend yielding stock that has some dividend growth. If I stop reinvesting dividends however, I income will lose purchasing power to inflation. The risk is also that a high dividend yield is due to a high payout ratio. If the business faces strong headwinds, this increases risk that dividend is cut if times get rough.

However, the opportunity cost of investing in an AT&T is a company like Coca-Cola (KO) or Johnson & Johnson (JNJ), which yield around 3% today, but grow dividends at 7%/year. Of course the 7% figure is very conservative and at the low range of my projections for those companies. In 18 years, I will be earning $5000 in dividend income, if I reinvest those growing dividends. In addition, once I stop reinvesting dividends and live off them, the dividend growth will protect purchasing power of income from inflation. To top it off, the portfolio would also have much higher appreciation potential relative to the AT&T centric portfolio. The drawback is that forecasting dividend growth over an 18 year period is tough, since no one knows what the world will look like in 2032.

In the matter of full disclosure, I do have a tiny position in Verizon, as a result of my investment in Vodafone (VOD) last year, which distributed those shares after selling their Verizon Wireless stake to Verizon. I think that Verizon owning 100% of Verizon Wireless is a good thing for the company, and could end up being accretive for long-term holders. I would probably hold this, since this tiny position is spread out in several tax-deferred accounts. At least I am able to reinvest those distributions automatically. Other than that, I am not planning on adding any money to either AT&T or Verizon, since I believe there are better uses for my capital. I usually invest for the next 30 years, which is why companies that have poor growth prospects are usually at the bottom of my list for purchase.

Full Disclosure: Long VZ and VOD

Relevant Articles:

Maintaining Moats in times of Technological Changes
Are these high yield dividends sustainable?
Highest Yielding Dividend Stocks of S&P 500
Margin of Safety in Dividends
Vodafone Group (VOD) Dividend Stock Analysis

Wednesday, July 23, 2014

Surprise: The real cost of inversions are paid by shareholders

There are several companies I own, which are trying to do a corporate inversion, in an effort to renounce their US corporate citizenship. This inversion is achieved when a US based company buys a foreign corporation, and as a result moves its legal domicile in the foreign country. As a result, the new combined company would be treated as a non-US company in the eyes of the US tax authorities. This is appealing to companies, because they would only owe US income taxes on income derived solely from US operations.

Under current laws and regulations, US companies that earn money abroad have to pay steep tax bills if they were to repatriate those funds to the homeland, in order to pay dividends, buy back stock or invest in the business. Once an inversion is complete however, these companies would not owe any taxes on income that is earned from foreign operations. As I discussed earlier, most of the companies that dividend investor tend to buy earn a very high percentage of revenues from abroad. This is the nice thing about owning a solid blue chip, which sells branded products and services around the globe, and earns more money to pay higher dividends to you over time.

There are some details that need to be met in order to do this inversion, such as the fact that at least 20% of shareholders of the new company need to be foreign, but this is not the point of this article. The important thing to remember is that inversions generally help reduce the tax rates of companies. From a tax perspective, if you are a US company and your top income tax rate is 35%, it does make sense to relocate to Ireland and pay a tax rate of 12.50%, if you can get away with it. This is essentially what an inversion does.

As a shareholder, less expenses translates into more earnings per share. In addition, cash that is locked abroad for so many US companies that do business internationally will now be easier to access for dividends, share buybacks, investment in the business. Furthermore, if the company relocated to a place like UK for example, dividend income is not subject to any withholding taxes to the US investor. Hence, those shares could still be held in tax-deferred accounts such as IRA’s. So at first glance, it seems like inversions are a good thing to shareholders of the acquirer, since they will result in higher earnings per share, and the possibility for higher dividends and share prices as a result.

As I dug deeper however, I learned that there is a tax that ordinary shareholders like you and me have to pay on inversions. When the tax inversion occurs, shareholders of the acquirer will be treated as if they sold their stock and then purchased the stock in the new, “inverted” company. This creates a taxable event, which means that investors would have to pay a tax on their gains. If the price at which investors acquired their shares was higher, then they might end up deducting losses. In the cases of Medtronic (MDT) and Abbvie (ABBV) however, I believe that most long-term investors are sitting at nice unrealized gains. The only consolation is that stock basis would be stepped up after this exercise. However, the forced tax leakage would be costly for long-term investors like me.

My cost basis in companies like Abbvie (ABBV), Medtronic (MDT) and Walgreens (WAG) is around 2 times lower than current prices ( I have been acquiring shares in each of the companies and their predecessors between 2008 and 2013). Only a small portion of my positions in each company is in tax-deferred accounts. For example, my basis in Abbvie is $29.43/share, while my basis in Medtronic is around $35/share.

I try to seldom sell, because I have to pay taxes. This reduces amount of money I have working for me. By not selling, I have a deferred tax liability to the IRS, which I hope to never pay. This is money I owe, but I don’t pay interest on. This is essentially float, that further helps me achieve financial freedom. It also means I have more money compounding for me. If I sell, I pay tax, and have less money to invest. The opportunity cost of a dollar paid in taxes, that grows by 10%/year for 50 years is $117. At a 3% yield, this is almost $3.50 in income in 50 years, for each dollar I put to work today. That is $1 less working for my descendants or my charitable causes.

These are not good news for any long-term holders like me, who have low tax bases. This is another reason I am trying to max out any tax-deferred accounts, in an effort to shield as much of my money from the crippling effect of annual taxes on my capital gains and dividends. Those friction costs do cost money, that means less money available for my dividend machine to use for its compounding purposes. Either way, over time, expansion of a business is good, since synergies are achieved, taxes are lowered, and this improves the earnings capability of the business. This increases the worth of the business, and the ability to pay higher dividends over time. The ability to pay dividends is further increased by the ability to access cash stored abroad at ease. So the net effect could be positive of course for the patient long-term holder. The effects would be really positive for the patient long-term holder, who placed their shares in a tax-deferred vehicle such as a Roth IRA.

I guess I am learning something new every day. Today is no exception. I thought this was a good deal for shareholders, since corporate taxes will decrease, which increases EPS, and allows companies to be able to access cash abroad for purposes of higher dividends and buybacks. However, this has to be weighed against the tax hit which many long-term investors are facing. What is really bad is the fact that most stock is owned through mutual funds, which do not care about many things such as corporate governance, taxes etc. For those who believe index funds are the way to go, you are one of the reasons why corporate managements think they can do what they want to do. When you have passive owners, who do not believe “active management” produces alpha, you are setting up really perverse incentives for management on executive compensation, corporate strategy, short-term thinking etc.

Hat tip to a reader in France, for alerting me to this topic.

Full Disclosure: Long ABBV, MDT, WAG

Relevant Articles:

My Retirement Strategy for Tax-Free Income
Dividends Provide a Tax-Efficient Form of Income
Roth IRA’s for Dividend Investors
Why should companies pay out dividends?
Dividends versus Share Buybacks/Stock repurchases

Monday, July 21, 2014

Five Dividend Machines With Growing Distributions

As part of my process of monitoring my proprietary list of dividend growth stocks, I monitor dividend increases regularly. This allows me to document any dividend increases for companies I own, by focusing on amount and frequency of the hike relative to past history and my expectations. This exercise also allows me to take note of any companies which have above average dividend growth potential. It is much easier to isolate companies that have certain behaviors such as high dividend growth, when they actually exemplify those behaviors, in comparison to a process where companies are screened for. Once a company with a certain set of characteristics is identified through the list of dividend increases, it is placed on the list for further research.

A few companies that raised dividends in the past week include:

Omega Healthcare Investors, Inc. (OHI) is a real estate investment firm. Omega Healthcare Investors increased quarterly dividend to 51 cents/share for an 8.50% increase over the distribution in the same time last year. This marked the 12th consecutive annual dividend increase for this dividend achiever. Omega Healthcare Investors has a five year dividend growth rate of 9.30%/year. This real estate investment trust (REIT) currently yields 5.40%. Check my analysis of Omega Healthcare Investors.

Kinder Morgan Energy Partners, L.P. (KMP) operates as a pipeline transportation and energy storage company in North America. Kinder Morgan Energy Partners increased quarterly distributions to $1.39/unit, for a 5.30% increase over the distribution in the same time last year. This master limited partnership has increased distributions to unitholders for 18 years in a row. Kinder Morgan Energy Partners has a ten year distribution growth rate of 7.40%/year. This MLP currently yields 6.70%.Check my analysis of Kinder Morgan.

Kinder Morgan, Inc. (KMI) operates as a midstream and energy company in North America, and is the general partner behind Kinder Morgan Energy Partners and El Paso Pipeline Partners. Kinder Morgan increased quarterly dividend to 43 cents/share. Kinder Morgan has managed to boost quarterly payouts by 43%, since going public in 2011. In comparison, the limited partnership has raised distributions by 20.90% over the same time period. I really like the fact that the owner of Kinder Morgan has almost all of his net worth in the company's stock, and limited partnership units. I enjoy being a part owner in enterprises, where management has skin in the game. The company currently yields 4.70%.

The J. M. Smucker Company (SJM) manufactures and markets branded food products worldwide. J. M. Smucker increased quarterly dividend by 10.30% to 64 cents/share. This marked the 17th consecutive annual dividend increase for this dividend achiever. Over the past decade, J.M. Smicker has managed to increase annual dividends by 9.50%/year. The company sells at 17.50 times forward earnings and yields 2.40%. I would consider initiating a position in the stock on dips below $102. Check my analysis of J.M. Smucker.

National Retail Properties, Inc. (NNN) is a publicly owned equity real estate investment trust. National Retail Properties increased quarterly dividend by 3.70% to 42 cents/share. This marked the 25th consecutive annual dividend increase for this dividend champion. National Retail Properties has a ten year dividend growth rate of only 2.30%/year. This REIT currently yields 4.50%.

Full Disclosure: Long OHI, KMR, KMI

Relevant Articles:

How to read my weekly dividend increase reports
Richard Kinder: The Warren Buffett of Energy
I admire Investors with Skin in the Game
Types of dividend growth stocks
Why am I obsessed with dividend growth stocks?

Friday, July 18, 2014

American Realty Capital Properties (ARCP) Dividend Stock Analysis

American Realty Capital Properties, Inc. (ARCP) owns and acquires single tenant, freestanding commercial real estate that is net leased on a medium-term basis, primarily to investment grade credit rated and other creditworthy tenants. Since going public in 2011, this Real Estate Investment Trust has managed to increase its monthly dividends from 7.3 cents/share to 8.3 cents/share.

However the company has expanded very quickly, which is why I believe that it is difficult to do any quantitative analysis of its financials. This is because FFO/share has had a very different composition in 2011, 2012, 2013 and 2014, due to the rapid growth in assets under this REIT umbrella. As a result, I am going to share mostly a qualitative opinion on the REIT. I purchased a position in this REIT in early 2013, after which I have not added to it. The only exception is that I have some shares in a Roth IRA, where dividends are set to reinvest automatically. I bought the stock because I viewed it as something that is similar to investing in Realty Income in the mid 1990s, before the company became an established REIT.

The rapid growth of acquisitions however makes me ask myself, "Are they doing this for the shareholders, or are they doing it for the executives?". It is good to see the scale of operations, which makes it easier to get high profile deals with major corporations. If you are Red Lobster, and you want to do lease-salebacks on 1,500 restaurant locations, you prefer to deal with one landlord that has the capacity to deal in the billions, rather than deal with hundreds of small landlords. The benefits of scale make it easier for that landlord to spread their costs over a larger pool of properties, which results in immediate gains to shareholders, if acquisitions are done properly. Acquisitions have been highly accretive to American Realty Capital Properties shareholders, which have resulted in increases in FFO/share and dividends per share.

American Realty Capital Properties currently yields approximately 7.90%. American Realty Capital Properties yields more than Realty Income (O) or National Retail Properties, Inc. (NNN) or W. P. Carey Inc. (WPC). These other REITs yield 4.90%, 5.50% and 4.30% respectively.  This is because investors view it as a higher risk play than the other triple-net REITs. Investors probably see a higher chance of a dividend cut from American Realty Capital Properties than say Realty Income (O) or National Retail Properties, Inc. (NNN) or W. P. Carey Inc. (WPC). On a side note, each one of those other REITs has managed to boost dividends for over a decade, placing them in the ranks of the dividend achievers list I regularly screen for ideas. ARCP on the other hand has only increased dividends for four years in a row, and therefore does not have a long track record.

The investment in American Realty Capital Properties is mostly an investment in management. I believe that the management is highly competent, and is working for the benefit of shareholders. Management has an extensive track record in dealing with real estate, as well as integrating companies that have been acquired. However, there is always the risk that management develops an ego, which could be disastrous for shareholders. It is one thing to get from $100 million in assets to 15 billion in assets. It is quite another thing to actually manage a portfolio of assets successfully and generate value for shareholders that way.

However, if there are issues in integrating new companies acquired, this could result in losses for shareholders. If you have high degrees in leverage, and no room for error, a botched acquisition could turn out to be very costly.

The other risk is that management is trying to get to be the largest triple-net REIT because they have huge egos, and because a huge size of assets under management could result in larger compensation for executives. For example, if you manage a REIT with $100 million in assets, you can probably command a salary in the hundreds of thousands of dollars per year. However, if you are now managing a REIT with $10 billion in assets, your compensation could be in the tens of millions of dollars, and having a smaller percentage impact on the organization than the lower compensation at $100 million in assets.

The risk with empire building and executive ego is that management ends up purchasing lower quality assets, accepts lower rates of return and gets in bidding wars that could result in unprofitable locations for the REIT portfolio. If you are an executive, you get much more respect if you manage a $10 billion dollar REIT than the executive that manages a $100 million dollar REIT.

I am not very happy about the proposed management compensation plan from a few months ago, which entitled the CEO to quite a handsome compensation package, provided that the shares return at least 7%/year. Given the fact that current yield is at 8%, this meant that the goal of management was to extract money from the business for their own gain, rather than work for the benefit of shareholders.

When I bought the shares in 2013, I believed that the company can develop to be the next Realty Income. It has so far developed a big scale, has managed to do a lot of deals in the process, and is very undervalued relative to competitors Realty Income (O), W. P. Carey Inc. (WPC), National Retail Properties, Inc. (NNN). However, it is yet to be seen if assets were integrated successfully in order for synergies to be generated. I want to see some clean financials, which would make it easier to do a quantitative analysis that would allow me to compare performance between quarters and years. I am also curious to see where management takes the REIT, after achieving such big scale so rapidly. While I would keep holding on to my shares for as long as the dividend is maintained, I am not sure about adding fresh money there. Of course, if shareholder fears are overblown, this REIT could deliver excellent performance going forward, given the fact that shares have been so beaten down.

Full Disclosure: Long ARCP and O

Relevant Articles:

Five Things to Look For in a Real Estate Investment Trust
Realty Income - A dependable dividend achiever for current income
Are we in a REIT bubble?
How to Generate an 11% Yield on Cost in 6 Years
Undervalued Dividend Stocks I purchased in the past week

Wednesday, July 16, 2014

Dividend Investors Will Make Money Even if the Stock Market Closed for Ten Years

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. Warren Buffett

Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years. Warren Buffett

In 1914, the New York Stock Exchange closed for five months. In 2001, the NYSE, Nasdaq and AMEX were closed for a week. Active stock traders did not make any money during those periods. Dividend investors kept receiving their dividend checks, without interruption.

Investors can buy and sell their stock in an instant. This ability to quickly cash out makes stock investing a preferable option for many investors. Compare this to real estate or a private business, where it might take months in order to buy and sell an asset.

Sometimes however this could be a curse as well. While stocks are a very liquid investment, sometimes investors end up being too focused on short-term price fluctuations, while ignoring fundamentals. During bull markets, investors bid up share prices to unsustainable levels. During bear markets, investors who see their portfolio values collapsing panic and sell at the wrong times. Those investors become too emotional, which creates opportunities for the enterprising dividend investors. The emotional investors tend to forget that stocks are not some lottery tickets or numbers blinking on a computer screen, but ownership pieces of real businesses. In a perfectly rational world, the value of business depends on its current and future estimated earnings powers. This is why when entire businesses are sold to a private buyer, the price paid is usually close to the intrinsic value. However, due to the emotional state of Mr Market, the ownership pieces that are exchanged between stock market participants are frequently mispriced.

Dividend investors know that dividend stocks represent ownership stakes in real businesses. As a long-term investor, your success is dependent on the success of the business. If the business manages to grow earnings per share, it would be worth more and would also be able to distribute more in dividend income.

Dividend investors who embrace a buy and hold mentality have an inherently psychological advantage over the average investor. Dividend investors generate a return on investment every time they receive a dividend payment. As a result, many retirees who are living off dividends, concern themselves with the company’s ability to grow earnings to pay higher distributions, than the stock price of the stock. Astute dividend investors focus on fundamentals, understanding the company’s operations and valuing the business as if it were a privately owned corporation.

Dividend investors are in essence much different than the rest of participants, who rapidly exchange little pieces of ownership between each other, in an effort to outwit each other. Dividend investors see stocks as partial ownership pieces of real businesses. They understand that their ultimate success in investment is based on the price they paid and on the success of the business itself. If you own a restaurant along with 10 other partners, you care about making sure the business succeeds, and stays relevant for as long as possible. The goal is to make sure that repeat business is earned, customers are happy, and profit margins are healthy, while trying to constantly increase profits. The advantage of dividend investors is that they focus on the fundamentals of the business, how it earns money, and whether this business has the potential to earn more money in the future. Then they try to purchase that business at an attractive valuation, which takes into consideration a range of potential outcomes, and provide an entry price range which would generate a satisfactory return on investment. If you are the partial owner of a McDonald's franchise, you earn profits whether the stock market is open or closed. In fact, if you have found the right business at the right price, it is highly likely that you will hold this business forever.

This is how I view ownership of high quality companies such as Coca-Cola (KO) and Johnson & Johnson (JNJ). Those are real businesses, that provide real goods or services to clients, and which generate profits to be distributed to me as the partial share-owner. I expect to hold those businesses forever, and expect to earn ever increasing dividends over time from those ownership stakes. I see the rapid trading as pure madness, which actually doesn't really affect me. Whether I pay $37 for Coca-Cola shares or $37.10/share is irrelevant to me. Let the high-frequency computers make that money. The real money is made by identifying a quality company,  buying it at an attractive price, and then sitting on it for decades. In the meantime, the business will be earning more and more in profits almost every year, and pay you an amount of dividends that will likely exceed the purchase price paid by a factor of a few times the purchase price.  Time is the ally of the long-term, buy and hold dividend investor. The initial results are slow, but eventually, the compounding ends up snowballing into mind-boggling yields on cost and capital appreciation returns.

This is why I spend so much time screening the list of dividend champions and dividend achievers, and then researching companies one at a time. I am looking for companies with strong competitive advantages, strong brands, that would allow those companies to have the potential to be around in 20 years, and still earn more per share over time. For example, if you are a part owner of the local water utility, you know that this business will be around in the next 20 - 30 years, because it would be impossible for someone else to compete with you, due to regulation and cost to set-up and maintain the system. If you are a part owner in a company that provides a unique product or serves, which is largely unregulated, it essentially has a monopoly that could mint profits to the shareholder for decades. A prime example of that is Coca-Cola, which has a strong distribution network throughout the world, is associated in consumers' minds with positive emotions, has over 500 brands globally that quench the thirst of people in 200 countries to the tune of 1.9 billion servings per day. If you believe this business has the staying power to be around in 20 years, then you can make projections on earnings, revenues and dividends with a much larger degree of comfort. You want a business which will not change too rapidly. People will get thirsty 30 years from now. If you have the distribution scale that covers 200 countries, and a portfolio of 500 branded drinks, chances are that consumers will use your products. This is why Buffett invests in quality companies with durable competitive advantages, operated by honest and able managers, which have attractive returns on capital and which are available at attractive prices. If you find such a company, the goal of the dividend investor is to hold on to it for decades, and let the power of compounding do the heavy lifting for them.

In contrast, while I might know that Apple will be around in 20 years, I am not so sure how much profitable the enterprise will be, due to the rapid changes in technology. Sony was another great consumer technology franchise, which has not done so well as of the past decade. Will Apple follow the steps of Sony? I don't know, and chances are that few investors really have the necessary knowledge to make an educated bet today. This is why I am sticking to companies I understand, and focus on their fundamentals for the next 20 - 30 years. As a long term buy and hold dividend investor, my goal is to live off the dividends from my collection of quality enterprises. Therefore, my success will be determined on the success of the businesses I invest in, not on stock price fluctuations. The stock market is only helpful to me as a tool where I find sellers of quality businesses, not as a place to instruct me on how to make my investments.

Full Disclosure: Long JNJ, KO. One share of BRK.B

Relevant Articles:

Coca-Cola: A wide-moat dividend growth stock to buy and hold
Maintaining Moats in times of Technological Changes
Seven Sleep Well at Night Dividend Stocks
How to analyze investment opportunities?
Let dividends do the heavy lifting for your retirement

Tuesday, July 15, 2014

Seven Dividend Stocks I purchased for the long-term

In the past week, I acquired stakes in seven dividend growth companies. For three of the companies, I am adding to existing positions. For the rest of the companies, I initiated positions in companies which I believe will be around in 20 years, and stand a chance of earning more over time. The higher estimated level of earnings will hopefully lead to higher dividend payments to me as a shareholder. While the positions are small initially, I find it much better to monitor a company I am interested in by having some skin in the game. That way, if prices drop from here, I will be in a better position to take advantage of the situation, since I have done the prep work already and am monitoring the situation by being invested in the stock.

I am now increasingly favoring tax-deferred accounts, in an effort to minimize tax liabilities today, and enjoy uninterrupted tax-deferred growth of dividends and capital gains for the next 30 – 40 years. The 401 (k), Roth IRA and SEP IRA accounts are here to house the assets that will be generating my buffer dividend income. This is the income I don’t expect to ever need in retirement, but would have it just in case. I am also exploring ways to utilize a Health Savings Account, as another tool to cut down on taxes today, and have uninterrupted tax-deferred growth for decades on those funds. My only regret is that I didn’t max those out prior to 2012. If I had, I would have been much better off. Better late than never of course.

With those moves, my Roth IRA is maxed out for the year 2014. The companies I purchased there include:

Exxon Mobil Corporation (XOM) explores and produces for crude oil and natural gas. This dividend champion has managed to increase dividends for 32 years in a row. In the past decade, the company has managed to increase annual dividends per share by 9.60%/year. Currently, the stock is attractively valued at 13.30 times forward earnings and an yield of 2.70%. Check my analysis of Exxon Mobil.

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. This dividend achiever has managed to increase dividends for 19 years in a row. In the past decade, the company has managed to increase annual dividends per share by 19.40%/year. Currently, the stock is attractively valued at 10.50 times forward earnings and an yield of 2.40%. Check my analysis of IBM.

The Chubb Corporation (CB), through its subsidiaries, provides property and casualty insurance to businesses and individuals. This dividend champion has managed to increase dividends for 32 years in a row. In the past decade, the company has managed to increase annual dividends per share by 9.20%/year. Currently, the stock is attractively valued at 12.70 times forward earnings and an yield of 2.10%. Check my analysis of Chubb.

The Williams Companies, Inc. (WMB) operates as an energy infrastructure company. The company’s Williams Partners segment owns and operates natural gas pipeline system extending from Texas, Louisiana, Mississippi, and the offshore Gulf of Mexico through Alabama, Georgia, South Carolina, North Carolina, Virginia, Maryland, Delaware, Pennsylvania, and New Jersey to the New York City metropolitan area. The company has managed to boost dividends for 11 years in a row, and has a ten year dividend growth rate of 43.10%/year. I like the fact that the company owns the General Partner rights to Williams Partners, and has plans for further growth in dividend income through 2017. I have been monitoring the stock for 2 years, and just now initiated a position, which might not be at the best price of the moment. Of course, noone knows where prices will go next, which is why the best time to initiate a position is today. The yield is at 2.90%.

With the investment listed below, my SEP IRA is close to being maxed out for the year 2014 as well. I purchased the following investments there:

Baxter International Inc. (BAX) develops, manufactures, and markets products for people with hemophilia, immune disorders, infectious diseases, kidney diseases, trauma, and other chronic and acute medical conditions. The company has managed to increase dividends for 8 years in a row. In the past decade, the company has managed to increase annual dividends per share by 12.40%/year. Currently, the stock is attractively valued at 14.70 times forward earnings and an yield of 2.80%. Check my analysis of Baxter.

Deere & Company (DE), together with its subsidiaries, manufactures and distributes agriculture and turf, and construction and forestry equipment worldwide. The returns from this company are going to be lumpy from year to year, but the possibilities are high if world population increases, and more people in developing countries can afford to eat as much as those in the developed world. Deere is a dividend achiever, which has managed to increase dividends for 11 years in a row, and has a ten year dividend growth rate of 16.30%/year I believe the company will be around in 20 years, and given the low valuation today of 10.50 times forward earnings and yield of 2.60%, it offer a good opportunity for dividend growth and capital appreciation. Check my analysis of Deere.

Republic Services, Inc. (RSG), together with its subsidiaries, provides non-hazardous solid waste collection, transfer, and recycling and disposal services for commercial, industrial, municipal, and residential customers in the United States and Puerto Rico. The company is essentially part of an oligopoly, given the fact that waste storage locations need a lot of money, expertise to open and operate. I also like the recurring annuity like cash flow streams for the company. I believe that waste is going to increase over time in this country, and companies like Republic Services are going to benefit from this. I also like the fact that the company has managed to increase dividends for 11 years in a row, and had a five year dividend growth rate of 6.60%/year. The stock is close to being pricey at 19 times forward earnings and yields 2.80%. Check my analysis of Republic Services.

I consider myself incredibly lucky that I have been able to save money consistently, and put it to work towards my future. I have been very lucky that I kept adding money even throughout the 2008 – 2009 crash, and the subsequent recovery, when everyone was telling me that stocks are about to crash. Even if they do fall by 20%, 30%, 50% from here, as an investor in the accumulation stage, I am going to view this as an opportunity to get more stock for my buck. If you are building out your stock portfolio today, you should be praying for lower stock prices, which means better stock values and better dividend incomes. In addition, to paraphrase Charlie Munger, if you are not willing to sit through a 50% decline in stock prices, then you should not be in stocks.

What purchases have you recently been making to your dividend portfolios?

Full Disclosure: Long all companies listed above

Relevant Articles:

Deere & Co (DE) Dividend Stock Analysis
Can everyone achieve financial independence with Dividend Paying Stocks?
I purchased this dividend machine last week
Multi-Generational Dividend investing
My Retirement Strategy for Tax-Free Income

Monday, July 14, 2014

ConocoPhillips Rewards Long-Term Investors with consistent dividend increases

ConocoPhillips (COP) explores for, develops, and produces crude oil, bitumen, natural gas, liquefied natural gas, and natural gas liquids worldwide. Over the past week, the company’s board of directors approved a 5.80% increase in the quarterly dividend to 73 cents/share. After this increase, this dividend achiever has managed to boost cash payouts to its patient long-term investors for a cool 14 years in a row. This was the second dividend increase after the spin-off of Phillips66. The first increase was by 4.50%  to 69 cents/share in 2013.

When I last analyzed ConocoPhillips, I really liked what I saw. I have been adding to the stock for the past two years. I really like the fact that the company trying to deliver value to shareholders by focusing on projects with the best potential for return on capital, in order to deliver an annual growth in production between 3 – 5 % per year. As a result of the company’s ongoing portfolio optimization and effort to increase returns on capital, the company has been able to deliver results to shareholders. One of the company’s stated objectives of delivering a return to shareholders has been through regular dividend increases.

In fact, after the dividend increase was announced, the company’s CEO was quoted in the press release, stating that “A compelling dividend remains a top priority for our company and reflects our commitment to deliver competitive shareholder returns”.

One of the biggest misconceptions about ConocoPhillips is that the company didn't increase dividends in 2012. To the inexperienced investor, who doesn't dig deeper into the data, it looks like the company maintained the dividend at 66 cents/share between 2011 and 2013. The reality is that the dividend investor from early 2012 owned one share of COP that paid them 66 cents/share. This dividend investor received half a share of Phillips 66 (PSX) in the middle of 2012, after the company was spun off, that paid them 20 cents/share initially. In addition, they still held on to their original share of ConocoPhillips, which paid 66 cents/share. So as a result, the investor was left with a share of the new ConocoPhillips (COP), and the half share in Phillips 66 (PSX). The new ConocoPhillips company owned only the exploration and production portion of the old ConocoPhillips, but it still paid the same dividend amount as if it was the larger predecessor company. The first quarter after the spin-off, the shareholder received 66 cents from ConocoPhillips shares and 10 cents from their half share of Phillips 66. Subsequently, Phillips 66 dividend has been increased to 50 cents/share. Phillips 66 ended up with the Refining and Marketing assets from the original ConocoPhillips company from pre-2012. Those include Refineries in the US, as well as pipelines and terminals across the US. Contrary to popular opinion, the gas stations that you see in the US, that have the name ConocoPhillips or Phillips 66 are not owned by either company. Those have been sold out almost a decade ago, in an effort for the legacy ConocoPhillips to focus on its core competencies.

This is why you need to hold on to your spin-offs, and not sell them. Investors who fixate on having a certain number of companies in their portfolios might end up selling companies like Phillips 66, because they are arguing that they have too many companies in their portfolios to monitor. In my experience, selling a spin-off is usually a mistake. My experience includes Phillip Morris separating into Altria (MO), Phillip Morris International (PM) and Kraft, and the subsequent split of Kraft into Mondelez (MDLZ) and Kraft (KRFT). It also includes the split of Abbott into Abbott (ABT) and Abbvie (ABBV). I hold on to those positions, because the research I have read indicates that this has been the smart thing to do in the past. I initiated a position in ConocoPhillips after the spin-off however, which is why I don't own any Phillips 66.

I believe that this is a great company to buy and then hold on for many decades, while receiving higher dividends over time, that eventually surpass the cost basis of the stock.Unfortunately, I believe that shares have gone up quicker than I anticipated. Depending on other opportunities available for my capital, I would not be opposed to further building out my position in ConocoPhillips. It would be nice if I can add to my position at a starter yield of 4% or forward P/E of around 11.

What is your opinion on the company and the shares?

Full disclosure: Long COP, MO, PM, KRFT, MDLZ, ABBV, ABT

Relevant Articles:

Four Practical Dividend Ideas for my SEP IRA
ConocoPhillips (COP) Dividend Stock Analysis 2014
Why Investors Should Look Beyond Typical Dividend Growth Screens
How to Generate Energy Dividends Despite the Peak Oil Nonsense
Six Slow & Steady Dividend Achievers Boosting Distributions

Friday, July 11, 2014

Deere & Co (DE) Dividend Stock Analysis

Deere & Company (DE), together with its subsidiaries, manufactures and distributes agriculture and turf, and construction and forestry equipment worldwide. The company is a dividend achiever that has paid dividends since 1937 and managed to increase them for 11 years in a row. The company’s peer group includes CNH Industrial (CNHI), Caterpillar (CAT) and AGCO Corp (AGCO)

The company’s latest dividend increase was announced in May 2014 when the Board of Directors approved a 17.60% increase in the quarterly dividend to 60 cents /share. "Deere is well-positioned to benefit long-term from global trends that hold great promise for the company's customers and investors," said Samuel R. Allen, chairman and chief executive officer. "Our dividend increase reflects our confidence in Deere & Company's ability to generate strong cash flow throughout the cycle. We remain committed to our plans for profitable growth and for returning cash to shareholders."

Over the past decade this dividend growth stock has delivered an annualized total return of 12.10% to its shareholders.

The company has managed to deliver a 21.30% average increase in annual EPS over the past decade. Deere is expected to earn $8.55 per share in 2014 and $7.73 per share in 2015. In comparison, the company earned $9.09/share in 2013.

Deere also has an impressive record of consistent share repurchases. Between 2004 and 2014, the number of shares declined from 506 million to 379 million.

I have been biased against Deere, because it looks like a cyclical company, which managed to get lucky and ride a profitable trend over the past decade. As most of you are aware of, the past 10 – 15 years have been characterized by the rapid growth in emerging economies, which has lifted the boats of a lot of other companies. I am afraid that Deere might keep capitalizing on the those emerging markets, but at some point in time, it would have to go back to being a cyclical company with cyclical earnings. This could be a decade down the road, or could occur within the next few years. As a dividend growth investor, my goal is not only to find a cheap stock with a good dividend, but also a company that can grow earnings over time. If earnings per share are not increased over the next decade, most of dividend growth will come from increases in the dividend payout ratio, which is seldom a good sign for dividend income stability. I simply do not view Deere as the type of set it and forget it dividend growth stock that I can pass on to my heirs. That being said, it could still be a profitable investment for someone who buys today, given the low valuation, even if earnings do not increase by much. That would be true, as long as earnings per share do not decrease.

Long-term prospects could be brighter than I imagine however. An increasing world population should continue to exert pressure on food supplies, which in effect could raise the demand for new efficient farm machinery. However, if commodity pricing pressures farmer’s profits, demand for equipment could soften.

New products could be another boost for farming equipment, as is a cycle to upgrade old equipment over time, in an effort to boost productivity. The company has strong position in North America, with an established brand name and a 50% market share, which should provide it with a good scale of operations.
I also like the fact that management seems very shareholder friendly, as evidenced by their commitment to dividend growth over the past 20 years, the consistent share buybacks, and the fact that operations are run pretty well. For example, the finance division has pretty low loan losses, which is encouraging and shows that proper credit evaluation is being done before lending money to farmers.

I also like the fact that the largest shareholders is Cascade Investments LLC, which is the holding company that holds the investment portfolio of Bill Gates. I have been reading some about Bill Gates, and have found that his holding company is managed by Michael Larson, who is a very successful value investor.

The annual dividend payment has increased by 16.30% per year over the past decade, which is lower than the growth in EPS.

A 16% growth in distributions translates into the dividend payment doubling every seven years on average. If we check the dividend history, going as far back as 1989, we could see that Deere has actually managed to double dividends every eight years on average. What makes this analysis tricky however the fact that the company cut dividends in 1982 is, and the annual dividend didn’t exceed the 1982 highs till 1990. The annual dividend from 1982 didn’t really double until 2005.

Over the past decade, the dividend payout ratio has mostly remained low below 25%, with the exception of 2009. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Deere has managed to increase return on equity from 30.60% in 2004 to 41.30% in 2013. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.

Currently, the stock looks cheap, as it trades at a forward P/E of 10.40 and a current yield of 2.60%. I believe that the business is more exposed to economic cycles than the typical dividend growth stock that I usually focus on. However, when a business is cheap, it can still generate shareholder value even if there is only a small improvement. With Deere, the $8 billion share buyback could be one catalyst that could result in better returns going forward. As a result, I initiated a small position in the stock this week.

Full Disclosure: Long DE

Relevant Articles:

Dividend Stocks Offering Positive Feedback to Investors
Caterpillar (CAT) Dividend Stock Analysis
Look beyond P/E ratios dividend investors
Return on Investment with Dividend Stocks
Price is what you pay, value is what you get

Wednesday, July 9, 2014

Look abroad for higher dividend yields

US stocks these days are offering much lower yields than the rest of the world. For example, S&P 500 yields less than 2%, while UK stock indices are yielding more than that. Given the fact that foreign companies are paying more generous dividends that US ones, should dividend investors venture abroad?

Before investors decide to invest in foreign stocks, they need to understand the risks and peculiar characteristics of foreign dividend paying stocks.

In general, most foreign dividend paying companies pay fluctuating dividends each year. Foreign companies are quick to cut dividends if earnings fall even by a small amount, since they target a particular dividend payout ratio, rather than a particular level of dividend payments. US investors who are used to the stability of dividend payments that most American firms exhibit might be disappointed by this feature. Fluctuating dividends make it particularly difficult to live off your investments, and as a result it is best that these companies are avoided.

Adding to the injury, most foreign companies tend to distribute cash to shareholders once or twice per year at best. Many multinationals such as Nestle (NSRGY) for example pay distributions once per year. As a result, investors who like to reinvest dividends have only one instance/year to compound their profits. As a dividend investor, I have found that having the ability to reinvest the same annual dividend in four quarterly installments allows for faster compounding than having the dividend compound just once per year. For the companies that pay dividends twice annually, they tend to split distributions into interim and final payments. The interim payments typically represent 40% of the total annual dividend, while the final payment represents 60% of the total annual dividend. As a result, many US services such as Yahoo!Finance, routinely miscalculate the dividend yields of companies such as UK based company Diageo (DEO), or Vodafone (VOD).

Another factor to consider before purchasing foreign shares is taxes. Many countries such as Canada, France, Switzerland and Netherlands, to name a few, impose taxes on dividends paid out to US investors. These taxes are typically around 15% for Canadian stocks held by US investors for example. While US investors can claim a credit for any taxes withheld at a foreign source in taxable accounts, they cannot do that in tax-deffered ones such as ROTH IRA’s. In addition, some foreign companies such as Unilever have dual class shares with similar rights that trade both in London and Amsterdam. Purchasing the Netherland based ADRs for Unilever N.V. (UN) could lead to tax withholdings, whereas purchasing the United Kingdom based ADR’s for Unilever PLC (UL) could pose no such problems. US dividend taxes would still be due of course, but there is less paperwork trying to claim foreign taxes withheld on dividends.

Another factor to consider includes transaction costs. Many US investors tend to purchase American Depositary Receipts (ADRs) on foreign listed shares. As a result, they end up paying US capital gains taxes and US commissions. If you dare to venture abroad however, you would have to deal with finding the right broker, paying taxes abroad and paying commissions which are probably much higher than the ones in USA.

In general, many foreign companies also report results under IFRS, which is a different accounting standard than the US GAAP. Other factors to consider include the fact that many foreign companies listed in the US are typically global businesses, and therefore would trade similarly with their US competitors. In other words, during the financial crisis of 2007 – 2009, many stocks lost almost half of their values. As a result, venturing out abroad might not have delivered the diversification benefits that international investing is supposed to deliver. However, by expanding the time-frame to look at performance of foreign shares before and after the crisis, one could note a few differences. Because of the global nature of business these days, I avoid international over diversification by purchasing shares of US based multinationals.

There are a few lists with dividend growth stocks, which could aid investors in their search for dividend paying companies with dependable and rising distributions. These include the international dividend achievers index, which lists companies traded in US, which have boosted distributions for at least 5 years in a row. Another interesting benchmark is the Europe Dividend Aristocrats index, which lists European companies which have raised distributions for over 10 years in a row.

Some foreign companies that fit in this criteria include:

Diageo (DEO), which produces, distills, brews, bottles, packages, and distributes spirits, beer, wine, and ready to drink beverages. The company has managed to increase dividends for at least 15 years in a row. Currently, the stock is selling for 19.70 times forward earnings and yields 2.70%. Check my analysis of Diageo.

Nestle (NSRGY), which provides nutrition, health, and wellness products worldwide. The company has managed to increase dividends for 18 years in a row. Currently, the stock is selling for 18.60 times forward earnings and yields 3.10%. Check my analysis of Nestle.

Novartis (NVS), which is a multinational company specializing in the research, development, manufacturing and marketing of a range of healthcare products led by pharmaceuticals. The company has managed to increase dividends for 17 years in a row. Currently, the stock is selling for 17.50 times forward earnings and yields 3%. Check my analysis of Novartis.

Unilever (UL), which is a consumer goods company operating in Asia, Africa, the Middle East, Turkey, Russia, Ukraine, Belarus, Europe, and the Americas. The company has managed to increase dividends for at least 19 years in a row. Currently, the stock is selling for 20.20 times forward earnings and yields 3.50%. Check my analysis of Unilever.

BHP Billiton (BBL), which operates as a diversified natural resources company worldwide. The company has managed to increase dividends 15 years in a row. Currently, the stock is selling for 16.80 times forward earnings and yields 3.50%. Check my analysis of BHP Billiton.

Those companies are a little pricey today, but are good long-term holdings for long-term investors. If prices decrease from here, it would be nice to have those company on a watchlist.

Full Disclosure: Long NSRGY, UL, VOD and DEO

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