Monday, April 6, 2015

My Favorite Exercise With Dividend Paying Stocks

I love dividend growth investing. I find it amazing that for the price of exchanging my labor for money at my job, and then identifying at least 40 or so dividend paying stocks, I will get paid dividends for decades in the future. This means that in 2044, I will be receiving income because of a decision I had made over 30 years prior to that point.

The reason behind this love for dividend investing is the fact that I like to build things, let them grow, and achieve my desired set of goals and objectives. I know that many investors choose not to do dividend investing, because they lack the patience to sit tight and earn a 3% - 4% yield in a current year. They would much rather trade actively, than wait for the power of compounding to quietly help them achieve their goals over time. On aggregate, those who actively trade end up much worse off than a simple investment in Certificate of Deposit or Treasury Bonds.

Many of those investors tend to criticize the fact that in the initial stages, anyone who puts say $1000, would not earn more than $30 - $40/year in dividend income. Where most others see nothing of interest, but only boredom that is not worth it, I see opportunity. I view each stock in my portfolio as an income generating asset that pays me to hold it, as it transforms capital, know-how, and human ingenuity into products or services that it sells to customers around the world for a healthy profit. Over time, businesses become smarter about processes, and how to do things more efficiently in order to maximize earnings. The people who work in those businesses make decisions every day, so that my interest in the business can generate profits and pay for my dividends. In essence, by being a dividend capitalist, you are having your money work hard for you, so that you don’t have to.

I view each of those dividends as dollars I didn’t need to physically work for. In other words, if you make $20/hour (average wage in the US), for every $20 in annual dividend income you receive, you can afford to work one hour less per year. Of course, this is an oversimplification, because a dollar of dividend income is worth more than a dollar of salary income, because dividends are a more tax efficient form of income. In addition, a dollar of dividend income does not require much time commitment from the dividend investor.  Over time, as more income generating assets are added to the portfolio, and dividends grow and are reinvested, the power of compounding eventually reaches a precipitation point in the dividend crossover point. Therefore, one should never despise the days of small beginnings. They should rather start their financial independence journey as early as possible, in order to benefit from the power of compounding to the maximum point.

I love the fact that if I build an equally weighted portfolio today consisting of 40 companies, and putting $40,000, I have a chance of generating over $38,000 in annual dividend income in 40 years. The money generated by the portfolio will be enough to cover the amount invested almost every year. This exercise assumes a 3% starting dividend yield and annual dividend growth of 6%/year.

The cash I earn from the portfolio is also essentially reducing the amount of capital I have at risk. For example, if I invest $1000 in Coca-Cola today, I can reasonably assume that I will receive about $30 - $32 in annual dividend income. If the dividend increases by 7%/year, this means that dividends will double every decade. This means that in 17 years, I would have received dividends equivalent to my entire investment, and I would also still be holding on to the original cash generating asset. Most importantly, over time, the quiet power of compounding would lift the amount of earnings, dividends and values of the average business that I invest in.

I know that of the 40 companies I purchase today, not all will be there in 2044 or 2054. Contrary to popular beliefs however, I expect that only a small percentage of those companies to fail outright. Many will end up merging with competitors, get acquired, change names or do spin-offs. Some will do just fine, while a small number will probably end up delivering outstanding returns to the portfolio, both in terms of dividends and capital gains. As a result, the goal is to do nothing but sit on that portfolio, and reinvest dividends when received in the best values available at the moment. It is important to avoid the temptation of selling

Since most investors I know do not have a lump sum just sitting there, waiting to be invested, the best course of action would be to start dollar cost averaging their way every month. If one gets into the habit of saving as much as possible, and then putting that capital in a broadly diversified portfolio of blue chip dividend stocks, reinvests dividends, and allows themselves a 20 – 25 years’ time horizon, they should do pretty well for themselves over time. This strategy worked even for those who were unlucky to start investing in US companies right before The Great Depression started. I view every $1000 that I save, I can essentially buy more time, and more freedom, that makes me get closer to my dividend crossover point. I love setting cash machines up, and then reinvesting dividends for decades to come.

As a result of all this, I have ended up with several brokerage accounts. I love starting a brokerage account from scratch, and then putting as much as I can save that month into it. The start is always slow, and usually the first dividend checks do not appear for one to three months at first. In addition, they could be anywhere from a few cents to a few dollars. As I keep putting more money to work however, as companies I own increase dividends, and I keep reinvesting those dividends into more shares, the total dividend income starts to reach pretty nice figures. It is absolutely exhilarating to watch the fruits of your regular investing efforts materialize. Once the portfolio achieves critical mass of $100,000 invested, I stop adding more money to it, and move onto my next portfolio building. I merely let the power of compounding do its heavy lifting over the next 30 years, while also remaining under the SIPC insured limits of $500,000 per account, that prevent me from partial loss of capital in case of broker failures.

In order to build wealth, it is important to focus on the big picture. We spend so much time in the present, that we sometimes get to forget that dividend investing is about putting money today, and leaving it uninterrupted for 25 years or so. In other words, the worries of today represent minor fluctuations relative to where things could be in 25 years. Focusing on noise today could prevent the investor from benefiting from the long-term power of compounding, which is what would truly bring success to the patient investor. Remember, time in the market is more important than timing the market.

I am often hearing even today that the stock market is about to crash, so people should wait on the sidelines and accumulate cash. I vehemently disagree with this - it is far better to have the discipline to put some money to work every month, like clockwork, and let that capital compound for 25- 30 years. In 25 - 30 years, it would not matter whether you purchased shares at the high or the low for the year. Even the 1987 stock market crash looks like a minor blip when taken in perspective.

A few companies available at fairly attractive valuations today include:

3M Company (MMM) operates as a diversified technology company worldwide. This dividend king has raised distributions for 57 years in a row. In the past decade, 3M has managed to boost dividends by 9%/year. The stock currently sells for 20 times forward earnings and yields 2.50%. Check my analysis of 3M company for more information about the company.

The Chubb Corporation (CB), through its subsidiaries, provides property and casualty insurance to businesses and individuals. This dividend champion has raised distributions for 33 years in a row. In the past decade, Chubb has managed to boost dividends by 9.80%/year. The stock currently sells for 13.20 times forward earnings and yields 2.30%. Check my analysis of Chubb for more information about the company..

Eaton Vance Corp. (EV), through its subsidiaries, engages in the creation, marketing, and management of investment funds in the United States. This dividend champion has raised distributions for 34 years in a row. In the past decade, Eaton Vance has managed to boost dividends by 12.70%/year. The stock currently sells for 16.90 times forward earnings and yields 2.40%. Check my analysis of Eaton Vance for more information about the company.

Altria Group, Inc. (MO), through its subsidiaries, manufactures and sells cigarettes, smokeless products, and wine in the United States and internationally. This dividend champion has raised distributions for 45 years in a row. In the past decade, Altria has managed to boost dividends by 11.60%/year. The stock currently sells for 18.30 times forward earnings and yields 4.10%. Check my analysis of Altria information about the company.

T. Rowe Price Group, Inc. (TROW) is a publicly owned asset management holding company. This dividend champion has raised distributions for 29 years in a row. In the past decade, T. Rowe Price has managed to boost dividends by 16.60%/year. The stock currently sells for 16.90 times forward earnings and yields 2.50%. Check my analysis of T. Rowe Price for more information about the company.

Johnson & Johnson (JNJ), together with its subsidiaries, researches and develops, manufactures, and sells various products in the health care field worldwide. This dividend king has raised distributions for 52 years in a row. In the past decade, Johnson & Johnson has managed to boost dividends by 9.70%/year. The stock currently sells for 16.90 times forward earnings and yields 2.80 %. Check my analysis of Johnson & Johnson for more information about the company.

Genuine Parts Company (GPC) distributes automotive replacement parts, industrial replacement parts, office products, and electrical/electronic materials in the United States, Canada, Mexico, Australia, New Zealand, Puerto Rico, the Dominican Republic, and the Caribbean region. This dividend king has raised distributions for 59 years in a row. In the past decade, Genuine Parts Company has managed to boost dividends by 6.80%/year. The stock currently sells for 19.20 times forward earnings and yields 2.70%. Check my analysis of Genuine Parts Company for more information about the company.

W.W. Grainger, Inc. (GWW) operates as a distributor of maintenance, repair, and operating (MRO) supplies; and other related products and services that are used by businesses and institutions primarily in the United States and Canada. This dividend champion has raised distributions for 43 years in a row. In the past decade, W.W. Grainger has managed to boost dividends by 18.20%/year. The stock currently sells for 17.80 times forward earnings and yields 1.90%. Check my analysis of W.W. Grainger for more information about the company.

United Technologies Corporation (UTX) provides technology products and services to building systems and aerospace industries worldwide. This dividend achiever has raised distributions for 22 years in a row. In the past decade, United Technologies has managed to boost dividends by 12.90%/year. The stock currently sells for 16.80 times forward earnings and yields 2.20%. Check my analysis of United Technologies for more information.

Full Disclosure: Long all companies listed above

Relevant Articles:

How to define risk in dividend paying stocks?
Stress Testing Your Dividend Portfolio
Time in the market is more important than timing the market
Common Misconceptions about Dividend Growth Investing
Warren Buffet’s Favorite Exercise


  1. As US income continues to drop with corporate America paying low-cost immigrant wages, the only financial success our children will have is a sound investment plan. I completely agree with DGI's strategy so both of my teenagers have Roth IRAs which currently generate dividends of $50/month. With continued contributions and reinvested dividends, they will have an opportunity to retire early. Most others will forfeit their retirement future by failing to choose the slow-and-steady path.

    1. I don't know, a new path to legal immigration could actually lead to growth in economic activity and therefore earnings for companies I own ;-) I would be happier if more people eat, shop, drink etc - more dividends for everyone.

      As for Roth IRA for kids - that is something that unfortunately only a tiny minority do for their kids. Imagine the tax-free compounding for decades on $5,500/year placed in a Roth between the ages of 15 - 18.

  2. "Remember, time in the market is more important than timing the market." -- I am making the [we are not worthy] bow in your direction.

    1. Ha, I didn't come up with that. I just try to stand on the shoulders of giants and use their knowledge for my advantage

  3. "I love the fact that if I build an equally weighted portfolio today consisting of 40 companies, and putting $40,000, I have a chance of generating over $38,000 in annual dividend income in 40 years. The money generated by the portfolio will be enough to cover the amount invested almost every year. This exercise assumes a 3% starting dividend yield and annual dividend growth of 6%/year."

    Hello Sir,
    Can you please let me know the calculation details behind the above. I am in my early 40's. Started Drip accounts using Computershare, amstock and
    I am trying to find out what it takes to get this $38,000 by the time I am 62.

    I would appreciate some kind of direction to get me this information. I will then do my own calculation.


    1. Hi Sairam,

      You might want to check this file. I think you can download it directly, but if not, please send me an email and I will forward it to you.

      Best Regards,


    2. The file views with the monthly dividends truncated to two decimal places, but opening it with Google docs allows you to expand and see the actual values. Very nice.

      Did you compile a spreadsheet without dividends reinvested? I calculate a monthly income of $970 for the 40,000 shares, so reinvesting dividends brings in an additional $2220 per month. Really nice if you can let the dividends compound for 4 decades. So, my daughters need to get into the stock market right now. :)

  4. Another excellent article. I agree with you on looking back 30 years at how dividends compound into a nice steady income, but I often look further and consider myself setting up a dynasty for generations to come. Real wealth takes generations to develop but it all starts with one person.

    1. That would be awesome! Things could change a lot after our lifetimes however, in many ways unimaginable to us today. You might like this article:

  5. Not only will the dividend income produce cash for you to live on in 30 years, but it will allow you to purchase even more shares of dividend growth stocks between years 0-30! Cash flow produced by dividend stocks is much better than cash itself!

    1. I know right? The money I invested will generate more money, which is reinvested and further grows my dividend growth machine. The power of compounding is truly amazing!

  6. Also I couldn't get the math on the $38,000 also.. I must be missing the reinvestment?

  7. Great article! Sairam, don't forget you also don't have to DRIP. Sometimes, to avoid automatically paying for overvalued stocks, you are better to accumulate cash and deploy it on stocks that meet the entry criteria that you are comfortable with. Happy investing!

  8. This is one of the biggest misunderstanding as far as dividend investing goes - that at the beginning you receive some 3% and that is boring and not worth it. Well, actually in today's zero interest environment, you won't get anything better anywhere else, so this claim is no longer valid either and it is actually a stupid one from the naysayers. But many people fail to see the growth of the dividend behind as well as the fact that the stock itself tends to grow at the same pace as the dividend growth. That's why when looking at the data of a stock you will see the yield at 3% even 5 years later but that's because the stock appreciated. So you get appreciation, dividend, dividend growth... what else you would ask for? A great example of this is JNJ I like to use. When I purchased the stock approx. 4 years ago, the yield was slightly above 3% (I think it was 3.2%). Today the yield is 2.6%. If you look at the numbers only you may say what a slack! But JNJ was trading at $58 back then and now $108 and thanks to dividend growth my original investment is already paying me a little over 4% in lieu the initial 3.2% yield! People chasing growth only are actually blind and do not see treasure in front of them.

  9. How can you recommend MMM at 20x forward earnings? Way too expensive my friend.

  10. Nothing on this site is a personal recommendation for you or anyone else to buy or sell anything.

    1. Fair enough. Let me ask in a different way. you are saying that MMM is fairly valued at 20x so will be great if you can explain why. A great company and growing div but capital appreciation is part of your TR So at 20x it doesn't look very compelling.

    2. The answer to your question depends on answering those three questions for yourself.

      - What is my opportunity cost?
      - What is my timeframe?
      - Would I rather buy a quality company at a fair price or a mediocre company at a steal price?

      If you have any further questions on overall philosophy, please be sure to check the archives:

  11. Nice write up! Always a big fan of your work. I have a question I hope isn't too off topic regarding your many brokerage accounts you mentioned in this post. I bought some BNS in my sharebuilder roth IRA account and right after buying I dug in a little deeper and saw an older article you wrote where you had problems with them taking out the withholding tax when they're not suppose to. I've learned my lesson to ask the brokerage first, but I'm interested in transferring that roth ira and was wondering if you've had any luck finding an alternative brokerage that doesn't withhold those taxes? Best wishes and thanks for all the content you provide.


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

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