Monday, October 15, 2018

Your favorite businesses are on sale

Last week, there was a correction in the stock market. For some reason, be it higher interest rates, trade wars, or fears of future inflation, stock prices went down. Your guess as to why this happened is as good as mine. The reason why this happened is not required to be a successful investor however.

As a dividend growth investor, I see myself as a part owner of a business. As a result, my focus is on acquiring shares in those businesses at attractive valuations. I could not care less about stock price fluctuations, other than as an opportunity to acquire more ownership in the world’s best run businesses at attractive valuations.

I focus on dividends, because dividends are more stable and more predictable than share prices. I focus on companies that can generate stable earnings and reliable dividend payments. Only a select few companies have even managed to grow dividends for more than a decade. A long streak of consecutive dividend increases is one of my filters to search for quality. A strong balance sheet, and the ability to generate strong recurring cashflows is the secret sauce that allows long track records of annual dividend growth to occur. I focus on the companies that can grow earnings per share, reinvest a portion to grow the business, and send any excess cash flows to shareholders in the form of dividends. I want those businesses at good entry prices however.

The next step in the process is evaluating the fundamentals of these businesses. As I mentioned in my article on how I analyze dividend stocks, this involves looking for growing earnings to support the future dividend growth. Evaluating the safety of those dividend payments is paramount.

Since dividends are a direct link with the fundamental health of the business, they are a form of return that is usually more stable and reliable than capital gains. Share prices on the other hand are derived from the collective expectations of stock market participants. Sometimes they are overly excited about the prospect of a business, and are willing to pay a high multiple for every dollar of earnings. Other times, these participants are gloomy, and not willing to pay even a bargain price for these earnings. Stock prices are driven by the madness of the participants with short-term expectations. As investors, our goal is to capitalize on those who set prices in the short run, and buy our future retirement income on sale. Our goal is to select the best businesses in the world, and buy them at attractive valuations. Our job after that is to monitor our holdings, and sit tight, as we are showered with a rising stream of dividends over time.

Since my focus is to grow my dividend income over time, I can focus on the dividend income, its safety and its potential for future growth. I could not care less if stock prices go up or down in the short-run.

As a result of the decline in the past week, I am seeing several companies I am monitoring for my dividend growth portfolio newsletter become attractively valued today. I will share the selections I am making on October 28 with premium subscribers. If further weakness continues, the list of potential additions to the portfolio will increase. That is great news, because I like to build out diversified dividend portfolios, in order to ensure that I generate a retirement stream of income that is defensible and can grow above the rate of inflation.

For example, Johnson & Johnson (JNJ) is selling at $133/share today, versus $142.88 at the highs last month and $148/share in January. The company is still expected to earn $8.15/share, yet participants valued the shares at different multiples. The company is still expected to pay $3.60/share in dividends.

In another example, 3M (MMM) is selling at less than $198/share today, versus $216 in September and $260 in January. At the same time the stock is attractively valued today using forward earnings at $10.29/share. 3M is expected to pay $5.44/share in dividends.

During the financial crisis, Johnson & Johnson’s share price fell from a high of $72.76/share in September 2008 to a low of $46.25/share in March 2009. At the same time, earnings per share went up from $3.63/share in 2007 to $4.57/share in 2008. Johnson & Johnson earned $4.40/share in 2009. The company’s dividend payments between 2007 and 2009 were $1.62/share in 2007, $1.80/share in 2008 and $1.93/share in 2009. Investors owning JNJ shares who focused on the growing stream of dividends could have been able to ignore the fact that share prices are volatile. They could do this, because the company they invested in had solid fundamentals, and the dividend was well covered and poised to grow. The diversified portfolio of businesses under the Johnson & Johnson umbrella represented products that consumers use on an everyday basis, which meant that the demand will not decrease as much during a recession. Those with cash to invest, would have been ecstatic to buy ownership interests in a world class business such as Johnson & Johnson below $50/share, rather than pay over $72/share for the same shares.

It is very likely that at some point, we will be entering a bear market. Investors in the accumulating phase should be looking forward to bear markets, because they will be able to buy shares in their favorite businesses at better entry valuations. This would mean that shares on other world class businesses such as Visa (V) and Starbucks (SBUX) will be available for sale at less than 20 times earnings.

To summarize, lower entry prices should be welcomed by dividend investors in the accumulation phase. As a result of lower prices, they can purchase future dividend income at a discount. Investors in the retirement phase should ignore stock price volatility, and should focus on dividend income, which is more stable, reliable and predictable than share prices. When you are paid for owning shares, holding those shares through the ups and downs of the economic cycle is much easier. Either way, the most important thing is to stick to your dividend portfolio through thick or thin. The consistency of dividend payments makes it easier to stick to your portfolio, and add to it, even when share prices are tanking. The investor with a clear strategy to pursue dividend paying equities, will continue following their plan, and invest money regularly in the best values at the moment. This consistency and long-term focus is the secret sauce that will help them succeed and reach their long-term goals.

Relevant Articles:

What are my dividend portfolio holdings?
Introducing Dividend Growth Investor Newsletter
How to value dividend stocks
How to read my stock analysis reports

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