Thursday, July 30, 2020

What if taxes increase?

When I invest in a taxable account, I have to pay taxes on any ordinary and qualified dividends I receive over the course of an year. While I am a buy and hold investor, I also have the occasional capital gain or loss. Naturally, I expect to receive a net capital gain when companies get acquired or perhaps a smaller gain when they cut dividends.

Taxes reduce the amount I can re-invest back into my portfolio. I view these investment taxes as waste in the accumulation process.

I made the capital for my investments through labor. I pay taxes on the income I generate through employment, which further reduces the amounts I can invest every month.

As part of my investment plan, I try to prioritize investing through tax-deferred accounts first, before adding to taxable accounts.

I do this in order to minimize the tax bite on dividends and capital gains in the accumulation phase, which can amount to a substantial amount. I also do this in an effort to reduce the amount of taxes I pay upfront, and compound my dividend income and capital without tax waste for decades down the road.

When I reduce the amount of taxes I pay today, I have more money to invest. I achieve that due to the tax breaks I have up-front from some accounts such as regular 401 (k), H SA and SEP IRA. I also have more money to invest, since a larger portion of my investment income is now in tax-sheltered accounts. For regular IRA/401 (k) accounts tax may either be due at some point in 30 – 40 years. For others like my Roth IRA/Roth 401(k), I will never have to pay tax on the distributions.
You can read a brief overview of each account in this article. You may also find it helpful to read about ways to withdraw from retirement accounts prior to the age of 59 1/2.

I have discussed previously how utilizing tax-deferred accounts correctly can result in higher dividend incomes for the same levels of effort. This simple change can shorten your financial independence journey by shaving off years of extra effort toiling away at a thankless job for no other benefit than to pay more taxes. If you enjoy working, tax advantaged accounts help shelter a ton in taxes in the accumulation process, when you are in a higher tax bracket than when you retire.

I view investing through tax-deferred accounts as a natural hedge against rising rates on income.
When you are investing in a taxable account, you have to pay the going tax rate on dividends and capital gains. You will likely have to pay money every single year. Under the current administration it is possible to avoid paying taxes if you earn $100,000 in qualified dividend income and have no other income source. However, it would take you many years of paying a lot in taxes on income and investments before reaching this goal. Naturally, you will be having less dollars working for you, since you will be paying the tax man every year.

If you invest through a tax-deferred account, you get to defer paying taxes on dividends and capital gains. Roth IRA’s are funded with after-tax dollars, but you will not have to pay taxes on withdrawals. This means that you paid your Federal and State taxes first, and then used that after-tax money to start your Roth IRA. This concept is the same for Roth IRA, Roth 401 (K) accounts as well, even if their contribution limits vary. Typically, you can withdraw contributions after 5 years, but you can only withdraw gains penalty-free after the age of 59 ½. There are required minimum distributions for Roth 401 (k) accounts at the age of 72, but not for Roth IRA accounts. Withdrawals are not taxable. In order to avoid required minimum distributions on Roth 401 (k) accounts, an investor can simply rollover that Roth 401 (k) into a Roth IRA. There may be other considerations involved, like asset protection, so it may make sense to speak to a tax professional first.

Regular IRA’s are funded with before-tax dollars, meaning that you get to avoid paying a tax at the Federal and State level when you contribute to these accounts. The concept is the same for Regular/SEP IRA’s, Regular 401 (k)/457b/403(a) plans, even if the contribution limits for each account varies. As a result of this tax hack, you get more money to invest today, since you are reducing your taxable amount due to your retirement plan contribution. When you withdraw principal and earnings from the account, they are all taxable at your ordinary income tax rate. It is not a problem for most folks however, since people tend to be at higher tax brackets when they work, and in lower tax brackets when they retire.

Other benefits of before-tax accounts include reducing your taxable income, which may potentially qualify you for different credits or benefits such as ACA credits. If maxing out your 401 (k) put you in a lower taxable income, and you became eligible for the 2020 economic relief payments, that was an ROI that was unexpected, but still a plus for maxing out your retirement contributions.

The government does want you to start taking money out of these retirement accounts by the time you are 72, because they want you to start paying taxes and not just defer paying forever. There are ways to avoid taking distributions however. My popular one is that if you are still working at a company that you own no more than 5% in, your 401 (k) at this company does not need to start required minimum distributions. I am sure that there are other loopholes to defer distributions from an IRA or 401 (k), but you would likely have to hire an expensive CPA for it.

The nice thing about retirement accounts is that you get to defer or avoid paying taxes in the crucial accumulation phase. This may also simplify your life if you actively manage your investments too.
As I mentioned above, when people work, they are usually in a higher tax bracket than when they retire.

As a result, putting money in regular IRA/401 (k) accounts is better than using the Roth option, due to this tax arbitrage nature of things. The risk you face with regular accounts is that the tax rates will be much higher when you withdraw the money, even if you are in a lower tax bracket.

With Roth accounts, you are essentially locking in the money at your going tax rate. If you end up moving up in your career, you would likely be better off starting with a Roth and then evaluating if a Regular IRA is better for you. The risk you take with Roth IRA’s is that tax rates would go lower by the time you retire, which means that you would have ended up with less money than ideal.
I believe that contributing to Roth IRA’s or Roth 401 (k) is best if you are a in lower tax bracket today, and effectively want to lock that rate in. Another reason for contributing to a Roth over a Regular account is if you cannot contribute to a regular IRA.

I recently shared my ideas with investors, and received some interesting pushback. It looked like some investors prefer taxable accounts to retirement accounts, because they are afraid that tax rates in 20 – 30 – 40 years will be much higher than they are today.

Naturally, no one knows where tax rates will be in the next 30 – 40 years. However, we do know that in general, most folks will be in lower tax brackets in retirement, in comparison to the tax brackets they had when they were working. It is all a moving target of course, since the lowest tax rate in 40 years may turn out to be higher than the highest tax bracket we have today. It could also be that the highest tax rate in 40 years will be about the same as the lowest rate we have today.

I decided to run some scenario analyses, in order to compare and contrast different outcomes. You can download this spreadsheet that includes the calculations behind each scenario.

The first scenario looks at an investor who is in the 22% Federal Tax Bracket today, and is in the 5% State Tax Bracket. The tax on qualified dividends is 15%, and they also owe their friendly state another 5% on dividends. We are going to assume that this investor will generate a total return of 7%/year –5% for capital gains and 2% for dividends. Our investor will save $1,000 in 2020, and have the option of doing a regular taxable account or a regular IRA account. We would assume that our investor would be withdrawing ALL the money in 2060 at the prevailing tax rates. My assumptions are that Federal tax rates in 2060 will be at 40%, the state tax rates will be at 5%, and qualified dividends will be taxed at 15% at the Federal and 5% at the State Level. This is an unfair comparison to tax-deferred accounts, because it assumes that the tax rates on ordinary income double, while taxes on investment income stay flat. We are also deferring at a pretty reasonable tax rate today, but that rate is average. The numbers would look differently for a highly paid physician, lawyer or executive.
It looks like in 2060, the taxable account ends up being worth 12,891.05. After selling all stock, and paying taxes on gains (15% + 5% = 20%), we are left with 10,512.84.

The IRA account is worth 20,512.96 by 2060. If we withdraw the money at once, we pay 40% to the Federal Government and 5% to the state government, and we are left with 11,282.13. The Federal Tax rate would have had to increase to 43.50% for the after-tax return on traditional IRA to be on par with the taxable account.

The reason for the difference is because the taxable account pays taxes on dividends each year, which results in a net return of 6.60%/year, versus 7%/year for the tax-deferred account. This difference would have been more pronounced if dividend yields were higher than 2% too. In addition, by contributing to an IRA in the accumulation phase, we save $369.86 on taxes, which are then plowed back into that IRA.

I had to double check the amount saved on taxes and make sure it makes sense. If we have hit the limits on how much we can put in a tax-deductible IRA, the savings are simply the tax rate times the amount contributed. So the amount saved would be $270 invested in a taxable account.
Because the IRA limits are much higher than $1,000/year, we have at least $5,000 in extra room to contribute. And if you view the traditional 401 (k) as a form of traditional IRA, we have an additional $19,000 to contribute to.

When you receive a tax deduction to contribute to an IRA, and you have extra room left to contribute, you can compound those tax advantages in a way.

That’s because if we just contributed an extra $270 to the IRA from the savings on the $1,000 contribution, we would also generate tax savings on the $270. That’s 72.90 in savings on the $270 extra that we were able to contribute to the IRA, because of tax savings in the first place.
That 72.90 in additional tax savings open up room for 19.68 in additional tax savings… And so on, until we are left with a total savings of $369.86 merely because we contributed to an IRA that is tax-deductible.

Either way, the upfront tax savings, and the deferral of investment gains for 40 years definitely help the traditional IRA investor over the taxable one.

If we had simply placed the money in a Roth IRA however, we would have not generated any upfront tax savings. However, we would have compounded the money at 7% per year, and we would have $14,974.46. Since there are no taxes on withdrawals, we have 14,974.46 to withdraw.

It looks like under this scenario, the Roth IRA beats the traditional IRA and the taxable account on an after-tax return basis. On a gross return basis in 2060, the IRA beats the Roth and taxable accounts.
The increase in taxes definitely makes the traditional IRA a worse option than the Roth in this scenario.

If you could pay less than 27% in taxes on the Traditional IRA distributions, you would have done better than the Roth. That would require forecasting future tax rates, but also knowing the intricacies of the tax code. If it comes down to moving from a state with income tax to a state with no income tax, this may be worth it. Again, a good CPA may be able to find a way to help you keep a larger portion of your wealth. And they may be able to help in planning along the way.

In a real-time scenario however it may be possible to withdraw money strategically, by increasing distributions before taxes rise and reducing them when they are higher. But tackling every individual scenario is beyond the scope of this blog post. You should feel inspired or bored out of your mind so that you think about your tax planning situation, and perhaps even hire a friendly CPA/tax accountant to help you plan ahead and devise a plan to minimize taxes and maximize wealth.

If you could pay less than 27% in taxes on the Traditional IRA distributions, you would have done better than the Roth. That would require forecasting future tax rates, but also knowing the intricacies of the tax code. If it comes down to moving from a state with income tax to a state with no income tax, this may be worth it. Again, a good CPA may be able to find a way to help you keep a larger portion of your wealth from the hands of the tax man.

The second scenario will look at the same inputs as the first one. The difference will be that taxes on dividends will rise to 20% at the Federal Level in 2021 but stay at 5% at the State Level. Taxes on Federal Level will be at 40% and at State Level 5% in 2060. The return assumptions are the same.
It looks like in 2060, the taxable account ends up being worth $12,416.07. After selling all stock, and paying taxes on gains (15% + 5% = 20%), we are left with 9,562.06. We end up compounding money at 6.50%/year, due to higher taxes on dividend income in the accumulation phase.

The IRA account is worth 20,512.96 by 2060. If we withdraw the money at once, we pay 40% to the Federal Government and 5% to the state government, and we are left with 11,282.13. The Federal Tax rate would have had to increase to 48.50% for the after-tax return on traditional IRA to be on par with the taxable account.

The Roth IRA ends up with $14,974.46 to withdraw tax free. It is a clear winner, unless you managed to find a way to obtain the distributions from a Traditional IRA while paying less in taxes. If you could pay less than 27% in taxes on the Traditional IRA distributions, you would have done better than the Roth. That would require forecasting future tax rates, but also knowing the intricacies of the tax code. If it comes down to moving from a state with income tax to a state with no income tax, this may be worth it. Again, a good CPA may be able to find a way to help you keep a larger portion of your wealth.

The third scenario looks at a situation where tax rates are unchanged for 40 years. This means that we get to withdraw the money at the same rates used when we put money in.

It looks like in 2060, the taxable account ends up being worth 12,891.05. After selling all stock, and paying taxes on gains ( 15% + 5% = 20%), we are left with 10,512.84.

The IRA account is worth 20,512.96 by 2060. If we withdraw the money at once, we pay 22% to the Federal Government and 5% to the state government, and we are left with 14,974.46. The after-tax return on the traditional IRA matches that of the Roth IRA in this example.

The fourth scenario looks at a situation where tax rates are lower in 40 years. The rates at which we would be contributing stay the same ( 22% Federal, 5% state, 15% dividends), but the rates at which we withdraw money will be reduced ( 12% Federal, 0% state, 0% dividends).

At this level, the rates of return for taxable and Roth and Regular IRA are at 7%/year. We end up at the same level of worth for the taxable and Roth IRA’s - $14,974.46.

For the Traditional IRA, we end up with 20,512.96 pre-tax. After we withdraw the funds, and pay the 12% tax rate, we are left with $18,051.40.

After reading through these examples, it may seem to you that I am a little biased towards the traditional IRA/ 401 (k). It is likely the case, or perhaps it is wishful thinking on my part that building a higher net worth in a traditional IRA is better from a pure numbers perspective, because it gives you a higher base to work with. It is easier in relative terms to have $1 million in an IRA, and have to worry about paying $200K - $400k in taxes on it, than to have $600K in a taxable account. You will likely find a solution on how to minimize the tax bite on the traditional, and find ways to tap the money in a tax-efficient way too.

In my personal situation, my assets are diversified across traditional 401K and IRA and Roth IRA /Roth 401 (k) accounts. I also have a taxable account. Since there are limitation on how much I can contribute, I maximize everything I am eligible for today. I see various scenarios playing out, so I will do differently under each. My withdrawals will be optimized to the situation at the time of withdrawals.

I try to maximize the traditional 401 (k) and IRA’s first, because I believe that I will be in a lower tax bracket than today when I withdraw these funds. This may be because my income is lower, because taxes are lower or because I may have also moved to a state that doesn’t tax income. Or perhaps a combination of all of the above. I would put H S A in this category as well. I am not going to calculate the effect of using H S A versus other accounts, because it affects social security contributions and income. I am not an actuary so I won’t go there today. You have already been bored sufficiently on this tax tirade.

I then try to max out any Roth amounts. If there is anything left over, I place it in a taxable account.
I would prefer tax-deferred compounding to compounding in taxable accounts.

My goal is to keep building, because I enjoy building my portfolios. I will probably defer withdrawing funds for as long as possible and just live off any active income I generate in the process (and trying to save and invest any remaining amounts too).

Right now, I won’t have to withdraw until the age of 72. I will consider converting regular 401 (k) dollars into Roth 401 (k) or Roth IRA if I ever find myself in the lowest tax brackets along the way.

As you can see, there are various scenarios when it comes to tax-deferred accounts. And we are assuming a typical 40 year career. Imagine how much more complicated the situation gets if we were looking for an early retirement, where we have to withdraw money in our 30s or 40s.

I actually discussed that in a way in a previous post. But the short summary is that you can withdraw Roth IRA/Roth 401 (k) contributions after 5 years. You can withdraw earnings after the age of 59 ½ without penalty.

For Regular IRA/401 (k) plans, the withdrawal options are very different. If you convert a 401 (k) into a Roth, you will pay taxes on the proceeds, but then you can withdraw that money in 5 years tax free. This makes sense if your rate in retirement is lower than the rate at which you were accumulating capital. You also have the 72 t option, which is the Substantially Equal Periodic Payments option, which allows you to withdraw money from retirement accounts according to a longevity formula. You have to do it every year. Finally, for 401 (k) accounts, you can start withdrawals from the 401 (k) account at the company you worked at, if you leave at or after the age of 55.

Today, we looked at a few different scenarios for contributing money to taxable and tax-deferred accounts. We also looked at how those scenarios play out when we change our assumptions just a little bit. I encourage you all to play around with the spreadsheet assumptions, and test various outcomes. I would also encourage all of you to think more about tax planning.

We also revisited various retirement account types in brief, and also discussed ways to withdraw from them early.

We should remember that life is not linear, and we will have occasional bumps on the road. These may be blessings in disguise. For example, a person who is laid off a couple of years before they plan to retire may be able to convert old IRA's into Roth by paying a minimum amount in taxes. Alternatively, a younger person may also be able to Rothify their 401 (k) accounts if they take an year off for graduate school for example, after a few years of working.

There are avarious possiblities and outcomes to think through. This is why I believe that it is important as investors to think through various scenarios, and learn at least a basic understanding of the tax code. That may pay real dividends down the road.

That being said, if you are afraid of taxes rising in the future, hedging that bet by maxing out retirement accounts may be a good start. Investing in a taxable account is an inefficient way to build wealth, particularly in the accumulation phase for dividend investors.

Thank you for reading!

Relevant Articles:

Taxable versus Tax-Deferred Accounts for Dividend Investing
How to buy dividend paying stocks at a 25% discount
How early retirees can withdraw money from tax-deferred accounts such as 401 (k), IRA & HSA
How to Grow Dividend Income Much Faster With Tax Advantaged Accounts

Monday, July 27, 2020

Two Sweet Dividend Increases For Long-Term Shareholders

I review dividend increases as part of my monitoring process. This helps me monitor existing holdings, and uncover companies for future research.

In general, I look for companies that have at least a ten year history of annual dividend increases under their belts. I do sometimes look at companies with shorter track records, but I have to really like the business model. I also rarely have a "full position" in companies with shorter track records.

For the purposes of this review this week, I focused on the two companies which declared a dividend increase last week. A third company, Carlisle (CSL) announced their intention to increase dividends for the 44th year in a row in September. However, they didn't specify the amount of dividend increase, which is why I am not going to review them in detail today. I may in September, if they follow through on their word.

The two sweet dividend increases over the past week include:

The Hershey Company (HSY) manufactures and sells confectionery products. The company operates through two segments, North America; and International and Other.

Hershey delivered a sweeet dividend increase of 4% to 80.40 cents/share. This marked the 11th year of consecutive annual dividend increases for this dividend achiever.

Over the past decade, Hershey has managed to increase dividends at an annualized rate of 9.65%.

Hershey has managed to grow earnings from $2.21/share in 2010 to $5.46/share in 2019.

The company is expected to generate $5.86/share in 2020.

The stock is overvalued at 24.85 times forward earnings. Hershey yields 2.20%.

The J. M. Smucker Company (SJM) manufactures and markets food and beverage products worldwide. It operates in four segments: U.S. Retail Pet Foods, U.S. Retail Coffee, U.S. Retail Consumer Foods, and International and Away From Home.

J.M. Smucker raised its quarterly dividend by 2.30% to 90 cents/share. This marked the 23rd year of consecutive annual dividend increases for this dividend achiever.

Over the past decade, J.M Smucker has managed to increase dividends at an annualized rate of 9.70%.

Between 2010 and 2020, J.M. Smucker managed to grow earnings from $4.15/share to $6.84/share.

The company is expected to earn $6.53/share - $6.93/share in 2021.

The stock seems attractively valued at 16.60 times forward earnings. J.M. Smucker yields 3.30%.

Relevant Articles:

Five Dividend Growth Stocks Rewarding Shareholders With Raises
Two Cheap Dividend Stocks Raising Dividends Last Week
My Favorite Exercise As A Dividend Growth Investor
Let dividends do the heavy lifting for your retirement

Thursday, July 23, 2020

Dividends are a fact, share prices are an opinion

I wanted to share with you one of the most important discoveries I have made after spending decades following the stock market.

Dividends are a fact. 

Share prices represent the opinion of a group of strangers.

Share prices represent the result of the collective opinions of all market participants. Investors usually look at things like earnings, estimates, the state of the economy, read balance sheets and the news, in order to determine whether they want to buy or sell or hold at a given price.

No individual investor knows everything, but their collective wisdom is combined into a marketplace for company stocks. This collective opinion on these securities prices, driven by short-term sentiment and fear and greed, forms share prices. Since emotions change on a day to day basis, prices change.

This is why you may get companies that report great results but shares tank, and vice versa. This is why Ben Graham and Warren Buffett have described the collective wisdom of the crowd as Mr Market. This Mr Market is a manic-depressive individual, who shouts random prices at you. You do not have to act on them however. Successful investors wait patiently, and only strike when they are offered a good deal for their money. Otherwise, they ignore Mr Market. Unsuccessful investors on the other hand, get swept up in the feelings of euphoria or despair. Rinse and repeat, and this has been going on for centuries – while we are more sophisticated than the Dutch Merchants who founded the first publicly traded company in Amsterdam in 1602, we are still only human.

Share prices represents the best guesstimates about the worth of the company, based on the future prospects of this company, as judged by the collective wisdom of the crowds. The crowds include bulls, bears, pigs and commentators. The quoted price that you see on your brokerage account is just an opinion. Until you press the buy or sell button, that opinion would have changed 100 times.
So your individual net results will change based on these opinions. If you see your stock up 100%, that is great, but until you sell to lock that gain, this is all an illusion. The same is true if you are down by 50% in a stock – it is an illusion, and unless you try to sell, it is not reality. Your actions of buying or selling the stock in either case will influence the market of course. While my 100 shares in Blackrock may not matter as much, if you are Warren Buffett you do know that if you had to sell all 400 million shares of Coke tomorrow, you would likely be in a pickle. You may see a price of $50/share, but if you sold right away, you may drive the price to $35 - $40/share. Also, if you try to buy 400 million more shares of Coke, you may drive the price up to $60/share easily.

Dividends on the other hand are a fact.

Dividends are cold hard cash, that is deposited to your brokerage account. Companies declare dividends after analyzing their business needs and share the excess cash flows with shareholders. Any successful business, organization and person knows how much they can save successfully. Dividends come from profits, and are relatively stable. This is quite evident when you compare the historical record of US corporations against share prices. Dividends are derived directly from company fundamentals. Dividends are a direct link between a company’s fortunes and investors returns. Share prices on the other hand are derived by the opinions of others on the prospects of future fundamentals on companies. Hence, dividends are more stable than share prices in the short and long runs.
Every shareholders is treated the same with dividends. They receive a proportionate share of the excess profits to be distributed by the corporation. A dividend is known in advance, and communicated to shareholders. Profitable companies in the US tend to follow a dividend policy that favors a stable dividend payment over time. Profitable and growing companies in the US tend to grow these dividends over time. If you contrast with share prices, each individual will receive a different prices if they were to sell their shares. They would also receive differed prices if they want to buy shares.

As a shareholder, I never know what the opinion on the worth of my shares will be over any given period of time.

I do know what the dividend payment that I can expect will be however.

For example, let’s look at PepsiCo (PEP). In the past 52 weeks, the stock went as low as $101/share in March 2020 and as high as $148/share in February 2020. Based on this information, I cannot tell you if the stock price will be above $101/share or below $148/share over the next year. So if you had to sell your stock, I have no idea at what price you will be able to accomplish that.

However, I do know that over the next 12 months PepsiCo will likely distribute at least $4.09/share in dividends to each share that a shareholder holds. This would be distributed in 4 equal installments of $1.0225/share. If history is any guide, PepsiCo would likely propose a dividend increase in February or March 2021, and finalize it by May 2021.

Dividends are yours to keep when you receive them. Share prices are opinions. You may be excited to see your shares go up in price, but you should know that the others opinion of the business may change by the time you decide to sell. That gain may turn into a loss, but unless you sell, it is merely an illusion.

Today we discussed the irrefutable truth, that Wall Street doesn’t want you to know.

Dividends are a fact. Share prices are an opinion.

Relevant Articles:

Does Paying a Dividend Reduce a Company’s Value?
Dividends versus Homemade Dividends
How to avoid being a dividend loser
How to be a Dividend Winner

Monday, July 20, 2020

Five Dividend Growth Stocks Rewarding Shareholders With Raises

As part of my monitoring process, I review the list of dividend increases every week This activity helps me to monitor the business performance of any companies I am invested in. It also helps me to identify any hidden dividend gems, and place them on my list for further research.

My reviews are an example of the quick way I use to evaluate companies, before deciding if they are worth a second look later or not.

The companies in today’s article have managed to grow dividends for at least ten years in a row. These companies also announced a dividend increase during the past week. The companies include:

PPG Industries, Inc. (PPG) manufactures and distributes paints, coatings, and specialty materials worldwide.

The company raised its quarterly dividend by 6% to 54 cents/share. This marked the 49th year of consecutive annual dividend increases for this dividend champion. PPG Industries has managed to grow dividends at an annualized rate of 6.40% over the past decade.

Between 2010 and 2019, PPG Industries managed to grow earnings from $2.31/share to $5.22/share.
The company is expected to generate $4.44/share in 2020

The stock sells for 24 times forward earnings and yields 1.95%.

Computer Services, Inc. (CSVI) delivers core processing, digital banking, managed services, payments processing, print and electronic distribution, and regulatory compliance solutions to financial institutions and corporate entities in the United States.

The company raised its quarterly dividend by 19.10% to 25 cents/share. According to their press release, this marked the 49th year of consecutive annual dividend increases for the company. Sadly, I have not been able to verify this with any other independent source. I see that the stock has been publicly traded since 2003, hence I have to use this data as a starting point for the dividend record. If the stock was privately held before, the record of annual dividend increases before that doesn’t count.
If I find reliable data showing that the record started 49 years ago, I would update my stance on the topic.

Computer Services has managed to grow dividends at an annualized rate of 15.80% over the past decade.

Between 2010 and 2019, Computer Services managed to boost earnings from 81 cents/share to $1.91/share.

The stock sells for 27 times forward earnings and offers a dividend yield of 1.90%.

National Retail Properties (NNN) invests primarily in high-quality retail properties subject generally to long-term, net leases.

This real estate investment trust raised its quarterly dividend by 1% to 52 cents/share. This marked 31 years of consecutive annual dividend increases for this dividend champion.

The company has raised dividends by 3.10%/year annualized over the past decade.

Over the past decade, National Retail Properties has managed to boost its AFFO/share from $1.73 in 2009 to $2.79 in 2019.

The REIT is selling for 13.35 times forward FFO and yields 5.85%.

Stanley Black & Decker, Inc. (SWK) engages in tools and storage, industrial, and security businesses worldwide.

The company raised its quarterly dividend by 1.40% to 70 cents/share. This marked the 53th consecutive annual dividend increase for this dividend king. This dividend king has managed to boost distributions at an annualized rate of 7.60% over the past decade.

The company managed to boost earnings from $2.79/share in 2009 to $6.35/share in 2019.
The company is expected to earn $5.73/share in 2020.

The stock is selling for 25.10 times forward earnings and offers a dividend yield of 1.85%.

Marsh & McLennan Companies, Inc. (MMC) is a professional services company that provides advice and solutions to clients in the areas of risk, strategy, and people worldwide. It operates in two segments, Risk and Insurance Services, and Consulting.

The company increased its quarterly dividend by 2.20% to 46.50 cents/share. Marsh & McLennan has managed to grow dividends at an annualized rate of 8.10% over the past decade.
Earnings increased from $1.55/share in 2010 to $3.41/share in 2019.

The company is expected to generate $4.60/share in 2020.

The stock sells at 24.65 times forward earnings and yields 1.65%.

MGE Energy, Inc. (MGEE) operates as a public utility holding company primarily in Wisconsin. It operates through five segments: Regulated Electric Utility Operations; Regulated Gas Utility Operations; Nonregulated Energy Operations; Transmission Investments; and All Other.

MGE Energy raised its quarterly dividend by 5% to 37 cents/share. This event marked the company's 45th consecutive year of increasing its dividend. MGE Energy is a dividend champion which has managed to grow dividends at an annualized rate of 3.60% during the past decade.

MGE Energy managed to grow earnings from $1.67/share in 2010 to $2.51/share in 2019.

The stock looks richly valued at 26.50 times forward earnings. It yields 2.20%.

Relevant Articles:

Investing is part art, part science
Avoiding High Portfolio Ownership of Successful Investments
Two Cheap Dividend Stocks Raising Dividends Last Week
Bank OZK and John Wiley & Sons Reward Shareholders With Raises

Thursday, July 16, 2020

How to Become a Millionaire

Charlie Munger taught me that in order to reach a certain goal, I need to invert. In other words, once I identify my end goal, I would have to work backwards in order to get the right parameters in action, and reach it.

“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

“Invert, always invert: Turn a situation or problem upside down. Look at it backward. What happens if all our plans go wrong? Where don’t we want to go, and how do you get there? Instead of looking for success, make a list of how to fail instead–through sloth, envy, resentment, self-pity, entitlement, all the mental habits of self-defeat. Avoid these qualities and you will succeed. Tell me where I’m going to die so I don’t go there.”

One such goal I have had over the years was to become a millionaire. Now you may say that a million is not what is used to be. Naysayers may also state that $1 million will have a lower purchasing power in 20 – 30 years. And they may be right. Or they may just be looking for excuses as to why they are no millionaires, which is why they pretend like it is not a big deal.

Actually, becoming a millionaire is a big deal in the United States. That’s because there seem to be only 12 million millionaires in the country. That’s compared to a population of 330 million. It means that roughly 4% of the population are millionaires.

For example, if you started 40 years ago, and saved and invested $160/month in the S&P 500, you would be a millionaire today. I believe that $160/month was within reach for a large portion of the population of the United States. Yet, less than 4% of the US population is comprised by millionaires.

And to make it even more interesting, a large portion of the millionaires reached this status by starting or owning a business, rather than investing in stocks. By starting a business, you can capitalize your earnings stream. However, a large portion of businesses fail within the first five years.

The second way to get rich is through wise investing. This is really the way I focus on my site, because I believe that you don’t need special skills to become a millionaire. You need time, patience, dedication and ability to soak up money in stocks for years. I believe that becoming a millionaire through regular savings and long-term stock market investing is easier for the large majority of people in the US than starting a business, striking it rich with real estate or through any other way possible. It is within reach for most folks that put this goal to mind, and act accordingly.

If you listen to naysayers however, it sounds as if becoming a millionaire is out of reach for a large portion of the population. But I am not sure why that is the case.

Becoming a millionaire is a function of your savings, your investments and your holding period. The result for your individual situation will vary, because the inputs for every unique individual will vary. We all live in different environments as well. If you graduated from college in 1980, you would have had different job prospects and investing returns than the person who graduated from college in 1930 or 2020.

That’s why I will present you with a simple formula, and a range of options for ponder through.

If you save $1,000/month, and you invest it at 7%/year, you will be able to reach $1 million in 28 years.

If you double that savings rate to $2,000/month, and invest at a 7% annualized returns, you will be able to become a millionaire in 20 years.

If you are able to save and invest $4,000/month at 7% annualized returns, you will be able to become a millionaire in 12 years.

If you are the next Warren Buffett and you generate 17%/year, and saving $4,000/month, you will become a millionaire in 9 years ( versus 12 years at $4,000/month at 7%/year)

A high savings rate brings you closer to the goal than a high return in the accumulation phase.

I used a 7% annualized return in my assumptions, in order to be conservative. Historically, US stocks have returned 10%/year, annualized over long periods of time. While year over year returns fluctuate, they have held through for longer periods of time. If you subtract the 3% annualized inflation rate, you end up with a real return of 7%/year, which is very good. While it doesn't account for taxes and investment fees, I am going to assume that the person who invests for their future is smart enough that they would minimize investment fees to the bone and that they would also invest their money in a tax efficient way ( Roth IRA's are a good start).

It is possible that future returns are much lower than the historical average. Or it is possible that they get closer to the average. You cannot control future returns, but you can control your savings rate, your investment costs, your holding period and what you invest in. If you give yourself every edge possible, you are setting yourself up for success, even if returns disappoint in the future.

I am not sure why more people in the US are not millionaires through investing. The past 40 – 50 years have witnessed a few major bull markets, which have delivered amazing returns to shareholders. anyone who started investing $160/month in US Stocks over the past 40 years could have become a millionaire today. This is a small amount, within reach for most investors. Yet, so many missed out on the great bull run since 1980.

Of course, this million dollar exercise is just a guideline. Instead of looking at dollars and cents, it is better to look at it as a percentage of income. If you spend everything that you earn, you will never have the savings to invest for your retirement. A high savings rate is more important than a higher absolute dollars savings amount.

For example, a person who earns $50,000/year and spends $25,000/year is better off than someone who earns $200,000/year and only saves $40,000/year. That’s because the first person saves 50% of their income, while the second person saves 20% of their income. In addition to that, it is easier to survive on a lower income, in case life throws unexpected surprises your way, such as a job loss and having to accept a position that pays much less. In this case, having a low cost of living is an edge.

Early retirement is easier to achieve through a high savings rate, not by generating high investment returns. That’s the truth in the accumulation phase.

For example, by saving 20% of your income, you can retire in 34 years

If you manage to save 50% of your income, you can retire in 17 years

By becoming a super saver and saving 70% of income, you can retire in a decade

Today, Investing has never been easier, and cheaper and more accessible to the masses. You can choose from thousands of securities from the comfort of your home, You can choose low cost funds holding thousands of securities. Yet, the share of the US population that holds stock is down from its peak in 2000. You just need to take the first step to start your journey towards financial independence.

There are multiple ways to invest money. Some do it through dividend paying stocks, others do index funds, a third group invests in real estate and a fourth group starts businesses. While a large portion of businesses fail, plenty of small business owners can build their net worth over time. One of the best ways to get rich in America is by starting a business. This is how most of the self-made billionaires on Forbes made their fortunes. A business capitalizes your earnings stream and creates wealth that way.

The second best way is to sell your time for money, and invest the difference in businesses. This is what a highly skilled professional, such as a doctor, lawyer, engineer, IT specialist, accountant would do. You have to pay a multiple for that earnings stream however, but you are also a passive owner, with less worries about day-to-day business operations.

- How to retire in 10 years with dividend stocks
Use these tools within your control to get rich
The Dividend Crossover Point
Simple Investing Principles to Follow
What drives future investment returns?

Tuesday, July 14, 2020

Wells Fargo Cuts Dividends by 80% to 10 cents/share

This morning Wells Fargo cut dividends by 80%, from 51 cents/share to 10 cents/share. This was not a surprise, since the bank stated that they would be cutting dividends on June 29th.

I shared this information on the blog on June 30th - "Simon Property Group (SPG) and Wells Fargo (WFC) to cut dividends"

While we didn't know at the time how big the dividend cut would be, we only knew that there would be a dividend cut.

Back at the end of June, the Federal Reserve initiated a new round of stress tests, which capped dividend payments at major financial institutions. I discussed this with you right when I posted an article: Expect Dividend Cuts and Dividend Freezes in the Banking Sector

"For the third quarter of this year, the Board is requiring large banks to preserve capital by suspending share repurchases, capping dividend payments, and allowing dividends according to a formula based on recent income. The Board is also requiring banks to re-evaluate their longer-term capital plans.

All large banks will be required to resubmit and update their capital plans later this year to reflect current stresses, which will help firms re-assess their capital needs and maintain strong capital planning practices during this period of uncertainty. The Board will conduct additional analysis each quarter to determine if adjustments to this response are appropriate.

During the third quarter, no share repurchases will be permitted. In recent years, share repurchases have represented approximately 70 percent of shareholder payouts from large banks. The Board is also capping dividend payments to the amount paid in the second quarter and is further limiting them to an amount based on recent earnings. As a result, a bank cannot increase its dividend and can pay dividends if it has earned sufficient income."

There were several banks that went through these stress tests, but almost all of them managed to keep their dividends unchanged.

The only bank to cut dividends was Wells Fargo (WFC). Again, the bank announced that on June 29th that they would be announcing a dividend cut when they reported their results on July 14th.

Our friends at Dripinvesting shared this chart comparing the average bank earnings to the dividend payouts. Wells Fargo looks like the only bank where the dividends exceeded its estimated average net income.

Source: Drip Investing/FactSet

Today, they reported their results, and cut dividends from 51 cents/share to 10 cents/share. The stock sold off, perhaps due to the poor quarterly results. In reality, the announcement of a dividend cut in advance, when everyone else is keeping their dividends should have been enough of a warning sign to prompt investors to re-evaluate their positions.

Chief Executive Officer Charlie Scharf said, “We are extremely disappointed in both our second quarter results and our intent to reduce our dividend. Our view of the length and severity of the economic downturn has deteriorated considerably from the assumptions used last quarter, which drove the $8.4 billion addition to our credit loss reserve in the second quarter. While the negative impact of the pandemic is unprecedented and many of our business drivers were negatively impacted, our franchise should perform better, and we will make changes to improve our
performance regardless of the operating environment.

“Though our income performance was weak, our capital and liquidity continues to be extremely strong with both our CET1 ratio and LCR increasing from the end of the prior quarter. However, it is critical in these uncertain times that our common stock dividend reflects current earnings capacity assuming a continued difficult operating environment, evolving regulatory guidance, and protects our capital position if economic conditions were to further deteriorate. Given this, we believe it is prudent to be extremely cautious until we see a clear path to broad economic  improvement. We are confident that this eventual economic improvement combined with our actions to increase our margins will support a higher dividend in the future,” Scharf added. Source: Wells Fargo

Probably the reason for Wells Fargo's dividend cut can be traced to the current recession that we are in, caused by Covid-19 and related depressed economic activity. The other reason is the several scandals that ruined Wells Fargo's reputation, and limited the scope of its operations. As a result, the bank didn't prosper as much in the past couple of years, and is taking things worse than competitors.

One of Wells Fargo's largest shareholders is no other than Warren Buffett's Berkshire Hathaway. Berkshire's annual dividend income from Wells Fargo will decrease from $705 million to $138 million. Buffett has gone from praising Wells Fargo and its culture, to being largely silent about the problems that the bank is facing. Of course, when you are a famous investor, you need to be very careful what you say in public.

Back when I analyzed the bank in 2013, it didn't look like a very good idea, since revenues were not growing. Earnings per share were growing due to the reduction in reserves for bad loans. I still bought some, because Buffett was buying it. It remained a very small position. I managed to sell a large portion of my position a few years ago when I did some reshuffling of assets in tax-deferred accounts. This was luck, not skill.

It looks like the US banking sector is not a good place for long-term dividend growth investing. Wells Fargo had a 34 year track record of annual dividend increases, but it lost it in 2009 when it cut dividends. It is now losing its 10 year track record of annual dividend increases. If it's earnings per share are not sufficient, Wells Fargo may be required to cut dividends or even suspend them. The same is true for all the other major banks of course.

It would be interesting to watch how the current economic recession plays out. If the recession deepens, because the Covid-19 does not seem to be under control in the US, then Wells Fargo would seem like the first shoe to drop. Translation - we may get more dividend cuts from other banks. If you believe this scenario, selling Wells Fargo may be a good choice.

On the other hand, if we manage to contain the virus through a combination of factors such as better usage of masks, vaccines/better treatments, people taking this virus more seriously, and others, we may be able to overcome a lot, and even get a decent recovery soonish. That scenario would entail a lower likelihood of dividend cuts from other major US Banks. If you believe this scenario, buying Wells Fargo today may be a decent choice.

Relevant Articles:

Expect Dividend Cuts and Dividend Freezes in the Banking Sector
Simon Property Group (SPG) and Wells Fargo (WFC) to cut dividends
Should you invest in Wells Fargo (WFC)?
Why Warren Buffett Likes Investing in Bank Stocks

Monday, July 13, 2020

Two Cheap Dividend Stocks Raising Dividends Last Week

Welcome to another edition of my weekly review of dividend increases.

I follow this process in order to monitor existing dividend holdings. It is helpful to see if my investments continue growing their dividends, and if my original investment thesis is working.

I also find this process helpful, in order to identify companies for further research.

Walgreens Boots Alliance, Inc. (WBA) operates as a pharmacy-led health and wellbeing company. It operates through three segments: Retail Pharmacy USA, Retail Pharmacy International, and Pharmaceutical Wholesale.

The company raised quarterly dividends by 2.10% to 46.75 cents/share. This marked the 45th consecutive year of raising the dividend for this dividend champion. During the past decade, Walgreen’s has managed to grow dividends at an annualized rate of 13.60%.The five year annualized growth rate is at 6.60%, and it seems to be slowing down.

Walgreen’s has managed to grow earnings from $2.12/share in 2010 to $4.31/share in 2019.
The company is expected to earn $5.39/share in 2020. For the past two or three years that I have analyzed the stock, the forward earnings per share have remained at $6. Walgreen’s has been unable to grow profits, and not it looks like forward estimates are coming down.

I believe that the stock is attractively valued today, and I believe that the dividend is well covered at a forward payout ratio of 34.70%. The lack of earnings growth means that future dividend growth would be very slow.

The stock is cheap at 7.45 times forward earnings and offers a high yield of 4.65%. The P/E multiple is low because the business is facing some headwinds and is expected to be unable to grow earnings per share. Without future growth in earnings per share however, future fundamental returns would be limited to the dividend yield you lock in at the time of investment. Obviously if the P/E multiple expands because future state of the business is rosier than we expect today, you would get an additional coiled spring like tailwind to future returns. Check my analysis of Walgreen's for more information about the company.

Duke Energy Corporation (DUK), operates as an energy company in the United States. It operates through three segments: Electric Utilities and Infrastructure, Gas Utilities and Infrastructure, and Commercial Renewables.

The company raised its quarterly dividend by 2.10% to 96.50 cents/share. Duke Energy has increased dividends for 16 years in a row. This dividend achiever has paid dividends for over 94 years. During the past decade, Duke Energy has managed to grow dividends at an annualized rate of 2.90%.

Duke Energy has managed to grow earnings from $3/share in 2010 to $5.06/share in 2019. The company is expected to earn $5.12/share in 2020.

The stock is attractively priced at 15.90 times forward earnings and offers a dividend yield of 4.75%. The forward payout ratio is at 75.40%, which is adequate for a utility.

Relevant Articles:

Dominion Energy (D) Cuts Dividends
Should I be adding to CVS and Walgreen’s?
How to read my weekly dividend increase reports

Popular Posts