Warren Buffett on Living Off Dividends In Retirement

I am a big fan of Warren Buffett, the Oracle of Omaha. His letters to shareholders are an excellent resource for students of value investing. I've studied his strategy, investments and his work, and believe that Warren Buffett is a Dividend Growth Investor in disguise.

I am also a big fan of Dividend Growth Investing. The goal of every Dividend Growth Investor is to generate enough in dividend income to pay for their expenses in retirement. To get there you save and invest consistently in quality dividend growth companies that sell at attractive valuations. The next step is to keep at it, and also patiently let the power of compounding do the heavy lifting for you. It takes time to build this portfolio, brick by brick, but once you reach critical mass, the power of compounding is very visible. With dividend growth on top of regular dividend reinvestment and regular investment and after giving it some time, that dividend income and net worth goes in turbocharged mode.

I like the concept of Dividend Growth Investing when it comes to investing for retirement. The investor builds a diversified portfolio by investing regularly, reinvests those dividends until their dividend income covers expenses. At that point, they can retire. 

I recently saw an interesting video clip of Warren Buffett, which discussed how he would invest if he were retired.

You can read the transcript below:

"Warren Buffett: If I were retired, I had a million-dollar portfolio of stocks paying me $30,000 a year in dividends. my children were grown and the house was paid off, I wouldn’t worry too much about having a lot of cash around."

I love this video because it is short and to the point. 

A million dollar portfolio could be built today to generate $30,000 in annual dividend income quite easily. If history is any guide, that income would likely grow at or above the rate of inflation over time, thus preserving the purchasing power of that income. In addition, as the dividend grow, it's very likely that the value of the portfolio would grow over time as well. This in effect would also help protect purchasing power of principal as well.

The concept of living off dividends in retirement is a very powerful one. It's also very simple. When the amount of dividend income generated by your portfolio covers your expenses, you can retire. I use the rule of 3% to determine how much money I need to accumulate to cover expenses. This means that I need to have roughly 33 times the amount of money accumulated for each dollar I plan to spend in retirement. In other words, if I spend $30,000/year, I need roughly $1 Million invested at 3%. If I need $100,000/year, I need to accumulate around $3.3 Million in income generating assets.

Getting to the million dollar portfolio of course requires time, patience, perseverance and consistency. I would think that a long-term investor can get there in a reasonable amount of time. Getting there is a function of the the dividend yield, dividend growth, amount invested and time you invest for (assuming of course that the investor keeps costs low in the process as well).

For example, someone who invests $30,000/year in a portfolio of dividend growth stocks yielding 3% and growing dividends at 6%/year annualized, would be able to generate about $30,000 in annual dividend income withing 15 years or so. If that investor keeps investing for 22 years, the total amount of dividend income would reach $60,000/year. You may like this spreadsheet to play with assumption.

However, if they can only invest roughly $1,250/month, it would take about 22 years to reach $30,000 in annual dividend income. At a 3% average dividend yield, this translates into a portfolio worth $1 Million.

The other part I liked about the video is the discussion around owning your home and being in a phase of life where your children are grown up and on their own. 

At a certain point in life you may either have your house paid off, and/or you are ready to downsize, which reduces housing costs. That in itself reduces amount of investable assets that are needed to produce income for you. If your housing cost is $30,000/year on top of every other expense you have, you need an additional $1 Million in retirement assets (dividend stocks/401k etc). But if you can reduce that amount to say $15,000, then you need less in retirement assets to support this part of your budget.

If your kids are grown up and on their own, that further reduces ongoing costs as well. Of course, the retired couple may have higher discretionary expenses related to travel, and helping out with grandchildren or helping children as well. But the necessary costs have definitely been reduced, as discretionary costs could be reduced somewhat more easily than necessary ones. You need to eat even during a recession, but that trip to Paris could wait another season or another year.

Of course, the other thing to consider is other income sources in retirement. If you plan to retire at the traditional age in your early 60s, you may also be eligible for social security in the US or a traditional pension plan. If you spend $30,000/year in retirement, but also generate $1,000/month in Social Security, you actually need only $18,000/year in dividends to cover the shortfall. That means that you only need $600,000 portfolio, rather than thee $1 Million one. Of course, if you do not plan to start your Social Security until the age of 70 or you plan to retire much earlier, then you would likely need that full $1 Million in income producing assets, before you can retire early.

Three Dividend Growth Stocks Rewarding Shareholders With Raises

I review the list of dividend increases every week, as part of my monitoring process. This exercise helps me to monitor developments in existing holdings. It also helps me to potentially identify companies for further research.

I usually focus on companies with a ten year streak of annual dividend increases, in an effort to weed out cyclical companies. It is not a small feat to raise dividends through a full economic cycle. Meeting this screen increases the chances of identifying quality companies for further research.

Of course, this is just a screen. I look at several data points in order to determine if a company should be put on the list for further research, or discarded. 

I look at growth in earnings per share over the past decade, because earnings per share are the fuel behind future dividend increases. 

I also look at the most recent dividend increase, and compare it to the 5 and 10 year averages.

Then I also review trends in dividend payout ratios. That's because I do not want dividend growth that happens solely from expansion in the payout ratio.

If a business is fundamentally sound, I would put it on my list for further research.

Last but not least, I also look at valuation. If a business is overvalued, I would determine a price that I would consider it and wait. If a business is fairly valued, I would research it first (assuming I haven't done that before".

Over the past week, there were three companies that raised dividends. These companies have also increased dividends for at least ten years in a row. The companies include:

Philip Morris International Inc. (PM) operates as a tobacco company working to delivers a smoke-free future and evolving portfolio for the long-term to include products outside of the tobacco and nicotine sector. 

The company boosted its quarterly dividend by 2.40% to $1.30/share. This is the 15th consecutive annual dividend increase for this dividend achiever. The company has managed to grow dividends at an annualized rate of 4.70%/year over the past decade.

The company is expected to earn $6.25/share in 2023. Earnings per share went from $5.26 in 2013 to $5.82 in 2022.

The stock sells for 15.34 times forward earnings and yields 5.50%.

You can view PMI's dividend history since 2008 below:

Realty Income (O) is a real estate investment trust ("REIT") with over 13,100 real estate properties primarily owned under long-term net lease agreements with commercial clients. 

The company increased monthly dividends to $0.256/share. This was a 0.20% increase over the previous quarter and 3.22% increase over the distribution paid during the same time in the previous year. Over the past decade, the company has managed to grow dividends at an annualized rate of 5.30%.

This dividend aristocrat has increased annual dividends since 1994.

Realty Income has managed to grow FFO/share from $2.41 in 2013 to $4.04 in 2022. Realty Income is expected to grow FFO/share to $4.12 in 2023.

The stock sells for 13.12 times forward FFO and yields 5.60%.

You can view Realty Income's dividend history from 1994 below:

Fifth Third Bancorp (FITB) operates as a diversified financial services company in the United States. It operates through three segments: Commercial Banking, Consumer and Small Business Banking, and Wealth and Asset Management. 

The company raised its quarterly dividends by 6.10% to $0.35/share. This is the 13th consecutive annual dividend increase for this dividend achiever. The company has managed to grow dividends at an annualized rate of 13.10% over the past decade. Unfortunately, the dividend is still below its peak 2007 levels.

Between 2013 and 2022, the company managed to grow earnings per share from $2.05 to $3.38.

The company is expected to earn $3.30/share in 2023.

The stock sells for 8.30 times forward earnings and yields 5.10%.

Relevant Articles:

- Three Dividend Growth Companies Increasing Dividends Last Week

- Eight Dividend Growth Companies Increasing Dividends Last Week

- Four Dividend Growth Stocks Rewarding Shareholders With Raises Last Week

- Nine Dividend Growth Stocks Rewarding Shareholders With Raises Last Week

Valuation

My investment philosophy is centered around buying quality dividend growth companies at an attractive valuation. I have discussed the importance of having a disciplined approach when it comes to prudent investing and avoiding overpaying for a stock. 

Just like everything else however, valuation could turn out to be in the eyes of the beholder.

I was thinking about valuation, and its components "growth" and "value", as I was compiling the returns of the Dividend Aristocrats from 2013. I looked at the ratios, and compared total returns through 2023 July 31.

Valuation is a double edged sword.

On one hand, if you overpay for a stock, you may end up losing money or not making much money.

On the other hand, if you're too conservative on your valuation assessment and don't invest, you may end up missing out on a lifechanging investment.

A stock may appear to be cheap, but in reality it could turn out to be a value trap as well. A primer example of that is AT&T over the past decade.

In my experience, I invested in Visa in 2011 when the stock was selling around 20 times earnings and had a dividend yield of about 0.70%. The stock seemed expensive at the time. Today it is up from $22 to $248/share and the dividend is at $1.80/share for an yield on cost of about 8%. In hindsight it seems cheap. If someone didn't invest in it because the yield was too low, they would have missed out on an incredible compounding.

Another company that seemed cheaper was Con Edison. Stock sold at 16 times earnings and had a dividend yield of 4.10%. Stock seemed fairly valued at the time. Today, it is up from $59 to $90/share and the dividend is up to $3.24/share for an yield on cost of 5.50%.. In hindsight it does not seem as cheap, as its share price and dividend has barely kept up with inflation.

This discussion is more of a reminder that investing is part art, part science. It is not a scientific exercise like physics, that has known laws which can be applied at all times with the same result. There is always an unknown factor after all.

This is also a reminder to be flexible in ones approach, without being too lenient however. Valuation is taking into consideration both “value” and ‘growth” schools of thought, without looking at things in isolation. Per Warren Buffett, the two approaches are joined at the hip: Growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive.

It’s definitely helpful to think through trade-offs, and opportunity sets, rather than thinking in definitive terms such as good and bad, black and white. It's more of a gray.

When it comes to valuation, it is important to understand what drives future returns in a company.

In general, returns comprised of dividends and capital gains.  The fundamental returns of a company are dependent on dividends and earnings growth. The speculative component is dependent on changes in the valuation multiple. 

The US stock market has generated annualized returns of about 10%/year since 1926. This was driven by the 4% average annual dividend yield and the 6% growth in earnings per share. Any changes in the valuation multiple have had a very small impact over the past 97 years or so. 

Changes in valuation multiples do not matter as much over really long periods of time. They do matter over shorter periods of time however, such as 10 or 20 years. This could be a long period of time for the average investor, who probably invests for the next 30 – 40 years.

I use this model in my investments as well.

In an ideal world, a company would grow earnings per share, grow dividends and increase intrinsic value at a decent pace over the course of time.  Intrinsic value is the value of a business that could be attained by selling to another knowledgeable buyer. Think of a restaurant owner selling their business to another person. In an arms length transaction they are unlikely to just sell their blood, sweat and tears at a ridiculously low price, in relation to value. A reasonable buyer is also unlikely to massively overpay in an arms length transaction. That does happen in the stock market however.

In the real world, things are messier. For example, even if earnings per share and dividends per share increase at the same pace over a long period of time, the share price may not do so. That’s because share prices fluctuate much more than fundamentals, as observed by dividends and earnings per share.

As a result, share prices routinely may go above or below intrinsic value. This creates opportunities to buy shares of a good company at a discount. However, there are a lot of companies available at a discount or premiums to choose from. We need to compare not only one investment on its own merits, but also in relation to other investments. That’s our opportunity cost.

This works for comparing two companies. But in the real world, we also compare to other alternatives, such as investing in fixed income like US Treasury Bonds for example. Let’s simplify and just look at how I would compare two companies.

For example, a company that earns $4/share that never grows and pays $3/share in dividends may look cheap at $40/share. This company sells at 10 times earnings and yields 7.50%.

Another company that earns $4/share, grows at 10%/year and pays $2/share in dividends may look expensive at $80/share. This company sells at 20 times earnings and yields 2.50%.

Many retired investors may focus on chasing the high current yield of investment A, and ignore the smaller but growing dividend in company B. In my opinion, they should think about expected returns. They should also think about future yields on cost.

The expected returns on company A are 7.50%, assuming the earnings multiple stays constant. If you bought that stock and spent the dividends, after 30 years you would still be earning only 7.50% yield on the original cost. Chances are that those dividends would have a lower purchasing power due to inflation as well.

The expected returns on company B are 12.50%, assuming the earnings multiple stays constant. If you bought the stock and spent the dividends, after 30 years you would be sitting on an yield on cost of over 43%.  Of course, just like chasing yield is bad, so is chasing growth. Trees don't grow to the sky.

This exercise assumes that a high yielding company that never grows would be able to maintain that high payout ratio and that its business would go on without any changes for 30 years. That is a wild cart that may or may not turn out to be true. In reality, some companies with high payout ratios may end up cutting dividends if earnings per share hit a temporary slide. If the business starts descending into a permanent decline, those dividends may end up on the chopping block. We need to consider those trade-offs in the opportunity set.

This exercise also assumes that company B would have a high earnings growth for a very long period of time. That’s probable for a company with a strong moat, a competitive advantage of sorts, which has the pricing power and/or riding a long secular tailwind in demand to be able to grow earnings over a period of 30 years. Growth is never a given. If the business is unable to grow those earnings, valuation multiples would shrink. We need to consider those trade-offs in the opportunity set.

Of course, the same exercise will have different conclusions if valuations changed. 

If company A above sold at the same multiple, but turned out they can grow at 2.50%/year, the expected returns goes up to 10%/year.

If company B above sold at a multiple of 40, and growth stayed at 10%/year, the expected returns go down. The yield would be 1.25% + growth of 10% would result in expected returns of 11.25%. 

The same exercise will be even more fun as valuation multiples change

For example, if company A starts growing at 5%/year, then it may get re-rated from a P/E of 10 to a P/E of 15. That’s because it went from a period of low expectations to a period of unexpected good news. Investors who locked in an initial yield of 7.50% would also see some decent dividend growth and doubling of yield on cost in about 14 years. They achieve a high return because expected returns went from 7.50% to a higher amount. With a low P/E company however, the risk is that earnings are in a slow gradual decline. If they unexpectedly grow, that may be a good situation for the investor. 

If company B however sees growth decelerating from 10%/year to 5%/year, then it may get re-rated from a P/E of 20 to a P/E of 10. That’s because it went from high expectations to lower expectations. Due to this re-rating of the stock, investors may sit for 14 years and see limited growth in the share price, even if earnings double over that time period. That’s because reality was worse than expected. Only return would be from the share price. The expected returns dropped from 12.50% to a lower amount. 

That’s always one risk I think about with growthier dividend stocks – 1. That growth would decelerate 2 . That the P/E multiple may shrink as a result.

These scenarios were mostly a discussion of how I think about expected returns. They were discussions about how to calculate expected returns. They were also a discussion of the trade-offs involved and the possibility of potential outcomes that differ from expectations. It’s important to think about the risks and opportunities present, when making an investment. That can help position ourselves to better prepared to minimize the impact of any negative items thrown our way, while providing us with the opportunity to reap maximum rewards when the winds go our way.

After going through this exercise, along with my experience investing for the past few years, I’ve come to the conclusion that missing out on a potential big investment is a bigger sin than buying a bad investment. This of course assumes a diversified portfolio. 

That’s because if you invest in a company, the most you can lose is the amount put to work there, minus any dividends received (unless reinvested through DRIP). But the amount that can be made is virtually unlimited. In other words, a potential great investment can pay for a few stinkers along the way, which the portfolio is guaranteed to have along the way. 

In addition, it is hard to determine in advance, the conviction behind each investment. Hence, it may make sense to buy a diverse basket of quality companies, over time, with strong fundamentals, and then hold them. While it seems “irresponsible” to ignore valuation, in reality, it is hard to determine in advance if a stock is cheap or expensive. That’s because while we may know the P/E and dividend yield, we do not really know what the future EPS and DPS growth is going to be. At least that’s my conclusion from observing the aristocrats.

In practical terms, I view this as investing equally, in a group of companies that have qualitative characteristics (dividend growth companies). Then in the spirit of Coffee Can Portfolios, let the portfolio concentrate on its own, and rarely sell. It may be hard to try to avoid value traps (low P/E, low growth companies), and growth traps (high P/E, high expected growth). But that would be the cost of admission to end up with the quality dividend growth companies that grow earnings and dividends and intrinsic values for decades, building immense wealth in the process. That would more than compensate for any losers.

Going back to the main point of this article, valuation is a double edged sword.

If you overpay for a stock on one hand, you may end up losing money or not making much money.

If you're too conservative on your valuation assessment and don't invest on the other hand, you may end up missing out on a lifechanging investment.

A stock may appear to be cheap as well, but in reality it could turn out to be a value trap as well.

While it is not easy to "value", you still need to take into consideration yield, growth, P/E ratios in order to make an educated guesstimate.  You also need to be cognizant of trade-offs, and put yourself in the best position to benefit from any wealth creations from companies you invest in, while also minimizing losses as much as possible.

Relevant Articles:

- How to value dividend stocks

- How to read my stock analysis reports

- Not all P/E ratios are created equal

- Why do I use a P/E below 20 for valuation purposes?

Three Dividend Growth Companies Increasing Dividends Last Week

I review the list of dividend increases as part of my monitoring process. This exercise helps me monitor existing holdings and uncover candidates for further research. Monitoring dividend increases is one of the inputs I use to evaluate companies.

Brady Corporation  (BRC) manufactures and supplies identification solutions (IDS) and workplace safety (WPS) products to identify and protect premises, products, and people in the United States and internationally. It operates through two segments, IDS and WPS. 

The company increased quarterly dividends by 2.20% to $0.235/share. This was the 38th consecutive annual increase in dividends for this dividend champion.

Brady Corporation lost $0.89/share in 2014, but then managed to grow out of the whole to $3.51/share in 2023.

The company is expected to earn $4.06/share in 2023.

The stock sells for 13.60 times forward earnings and yields 1.71%.

New Jersey Resources Corporation (NJR) provides regulated gas distribution, and retail and wholesale energy services. The company operates through four segments: Natural Gas Distribution, Clean Energy Ventures, Energy Services, and Storage and Transportation. 

The company raised its quarterly dividend by 7.70% to $0.42/share. This is the 28th consecutive year of annual dividend increases for this dividend champion.

Between 2013 and 2022, the company managed to grow earnings from $1.38/share to $2.86/share.

The company is expected to earn $2.69/share in 2023.

The stock sells for 15.70 times forward earnings and yields 3.70%.

Verizon Communications Inc. (VZ) provides communications, technology, information, and entertainment products and services to consumers, businesses, and governmental entities worldwide. It operates in two segments, Verizon Consumer Group (Consumer) and Verizon Business Group (Business).

The company raised quarterly dividends by 1.90% to $0.665/share. This is the 17th consecutive year Verizon’s Board has approved a quarterly dividend increase. The company is a dividend achiever.

Verizon managed to grow earnings per share from $4.01/share to $5.06/share between 2013 and 2022

The company is expected to earn $4.72/share in 2023.

The stock sells for 7.16 times forward earnings and yields 7.72%.

Relevant Articles:

- Nine Dividend Growth Stocks Rewarding Shareholders With Raises Last Week

- Eight Dividend Growth Companies Increasing Dividends Last Week

- Seven Dividend Growth Stocks Rewarding Shareholders With Raises

- Four Dividend Growth Stocks Rewarding Shareholders With Raises Last Week

Should I sell or should I hold

There comes a time in the life of every investor, where one of their holdings experiences troubles of some sort. It doesn’t matter how much research you did upfront, you will have those.

I’ve had those too. 

Typically a company would have missed earnings, and the share price would go down or stay flat for extended period of time. Some shorter-term investors would panic, and start abandoning the ship. The sentiment turns sour, and more people start abandoning the company. Just mentioning the name makes people uncomfortable, let alone have them admit they have ever owned it.

I’ve had those too.  In fact, I probably have a few of them right now.

I have learned that I do not know in advance if a company’s troubles are temporary or the beginning of the end. Few can tell really.

I do know however that I should hold tight for as long as possible, for as long as the reason I bought still holds on.

I buy companies with a long streak of annual dividend increases. When I buy a company, I believe it to be a quality company selling at what I believe to be fair valuations. For as long as that company can at least maintain dividends, I would hold on to it. I would likely not add to it if fundamentals do not meet my entry criteria, but I would hold on to it.

As someone who has spent a lot of time reviewing dividend histories for a lot of companies (dead or alive), I can tell you that dividend growth does change from year to year and from cycle to cycle for different companies. It is rare to see a company grow at the same rate of dividend growth all the time. In reality, dividend growth goes up, then goes down, and may even turn flat as companies experience short-term turbulences. The best businesses adapt, and thrive. They take punches, consolidate, but then get back on their feet. They only tend to cut dividends when something is irreparably damaged. This typically tells you that the business environment or the product or the company no longer rides the same tailwind that produced the historical record of success. This means this change has caused this business to be outside my circle of competence in defiance of my original expectations, so it’s time for me to move on to some other long-term trend that can build wealth. 

I would sell in an instant however one second after the company cuts or suspends its dividend.

I would be very patient in holding through the ups and downs, and give the company as much time as it needs to turn the ship around. Even if it takes 5 or 10 years. I invest for the next 20 – 30  years or longer, so I can afford to hold for as long as they don’t cut the dividend. Many would have opinions, and have fear or greed, but I would be able to hold on and sit tight, for as long as I am getting paid to hold and that amount is not cut. If that dividend is cut however, then my original reason for owning the stock (enjoying a stable and growing dividend income) is not longer valid. That’s a fact that causes me to sell.

I follow a fact based approach to investing. I do not care about hopes and dreams and opinions, but facts. A dividend cut is a fact, so I sell. If the dividend is unchanged, then that’s a fact that causes me to hold. 

Management teams in the US are reluctant to cut dividends, because they view it as a failure. They are right, it is a failure. 

I do not want to sell a stock willy-nilly, just because there is some pressure. There is a trade-off of course. The issues companies face could either be temporary, in which case selling would have been a mistake. OR The issues companies face could be permanent, in which case selling is the best decision. But if you have to choose between worrying that you sold a value trap at $10 or $5, it doesn’t really matter in my opinion. It matters to keep amount at risk limited, and try to own companies that may grow EPS/DPS and intrinsic value.

If that pressure turns out to be right, and I sold “early”, I will have retained a higher amount of money to redeploy elsewhere. At least in theory. Otherwise, the theory says, by the time the dividend is cut and I sell, it would be too late. (They are probably right, but I also know that I won’t be right 100% of the time and I do not need to predict every twist and turn in a company share price. I buy companies with the expectation that they do well over time. If I am wrong, I cut my losses and get out when dividends are cut. I also keep amount invested per stock limited, so as to protect my capital when bad things happen to (good people -me ))

If that pressure turns out to be wrong however, and I sold “early”, I would have wasted a high amount of money by selling low and missing out on all upside. At least in theory. The theory says that if I try to predict a dividend cut that never comes (meaning I am wrong), I would be selling low and it would be too early. It could be even worse if I end up missing out on all the future prosperity and also ended up replacing a perfectly good company with something that turns out to be a value trap on its own. Compounding mistakes is never fun.

I know that this is getting to be a little bit of a rambling post, so let me provide some examples from my own experience.

Back in 2014 – 2017 we had McDonald’s (MCD) share price go nowhere for a few years. Earnings had started to stagnate, and people started to create all sorts of narratives about things. A lot of folks sold their stock. The company then simply managed to try and right the ship, and has managed to double earnings per share in the past 6 years. The stock has rebounded and dividends per share are rising as well.

In this case, holding on seems like a good idea. I’d tell you however that a lot of folks disagreed with me and argued with me against me holding. Urging me to sell. The issue is if I sold, I would have likely bought another company that may have done worse than McDonald’s. So I would have had a double loss of missing out on McDonald’s prosperity and ending up with a value trap.

This is not the first time McDonald's investors had their patience tested out. Back in the early 2000s, the company had experienced some growing pains, it had overexpanded and level of service had been declining. We also had an increased attention to the fact its food is not very healthy (remember "Supersize Me"). That being said, for the investor who held on, they did well. Of course, if they hadn't turned the operations around, and had cut dividends, the picture would have been much different.

Perhaps it’s still early to tell, but I am also holding on to Cardinal Health (CAH), a position I initiated about 5 years ago. The investment had been dead money for quite some time, and has generated abysmal annualized dividend growth over that time period. However, the share price has almost doubled, so perhaps the market is foolishly or smartly predicting that things are about to turn around. Perhaps EPS growth and dividend growth would return? That being said, the company is on track to earn $6.67/share in 2023, versus $3.42/share in 2014 and $4.54 in 2019.

I experienced a few years of slow dividend growth with the types of oil majors such as Exxon-Mobil over the past decade, particularly since 2019. Remember when oil prices turned negative in 2020, amidst the glut around the time after Covid hit? Several companies like Shell or BP cut dividends. Share prices were down for every oil major, including Exxon Mobil and Chevron. If someone sold in anticipation of a dividend cut, they would have sold low. Oil prices ultimately recovered, and so did share prices. I do remember sentiment being terrible for the energy sector in 2020. One of risks of selling after a company has not done well, is that you let emotions such as fear drive the actions. As a group, investors tend to feel the worst and most likely to capitulate around the time of a major bottom. We want to avoid that. However, we also want to avoid hoping for a turnaround that never happens, tying up precious capital in the process. This is where having an objective signal can be helpful in knowing what to do. That signal for me is the dividend - if it is held, I will hold on to the company. If it is cut, I will sell and re-evaluate. If it is increased again in the future, I would consider initiating a position again.

Two companies I am in the red today include 3M (MMM) and Walgreen’s (WBA). I’ve held those for over 10 – 15 years. When I bought them, they were considered to be quality dividend aristocrats, and they had managed to grow earnings and dividends at a good pace. In fact, they have increased dividends at a decent pace over the past 10 – 15 years.

In the case of Walgreen’s, the company had strong earnings growth and dividend growth prospects around 2010 – 2011 - 2012. Dividends have doubled over the past decade. Earnings per share also almost doubled from $2.69 in 2013 to $5.02 in 2022. It’s expected to earn $4/share in 2023, and pay $1.92/share in dividends. The dividend seems adequately covered from earnings. Dividend growth has come to less than 1% in 2022 and the company has skipped its dividend increase so far in 2023. I understand that things are looking hard, and there are a lot of competitive pressures. I will stick to the stock for the time being, for as long as the dividend is not cut. I viewed Walgreen’s as a growth stock about 10 – 15 years ago. It’s just a good reminder that you should not chase growth, just the same way as you should not chase yield either. Either way, I am sticking to this stock for as long as they don’t cut the dividend. I am not adding to it however. 

In the case of 3M, the company has managed to grow earnings per share at a decent clip between 2013 and 2022 from $6.83 to $10.21. It’s expected to earn $8.87/share in 2023. It pays a $6/share annualized dividend, so the distribution has a high payout ratio of around 67%. It’s manageable, for as long as earnings do not dip further. Any lack of future earnings growth would mean lack of future dividend growth as well. There are some lawsuits around, which are taking managements focus away from running the business in my opinion. Once these are behind us (or if they are behind us), they have the chance to regroup and hopefully get the business back on its feet. Either way, I am sticking to this stock for as long as they don’t cut the dividend. I am not adding to it however.

The annualized dividend growth for 3M has definitely been very slow over the past 4 - 5 years. The company has increased the quarterly dividends by 1 penny/share since 2019. This is not the first time that 3M's annualized dividend growth slowed down. However, that was around the time of the Global Financial crisis, when expectations were low and the issues surrounding that dividend increase were affecting more companies and the whole economy. It's much harder to take the pain when everyone else is doing well.

Another fun company I hold on to is Altria (MO). Back in 2017, the stock was overvalued, selling for roughly 25 - 30 times free cash flows per share. Free Cash Flow per share went from $2.12 in 2013 to $2.45 in 2017 to $5.02 in 2022. Yet, today the stock sells for 8 times Free Cash Flow/share. The stock price is down from a high of $70 - 75/share in 2017 to about $40 - $45/share in 2023. While management did burn billions of dollars on some terrible acquisitions (JUUL and Cannabis), the core business seems to be printing money for the time being.

Of course, tobacco has been a challenging business to hold, if you go by news headlines at least. Back in the late 1990s, tobacco companies almost went under due to heavy litigation. After the Tobacco Master Settlement Agreement, tobacco companies bounced back and kept printing cash to shareholders. There were some challenging times in the late 1990s, but shareholders who persisted despite the negative news headlines did well. There were no dividend cuts from the likes of Altria (then Phillip Morris). Phillip Morris did fail to raise quarterly dividends in 1997, though it did raise them in the third quarter of 1998. However, due to the timing of the increases, annual dividends kept increasing in 1996, 1997 and 1998, thus preserving its status of a dividend aristocrat. Again, nobody knew what would happen with tobacco in 1996 or 1997. But someone who held on for as long as the dividend is not cut would have done fine. If they had cut dividends however, mostly due to unfavorable litigation, that would have likely marked the end of the sector as an investable opportunity. However, someone who sold in fear of failure in 1997, would have likely regretted their behavior, as the company has delivered amazing total returns and dividend growth over the past 25 years.

I summary, when I invest, I try to buy shares in a quality business, at an attractive valuation. That business has a track record of annual dividend increases, which I expect to continue. I will continue holding on to that business, for as long as it does not cut or suspend dividends. 

Ultimately, it is hard to say in advance whether a business is experiencing temporary struggles or whether this business is experiencing an existential crisis all the way down to zero. This is why I keep holding on through the ups and downs, until the dividend is cut.

One of risks of selling after a company has not done well, is that you let emotions such as fear drive the actions. As a group, investors tend to feel the worst and most likely to capitulate around the time of a major bottom. We want to avoid that. However, we also want to avoid hoping for a turnaround that never happens, tying up precious capital in the process.

I also limit the amount of money I will allocate to that business as well, which limits the amount at risk for this particular position. I have a diversified portfolio, which I build over time as well, which serves as protection from the proverbial bad apple.