Dividend Articles for the week of 7/13/2013

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

Below, I have highlighted a few articles posted on this site, which many readers have found interesting:

• Common Misconceptions about Dividend Growth Investing
• Why most dividend investors never succeed
• Most Widely Held Dividend Growth Stocks
• Your Retirement Income is on Sale!
• Dividend Investing Goals for 2013

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

• Royal Dutch Shell Class A vs Class B Shares
  
• Delaying Gratification? What's Gratifying To You?
• BHP vs BBL for Investors in the United States
• Omega Healthcare Investors (OHI): Solid REIT At This Price
• Portfolio in Action: Semi Annual Review

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

Ameriprise Financial (AMP) Dividend Stock Analysis

Ameriprise Financial, Inc. (AMP), through its subsidiaries, provides a range of financial products and services in the United States and internationally. Ameriprise operates in five segments – Advice & Wealth Management, Asset Management, Annuities, Protection and Corporate & Other. The company was created as a result of a spin-off from American Express (AXP) in 2005. This dividend stock has paid dividends since 2005, and has increased them every year since then.

The company’s last dividend increase was in May 2013 when the Board of Directors approved a 15.60% increase in the quarterly distribution to 52 cents /share. The company’s peer group includes Principle Financial Group (PFI), Northern Trust (NTRS) and Waddell & Reed (WDR).

Since going public in 2005, this dividend growth stock has more than doubled in price.

The company has managed to deliver a 5. % average increase in annual EPS since 2003. Analysts expect Ameriprise Financial to earn $6.60 per share in 2013 and $7.60 per share in 2014. In comparison, the company earned $4.63/share in 2012. Over the next five years, analysts expect EPS to rise by 14.70%/annum.

Overall, I am very bullish on companies that offer the tools to assist the 60 million Baby Boomers in their retirement. As there are 10,000 boomers retiring each day, there is the need for retirement advice. Financial advisors help individual investors craft a plan, and execute it, while trying to create a long-term relationship with the client. The future growth of the company would come from building and retaining long-term relationships with customers. The company has an active sales force of 9,700 financial advisers, which help address customers’ needs by selling them Ameriprise products. Almost 75% of its advisors are independent franchisees, who have the right to use the Ameriprise name.

Future growth will also be dependent on attracting more client money both domestically and internationally. A rising market generally helps in increasing assets under management, which is accretive to revenues and profitability.

The return on equity has been pretty consistent between 8 and 11% over the past decade, with the exception of the dip in 2008, during the depths of the Financial Crisis. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.

The annual dividend payment has increased by 20.60% per year over the past five years, which is slightly higher than the growth in EPS. This was possible because as a new dividend payer, Ameriprise started paying out a small amount, which was later increased significantly.

The dividend payout ratio has increased from 5% in 2003 to 30.90% in 2012. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Currently Ameriprise Financial is attractively valued at 16.20 times earnings, yields 2.50% and has a sustainable distribution. I recently initiated a position in the stock and plan on adding to it on dips.

Full Disclosure: Long AMP

Relevant Articles:

- Check Out the complete Archive of Articles
- Attractively valued dividend stocks to consider today
- Four Attractively Priced Dividend Stocks Boosting Distributions
- How to invest like a Dividend Billionaire
- Dividend Macro trends: The Baby Boomer Retirement Investment

Business Relationships Can Deliver Solid Dividends to Shareholders

We live in a service- oriented economy. As a result, a large portion of the economic output is based upon purchases of services, rather than the purchases of pre-fabricated tangible products. Using an example from everyday life, a haircut is a service. Many people living in small communities across the United States go to a barber shop or a hair salon every few weeks or so. After a few months of trial and error, consumers generally tend to find a place to have their hair cut and stick with it. The service provider lures in the customer with quality of service, and builds a long-term relationship of repeat purchases that might last for years if not decades. So why should dividend investors care about haircuts and services?

The answer is simple – there are dividends to be made from service oriented companies.

While corporations are not people, they tend to consume services on a regular basis. One of the biggest assets that corporations might have are the intangible relationships that they have built over the years. For example, many public companies tend to keep their audit or law firms for years if not decades, which translates into millions of fees for the latter. The corporations are satisfied with the quality of service offered, and know that the service providers have their best interests at heart. The service provider strives to provide outstanding service, in order to keep the relationship going and generate extra billing opportunities when the right time comes. As a result, it could be argued that offering an outstanding service on a consistent basis could be a source of a wide moat, or a strong competitive advantage.

The areas to focus on include repeat purchases from service providers. A few of those include:

Automatic Data Processing, Inc. (ADP) provide business outsourcing solutions, such as payroll processing. Payroll is an important aspect of a small business. One small error could be bad for business and employees morale. As a result, businesses tend to keep service providers like ADP, even if prices tend to increase over time. The hassle of switching to a new provider makes this service sticky, as long as quality of service is maintained. As a result, this dividend champion has managed to boost dividends for 38 years in a row. Currently, the stock is a little pricey at 23.90 times earnings, although the yield is attractive at 2.50%. Check my analysis of ADP.

International Business Machines Corporation provides information technology (IT) products and services worldwide. The company has transformed itself from a major hardware producer to a service provider. It provides consulting services to clients across the globe. Major corporations are willing to pay large sums of money in order to improve operations, and companies like IBM are there to help. Once companies are comfortable with the services offered by IBM, this relationship will keep on delivering dividends as long as quality of execution is maintained. After all, chances are that a company would ask for IT services only from service providers they are comfortable with. They get comfortable with service provider only after a business relationship is built and maintained over time. A competing firm would have a lot of trouble making a new relationship with an IBM client, since they would have to prove themselves first. Even if they undercut prices, the fears that they might not deliver, since no relationship exists, would likely deter clients from leaving their service providers. This dividend achiever has been able to boost dividends for 18 years in a row, while also being one of the largest and most consistent share repurchasers in the world. The stock is cheap at 13.30 times earnings, although the current yield is low at 2%. Check my analysis of IBM.

One of IBM's competitors is Accenture (ACN), which provides management consulting, technology, and business process outsourcing services worldwide. This international dividend achiever has increased dividends for 8 years in a row. The company has a five year dividend growth rate of 28.70%/year.  Currently, the stock is trading at 16.30 times earnings and yields 2.30%. I would try to post a more detailed analysis of the firm over the next few weeks.

As a result, businesses that manage to build and maintain relationships with clients have an inherent advantage that is as close to a wide moat as possible. It would be very difficult for competitors to steal an existing client, as long as an adequate level of service is offered. This wide moat also provides pricing power, which could translate into higher profits and provide the necessary cash to boost dividends over time.

Full Disclosure: Long ADP, IBM

Relevant Articles:

- Check Out the complete Archive of Articles
- IBM (IBM) Dividend Stock Analysis
- Automatic Data Processing (ADP) Dividend Stock Analysis
- Seven wide-moat dividends stocks to consider

How to accumulate your nest egg

On my website, I often talk about investments, but very rarely do I discuss the process to accumulate anest egg. I often assumed that investors who read my site are there because they have the cash. However, some feedback in my previous article, where I outlined the benefits of dividend investing for young investors, made me realize that an article on the subject might be a good idea.

There are essentially a few major ways for an ordinary investor to accumulate a nest egg. The first way is by contributing or maxing out your 401k and IRA, and let it compound tax-free for several decades until you reach your target retirement date. At this stage, you can follow the traditional four percent rule. Or you could decide to embrace dividend investing by selling your index funds and purchasing individual dividend growth stocks. This could be done a few years prior to your target retirement date on several tranches. For example, if you have a $600,000 in a 401k and five years to retirement, you can essentially sell $1000 worth of index funds and purchase $1000 worth of dividend stocks every month for 60 months. The value of your index funds will fluctuate as you perform this exercise, and the mathematics will be different for every investor, but the idea should be fundamentally sound and easy to follow. Of course, you can decide to convert your 401K by selling off your index funds, rolling the proceeds into an IRA, and then buying as much dividend paying stocks as you can get your hands on. I rolled over an old 401K in April, and replaced the index funds with a portfolio of twenty dividend paying stocks.

Below, you can view the annual contribution limits for 401K plans for individuals below 50 years of age since 1987.

If you maxed out your 401K between 1987 and 2012, and invested in an S&P 500 index funds (VFINX), your portfolio would be have been worth over $738,000. I assume dividends were automatically reinvested during those 25 years, and all of the money was invested at year-end. I do not account for any catch up contributions in this scenario.

The second way to accumulate your nest egg is to focus on income only. You can put the bare minimum in 401K or IRA plans, and then invest most of the funds in a taxable brokerage account In this account the investor will be able to invest in anything they want, and have the flexibility to either spend the dividends or reinvest them in more stock. This is the ideal method for anyone who plans on retiring in their 30s or 40s. With this method however, the accumulation of funds might be slower than with the first one, since it is done with after-tax money. As I mentioned in an earlier article, someone who is saving $3,000/month in dividend growth stocks yielding 4% and growing distributions at 6%/year should be able to generate $4,000/month in 15 years. If you put $1,000/month, in 15 years you would be able to earn approximately $1,330/month in passive dividend income.

The types of dividend stocks I could purchase today, which would allow me to pursue option two include:

Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends for 5 years in a row. Over the past five years, Philip Morris International has managed to raise dividends by 13.10%/year. The stock trades at 16.90 times earnings and yields 3.90%. Check my analysis of Philip Morris International .

Wal-Mart Stores, Inc.(WMT) operates retail stores in various formats worldwide. The company has raised dividends for 39 years in a row. Over the past decade, Wal-Mart Stores has managed to raise dividends by 18.10%/year. The stock trades at 14.70 times earnings and yields 2.50%. Check my analysis of Wal-Mart.

McDonald'’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company has raised dividends for 36 years in a row. Over the past decade, McDonald’s has managed to raise dividends by 28.40%/year. The stock trades at 18.60 times earnings and yields 3.10%. Check my analysis of McDonald’'s.

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. The company has raised dividends for 26 years in a row. Over the past decade, Chevron has managed to raise dividends by 9.60%/year. The stock trades at 9 times earnings and yields 3.40%. Check my analysis of Chevron.

Realty Income Corporation (O) is a publicly traded real estate investment trust. It invests in the real estate markets of the United States. The company has raised dividends for 19 years in a row. Over the past decade,  Realty Income has managed to raise dividends by 4.20%/year. The stock trades at times FFO and yields 5.20%. Check my analysis of Realty Income.

A third way is to follow a blend of contributing out 401K and IRA contributions, while investing any remaining amounts in taxable brokerage accounts. I am somehow following this strategy today, as I max out tax deferred accounts in order to get the most tax benefit today, while adding any additional funds to taxable accounts. This was difficult to implement 5 - 6 years ago for me, but now it is easier.

For the first five - six years of my dividend investing pursuits, I purchased almost all of my investments in taxable accounts. As a result, I have been able to accumulate a dividend income stream, which can cover over 50% of my expenses. This income stream is somewhat tax efficient, as the top rate on dividends is approximately 20%. In addition, the taxable brokerage accounts provide me with a lot of flexibility, as I can withdraw money at any time from my margin balance if I have a short term need for funds. I can also sell stocks short, sell naked puts and buy stocks on margin. I do not do those things, except for selling options, but it is nice to know you have options. I do have to pay taxes every year on the dividends I earn and capital gains I realize. However, if someone is just starting out in investing, I strongly encourage them to start small in a taxable account, while taking advantage of 401 (k) plan company matches. That way, any mistakes you make in your brokerage account will be deductible on your tax returns. The distribution stream from a taxable account will also provide you with a nice buffer of income when you build your early retirement dividend machine.

This dividend income stream is what will allow me to allocate so much money to max out my 401k and SEP IRA. Earlier this year, I discussed that I am now maxing out my 401k and am also planning on maxing out my SEP IRA. The goal of this exercise was to reduce the amount of taxes I pay each year. Unfortunately, I am not eligible to receive a tax deduction on the regular IRA at this time. I realized that I would much rather have a large amount of money sitting in a tax deferred account to my name, rather than pay taxes and receive no specific benefit attributable to me. I understand that in order to access this money I will have to jump through hoops such as early retirement penalties as high as 10%, in addition to paying ordinary income tax rates to withdraw the money before the age of 59.50 years. I will convert the 401k plan into a regular IRA at my retirement date, if I choose to leave current employer.

With 401k plans, there are limited investment options, such as index funds or target date funds. However, by rolling over the funds from a 401k to an IRA when I retire, I should be able to invest in individual stocks. Some 401k plans might also have a brokerage window, which would allow investors to buy individual stocks. I have to research to see if my provider offers this option, and what the costs associated with it are.

If I retire in five – six years, I can take out Substantially Equal Period Payments (SEPP) if I really needed to withdraw distributions from an IRA. It looks like the amount that I can take out in 5 years would be equivalent to somewhere close to 2.50% -3% of my net account value. If my dividend stocks in the IRA yield more than 2.50%, then I would essentially have a stream of income that would compound for life. I would essentially have distributions that are growing each year because companies are raising them, and also excess dividend checks would accumulate and would have to be invested into more shares. All of this money that is retained in the IRA would compound tax free for decades, until I reach the ripe age of 70.50 years. At that time I would have to take mandatory withdrawals, and pay ordinary taxes on it.

Relevant Articles:

- Check Out the complete Archive of Articles
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High Dividend Utility Stocks – Are they a trap for income investors?

Utility stocks have traditionally been seen as safe investments by retirees looking for high current income. The sector is well known for its rich dividend policies, as most companies in the group tend to distribute an above average portion of earnings out to shareholders in the form of dividends. As a result, most utility stocks end up paying above average yields to investors. It is not surprising then that many retired investors have preferred utility stocks for their high yields.

I own shares of two utility companies at the moment in my personal portfolio - Dominion Resources (D) and Con Edison (ED).

Dominion Resources, Inc. (D), together with its subsidiaries, engages in producing and transporting energy in the United States. This dividend achiever has raised distributions for 10 consecutive years. Over the past decade, distributions have been raised by 5%/year. The stock is trading at 16.80 times forward earnings and yields 4%.

Consolidated Edison, Inc. (ED), through its subsidiaries, engages in regulated electric, gas, and steam delivery businesses. This dividend champion has raised distributions for 39 consecutive years. Over the past decade, distributions have been raised by 0.90%/year. The stock is trading at 15.10 times forward earnings and yields 4.20%.  In 2012 I sold most of my stock in Con Edison and replaced it with ONEOK Partners (OKS). This remaining position in the stock accounts for 0.07% of my total portfolio size, because it is sitting in a legacy account, where the transactions costs and paperwork involved are prohibitively high in relation to the position size. As a result, I am better off simply sitting on it. Dominion accounts for 1.56% of total portfolio size.

The business model of a typical utility is pretty stable. Most publicly traded utilities are involved in the generation and/or transmission of electricity, natural gas or water. Utility companies are heavily regulated and have the monopoly to conduct their business over a certain geographic area. Governments have decided that competition for a service such as electricity would be too costly over a certain geographic area, and have thus granted the monopoly to the utility company. The corporation has to abide by the government regulations however, which limit how much prices can be increased and what target return on equity should be achieved. This creates a very stable business environment, which is characterized by consistent cash flows, and stable dividend payments. You would not see a utility company delivering double digit earnings increases over time, but you would also not see many utility companies going broke either.

Despite this stability, few utility companies have managed to have a long and meaningful records of dividend growth. I analyzed the dividend records of the companies comprising the Dow Jones Utilities average index, and noticed that most utility dividends do not tend to increase over time. It is evident that utility dividends tend to increase for a period of one or two decades, before the rise is interrupted followed by a steep cut in distributions. After the dividend cut, distributions start increasing once again, before reaching a high point, after which dividend growth stops or turns into dividend cuts again. This cyclical nature of utility dividends exposes investors to the ravages of inflation, since purchasing power of these distributions is eroding over time without any meaningful growth.

There are many reasons behind dividend cuts for utilities.  Some of them include nuclear disasters, failure to effectively deal with regulators, or failure to effectively pass on cost hikes to consumers.

Incidentally, because of the cyclical nature of dividend cuts and increases, utilities are one of the few sectors where it might make better sense to purchase after a dividend cut. For example, Con Edison suspended dividends in 1974, from the 11.25 cents/share paid every quarter. Later in 1974, the company initiated a quarterly dividend of 5 cents/share, which has been increased ever since. $1 invested in the company after the dividend elimination would have turned into over $350 over the next 39 years.

Most younger Americans do not remember the Three Miles Accident in 1979, which was a partial nuclear meltdown that occurred in one of the two United States Three Mile Island nuclear reactors in Dauphin County, Pennsylvania, on March 28, 1979. It was the worst accident in U.S. commercial nuclear power plant history. The project was operated by General Public Utilities (GPU), which cut dividends in 1979 and then suspended them in 1980. The dividend was not reinstated until 1986, but by 1992, the stock was up almost 9 times in value since the accident, and the dividend exceeded the amounts from before the accident. GPU is now part of FirstEnergy (FE).

That being said, utility companies could be good investments that can generate current income in retirement for retirees. However, always make sure you get the facts, prior to investing in utility companies. This involves reading annual reports, purchasing at attractive valuations and not over committing your portfolio allocation to this or any particular sector. At this moment however, I do not view utility companies as favorable investments as a group, because of their low current yields and low expected growth rates. If I had held utilities purchased at least several years ago at lower prices however, I would probably keep holding to these shares, although dividends would be either spent or allocated elsewhere.

Full Disclosure: Long OKS,ED, D.

Relevant Articles:

- Why I am replacing ConEdison (ED) with ONEOK Partners
- Utility dividends for current income
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- Dividend Champions - The Best List for Dividend Investors
- Reinvest Dividends Selectively