One of the assets that a typical middle class person owns is their house. Houses are purchased with approximately 20% down or less. People usually get a mortgage for the remainder, and they pay the credit off for 30 years. The house provides shelter to the family that purchased it, and hopefully its price keeps up with inflation. Houses however cost a lot of time and money, including renovations, property taxes etc.
With stocks however, regular investors rarely go into debt to purchase partial ownerships of companies. This could be attributed to several factors such as lack of desire to invest in stocks in the first place, the lack of understanding of margin and the higher interest rates paid on stocks with borrowed money. Dividend stocks on the other hand pay you money and you can offset interest expense against dividend income.
Stocks are usually valued mark to market in a brokerage account. If they fall in value the broker would require more money as collateral. This is the dreaded margin call where we either need to add more money or the broker would sell your position. Stock prices fluctuate daily, and as a result if one were to invest $1000 in shares of Procter & Gamble (PG), and bought $1000 more on margin they could end up with nothing if the stock price fell by 50%. If your house value fell by 50%, the mortgage company wouldn't require more money as collateral. They would not repossess your house, unless you are really late on your payment.
Another reason why investing with borrowed money is not popular is because interest rates on margin loans are usually very high. Many brokers charge over 6% presently, which is very high in the current interest rate environment. Only a few brokers, such as Interactive Brokers have margin rates at around 1%. In addition, margin interest rates are also not fixed, but variable. While interest rates are expected to remain low until 2014 - 2015, an increase in the benchmark rate would likely increase the cost of interest rates on margin loans. This could reduce investor returns as a result.
By using borrowed money to purchase dividend stocks, investors can magnify their dividend income significantly. For example, an investor with $100,000 in dividend paying stocks yielding 3% will generate $3,000 in annual dividend income. If they were to buy $100,000 in dividend stocks on margin, they would end up paying around 1.67%/year to a broker like Interactive Brokers, and increase dividend income to $4,330/year. This strategy can work for investors in the accumulation phase, as it could speed up the accumulation of dividend paying shares and compounding of dividend income.
In order to minimize risks mentioned above, an investor should use an adequate margin of safety with leveraged dividend investing. This would means that they should not borrow more than 25% – 30% from their account for margin investments. This would protect the investor from margin calls even if stock prices fell by 50%.
In addition, investors in the accumulation phase should have a plan to pay off their margin loans from their expected monthly contributions to their portfolio within 4- 5 years.
For example let’s assume that our investor with the $100,000 portfolio plans on adding $12,000/year for the next five years. This means that if they purchased $25,000 on margin, they could pay it off within 2 years simply by sticking to their regular investment schedule. However, by using a low cost margin loan, they would be accelerating their dividend compounding process.
In my personal portfolio, I sometimes purchase shares on margin when I see good values in the market. For example, if my portfolio was worth $100,000, and my lot size was $1,000, I might spend $2,000 - $3,000 on 2 – 3 stocks that looked attractive. I would then pay off the margin in a few weeks. I always pay my margin within a couple weeks however, as I use it to scoop up shares that are temporarily beaten down, while waiting for my paycheck to get deposited.
In the past month, I purchased shares of Target (TGT) and Becton Dickinson (BDX) on margin. However, as of this time, the margin has been repaid.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has rewarded shareholders with higher dividends for 46 years in a row. Over the past decade, Target has managed to raise dividends by 18.60%/year. Currently, the stock is attractively valued at 16 times earnings and yields 2.60%. Check my analysis of Target for more details.
Becton, Dickinson and Company (BDX), a medical technology company, develops, manufactures, and sells medical devices, instrument systems, and reagents worldwide. This dividend champion has rewarded shareholders with higher dividends for 42 years in a row. Over the past decade, Target has managed to raise dividends by 16.80%/year. Currently, the stock is attractively valued at 16.70 times earnings and yields 2%. Check my analysis of Becton Dickinson for more details.
I am also playing around with Loyal3, which lets you buy shares with a credit card, commission free. If you time your monthly purchases there, you can essentially get an interest free loan for almost 6 - 8 weeks, while also earning credit card rewards points. In addition, Loyal3 allows investors to buy shares with as little as $10 per each investment.
Full Disclosure: Long TGT, BDX, PG,
Relevant Articles:
- Dividend Investors are Getting Paid for Holding Dividend Paying Stocks
- Reinvesting Dividends Pays Off
- What to do about those rising stock prices?
- How to buy dividend stocks with as little as $10
- Check the Complete Article Archive
Wednesday, December 18, 2013
Monday, December 16, 2013
Five Dividend Payers to Consider for 2014 and beyond
Many investors find it difficult to put more money in the stock market nowadays, given the rapid rise in stock prices this year. As stock indexes are hitting all-time-highs several times in 2013, it is very difficult to commit when you have talks of ending the stimulus, which could potentially cripple the already fragile economic recovery.
As a dividend investor, I do not pay attention to these items. Despite all of those negative factors, there are attractively valued companies in almost any market environment. The current one is no exception. I focus my attention on picking individual securities in businesses I understand, rather than the overall macroeconomic factors. I try to uncover companies which have strong competitive advantages, trade at fair valuations, and have catalysts for long term growth. I then buy them, and plan on holding them forever.
The goal of dividend investing is to generate a rising stream of income in order to pay monthly expenses. Dividend income is always positive and is more stable than capital gains, which makes it a preferred way to live off your portfolio. With dividend investing, your retirement income is not reliant on the wild swings of stock prices, unlike traditional asset depleting strategies like the four percent rule.
In other words, with dividend paying stocks you earn a positive return on your money no matter if the stock price goes up or down. The beauty of dividend growth stocks is that by regularly growing dividends, they provide investors with more cash over time, which also makes the stock more valuable to investors at the same time. As a result, a company that yields 3% today but grows dividends by 10%/year, would yield 6% on cost in 7 years and 12% on cost in 14 years.
I am finding value in the following companies, which have strong recognizable brands, sell at fair valuations and could increase earnings over the next 15 – 20 years. I believe that each one of these companies would be a very good addition to a diversified dividend portfolio. As mentioned above, these companies would be great long term holdings to hold “forever”. They are selling at good prices to acquire today, and are good candidates for holding in 2014 and for a long time after that.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has raised dividends for 46 years in a row. Over the past decade, Target has managed to boost dividends by 18.60%/year. Currently, the stock trades at 17 times earnings and yields 2.70%. Check my analysis of Target for more information about the company.
General Mills, Inc. (GIS) produces and markets branded consumer foods in the United States and internationally. This dividend achiever has raised dividends for 10 years in a row. Over the past decade, General Mills has managed to boost dividends by 8.70%/year. Currently, the stock trades at 17.70 times forward earnings and yields 2.90%. Check my analysis of General Mills for more information about the company.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend champion has raised dividends for 46 years in a row. Since the spin-off from parent Altria Group in 2008, Philip Morris International has managed to boost dividends by 15%/year. Currently, the stock trades at 16.30 times earnings and yields 4.40%. Check my analysis of PMI for more information about the company.
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. This dividend champion has raised dividends for 38 years in a row. Over the past decade, McDonald’s has managed to boost dividends by 28.40%/year. Currently, the stock trades at 17.30 times earnings and yields 3.30%. Check my analysis of McDonald’s for more information about the company.
Realty Income Corporation (O) is a publicly traded real estate investment trust. This dividend achiever has raised dividends for 19 years in a row. Over the past decade, Realty Income has managed to boost dividends by 4.20%/year. Currently, the stock trades at 15.60 times Funds from Operations (FFO) and yields 5.90%. Check my analysis of Realty Income for more information about the company.
Full Disclosure: I have a position in all the companies listed above
Relevant Articles:
- Check the Complete Article Archive
- What to do about those rising stock prices?
- How to invest when the market is at all time highs?
- The right time to sell dividend stocks
- Why would I not sell dividend stocks even after a 1000% gain?
As a dividend investor, I do not pay attention to these items. Despite all of those negative factors, there are attractively valued companies in almost any market environment. The current one is no exception. I focus my attention on picking individual securities in businesses I understand, rather than the overall macroeconomic factors. I try to uncover companies which have strong competitive advantages, trade at fair valuations, and have catalysts for long term growth. I then buy them, and plan on holding them forever.
The goal of dividend investing is to generate a rising stream of income in order to pay monthly expenses. Dividend income is always positive and is more stable than capital gains, which makes it a preferred way to live off your portfolio. With dividend investing, your retirement income is not reliant on the wild swings of stock prices, unlike traditional asset depleting strategies like the four percent rule.
In other words, with dividend paying stocks you earn a positive return on your money no matter if the stock price goes up or down. The beauty of dividend growth stocks is that by regularly growing dividends, they provide investors with more cash over time, which also makes the stock more valuable to investors at the same time. As a result, a company that yields 3% today but grows dividends by 10%/year, would yield 6% on cost in 7 years and 12% on cost in 14 years.
I am finding value in the following companies, which have strong recognizable brands, sell at fair valuations and could increase earnings over the next 15 – 20 years. I believe that each one of these companies would be a very good addition to a diversified dividend portfolio. As mentioned above, these companies would be great long term holdings to hold “forever”. They are selling at good prices to acquire today, and are good candidates for holding in 2014 and for a long time after that.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has raised dividends for 46 years in a row. Over the past decade, Target has managed to boost dividends by 18.60%/year. Currently, the stock trades at 17 times earnings and yields 2.70%. Check my analysis of Target for more information about the company.
General Mills, Inc. (GIS) produces and markets branded consumer foods in the United States and internationally. This dividend achiever has raised dividends for 10 years in a row. Over the past decade, General Mills has managed to boost dividends by 8.70%/year. Currently, the stock trades at 17.70 times forward earnings and yields 2.90%. Check my analysis of General Mills for more information about the company.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend champion has raised dividends for 46 years in a row. Since the spin-off from parent Altria Group in 2008, Philip Morris International has managed to boost dividends by 15%/year. Currently, the stock trades at 16.30 times earnings and yields 4.40%. Check my analysis of PMI for more information about the company.
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. This dividend champion has raised dividends for 38 years in a row. Over the past decade, McDonald’s has managed to boost dividends by 28.40%/year. Currently, the stock trades at 17.30 times earnings and yields 3.30%. Check my analysis of McDonald’s for more information about the company.
Realty Income Corporation (O) is a publicly traded real estate investment trust. This dividend achiever has raised dividends for 19 years in a row. Over the past decade, Realty Income has managed to boost dividends by 4.20%/year. Currently, the stock trades at 15.60 times Funds from Operations (FFO) and yields 5.90%. Check my analysis of Realty Income for more information about the company.
Full Disclosure: I have a position in all the companies listed above
Relevant Articles:
- Check the Complete Article Archive
- What to do about those rising stock prices?
- How to invest when the market is at all time highs?
- The right time to sell dividend stocks
- Why would I not sell dividend stocks even after a 1000% gain?
Friday, December 13, 2013
Kellogg Company (K) Dividend Stock Analysis
Kellogg Company (K), together with its subsidiaries, manufactures and markets ready-to-eat cereal and convenience food products primarily in North America, Europe, Latin America, and the Asia Pacific. The company has paid dividends since 1925 and has increased them for nine years in a row. Between 1960 and 2001, the company had raised annual dividends every year. However it kept dividends unchanged between 2002 and 2004, this ending the long streak of consecutive dividend increases.
The company’s last dividend increase was in April 2013 when the Board of Directors approved a 4.50 % increase in the quarterly annual dividend to 46 cents /share. The company’s peer group includes Nestle Group (NSRGY), General Mills (GIS), Campbell Soup (CPB) and Hershey (HSY).
Over the past decade this dividend growth stock has delivered an annualized total return of 8.40% to its shareholders.
The company has managed to deliver a 3.70% average increase in annual EPS between 2003 and 2012. The company is expected to earn $3.77 per share in 2013 and $4.06 per share in 2014. In comparison, the company earned $2.67/share in 2012. The low earnings were the result of a one-time accounting hit of 85 cents/share, related to a change in accounting for pensions.
The board of directors authorized a $1 billion stock repurchase program in April 2013, which expires in April 2014. At current prices, it can result in the retirement of as much as 4% of shares outstanding.
An interesting fact about Kellogg is that the Kellogg WK Foundation Trust owns approximately 20.60% of shares outstanding. This is a great example of a trust fund, which has been “living off dividends” for several decades. In fact, the trust is projected to earn over $136 million in annual dividend income from their ownership of Kellogg shares.
I also found another hidden dividend millionaire after researching Kellogg. Agnes Plumb inherited Kellogg stock from her father, who was one of the early investors in the company. When she died in 1996,she left almost $100 million worth of Kellogg stock to charity.
The company has strong brand names like Special K, Frosted Flakes, Corn Flakes, Pop-Tarts, Pringles etc, and it continuously invests to strengthen them. Another source of growth could include product innovation. The firm has invested approximately 2% of sales on R&D over the past two years.
Kellogg can increase earnings through new acquisitions, such as the purchase of Pringles from Procter & Gamble (PG) in 2012 for almost $2.7 billion in cash. This purchase could be a strong platform for international growth that Kellogg’s snack business can definitely benefit from. Other historical acquisitions include Kashi in 2000.
The US accounts for 2/3rds of sales in 2012. A potential opportunity for growth could materialize in emrging markets, where the company is lagging behind competitors right now. In 2012, Kellogg also announced a joint venture with Wilmar International, which would make snack foods in China. Wilmar will contribute infrastructure, supply chain scale, an extensive sales and distribution network in China, as well as local China market expertise to the joint venture. Kellogg will contribute a portfolio of globally recognized brands and products such as Kellogg and Pringles, along with deep cereal and snacks category expertise.
Kellogg has a very high return on equity at 46%. Over the past decade, the returns on equity have stayed between 43% and 67%. 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 5.60% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 6% growth in distributions translates into the dividend payment doubling almost every 12 years on average. If we look at historical data, going as far back as 1959, one would notice that the company has managed to double distributions every eight years on average.
The dividend payout ratio has increased from 52% in 2003 to almost 65% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 49%. 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 Kellogg is attractively valued at 16.10 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been rather slow in the past decade. I am planning to add to the stock in the next year, subject to availability of funds. However, if a faster growth company like General Mills is available at comparable valuations at the time I have available funds, I would choose General Mills instead.
Full Disclosure: Long K, GIS, NSRGY
Relevant Articles:
- Check the Complete Article Archive
- Nestle (NSRGY): A Global Dividend Powerhouse
- General Mills (GIS) Dividend Stock Analysis
- Dividend income is more stable than capital gains
- What is Dividend Growth Investing?
The company’s last dividend increase was in April 2013 when the Board of Directors approved a 4.50 % increase in the quarterly annual dividend to 46 cents /share. The company’s peer group includes Nestle Group (NSRGY), General Mills (GIS), Campbell Soup (CPB) and Hershey (HSY).
Over the past decade this dividend growth stock has delivered an annualized total return of 8.40% to its shareholders.
The company has managed to deliver a 3.70% average increase in annual EPS between 2003 and 2012. The company is expected to earn $3.77 per share in 2013 and $4.06 per share in 2014. In comparison, the company earned $2.67/share in 2012. The low earnings were the result of a one-time accounting hit of 85 cents/share, related to a change in accounting for pensions.
The board of directors authorized a $1 billion stock repurchase program in April 2013, which expires in April 2014. At current prices, it can result in the retirement of as much as 4% of shares outstanding.
An interesting fact about Kellogg is that the Kellogg WK Foundation Trust owns approximately 20.60% of shares outstanding. This is a great example of a trust fund, which has been “living off dividends” for several decades. In fact, the trust is projected to earn over $136 million in annual dividend income from their ownership of Kellogg shares.
I also found another hidden dividend millionaire after researching Kellogg. Agnes Plumb inherited Kellogg stock from her father, who was one of the early investors in the company. When she died in 1996,she left almost $100 million worth of Kellogg stock to charity.
The company has strong brand names like Special K, Frosted Flakes, Corn Flakes, Pop-Tarts, Pringles etc, and it continuously invests to strengthen them. Another source of growth could include product innovation. The firm has invested approximately 2% of sales on R&D over the past two years.
Kellogg can increase earnings through new acquisitions, such as the purchase of Pringles from Procter & Gamble (PG) in 2012 for almost $2.7 billion in cash. This purchase could be a strong platform for international growth that Kellogg’s snack business can definitely benefit from. Other historical acquisitions include Kashi in 2000.
The US accounts for 2/3rds of sales in 2012. A potential opportunity for growth could materialize in emrging markets, where the company is lagging behind competitors right now. In 2012, Kellogg also announced a joint venture with Wilmar International, which would make snack foods in China. Wilmar will contribute infrastructure, supply chain scale, an extensive sales and distribution network in China, as well as local China market expertise to the joint venture. Kellogg will contribute a portfolio of globally recognized brands and products such as Kellogg and Pringles, along with deep cereal and snacks category expertise.
Kellogg has a very high return on equity at 46%. Over the past decade, the returns on equity have stayed between 43% and 67%. 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 5.60% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 6% growth in distributions translates into the dividend payment doubling almost every 12 years on average. If we look at historical data, going as far back as 1959, one would notice that the company has managed to double distributions every eight years on average.
The dividend payout ratio has increased from 52% in 2003 to almost 65% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 49%. 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 Kellogg is attractively valued at 16.10 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been rather slow in the past decade. I am planning to add to the stock in the next year, subject to availability of funds. However, if a faster growth company like General Mills is available at comparable valuations at the time I have available funds, I would choose General Mills instead.
Full Disclosure: Long K, GIS, NSRGY
Relevant Articles:
- Check the Complete Article Archive
- Nestle (NSRGY): A Global Dividend Powerhouse
- General Mills (GIS) Dividend Stock Analysis
- Dividend income is more stable than capital gains
- What is Dividend Growth Investing?
Wednesday, December 11, 2013
Dividends Provide a Tax-Efficient Form of Income
A famous saying goes that there are two things certain in this world: death and taxes. While I am pretty sure I can’t escape death, I know that I can try to legally minimize taxes as much as possible. I hate paying more taxes than I have to. In a previous series of articles I discussed how I am maxing out tax-deferred accounts today, in order to minimize my tax liabilities as much as possible. In addition, I am trying to get a deduction today, and then roll these amounts into Roth and try to pay as close to zero percent on the conversion as possible. The amounts in tax-deferred accounts will be the tip of the iceberg, or the “safety net” in case my main strategy experiences turbulence. In effect, these tax-deferred accounts are equivalent to an emergency fund for my retirement.
However, I think I didn't stress enough the fact that most of my income in retirement would be coming from qualified dividends. This will be my bread and butter, because dividends provide the best tax-efficient method of income in the US.
Did you know that if you were single, and your taxable income does not exceed $36,250 in 2013, you would owe zero dollars in Federal taxes on your qualified dividend income? If you were married, filing jointly, you won’t owe a dime in taxes on qualified dividends at the Federal level as long as your taxable income does not exceed $72,500.
This means that if you are single, living on your own, and only claiming yourself as a dependent, you can essentially make $46,250 in annual qualified dividend income, and pay zero taxes on that. This includes the Standard Deduction of $6,100 and the Personal Exemption of $3,900. This calculation also assumes you have no other sources of income and no other deductions for the sake of simplicity and to illustrate the point. In order for you to generate so much in income, your portfolio would likely be worth anywhere between $1.321 million and $1.542 million at yields between 3% – 3.50%. If you made your selections wisely, your dividend income should at least keep up with inflation over time. With most dividend growth stocks, I expect a 6% annual dividend increase in the long run, ahead of the annual inflation rate of 3%.
This net dividend income for the single individual above is equivalent to $58,900 in salary earnings. In other words, if you are single, it would take you to earn $58,900 from a day job in order to end up with the same amount of net income that the same individual can achieve with “only” $46,250 in qualified dividend income. And you were wondering why Warren Buffett’s secretary is so vocal about her bosses taxes.
Let’s see how this translates for a married couple, filing jointly, without any kids, mortgages and student loans. They could essentially earn $92,500 in annual qualified dividend income, before owing a single cent to the Federal government in 2013. This includes two standard deductions and two personal exemptions in the tax return. In order for this couple to generate so much in income, their dividend growth portfolio would likely be worth anywhere between $2.643 million and $3.083 million at yields between 3% – 3.50%.
This net dividend income for the married individuals above is equivalent to $117,800 in salary earnings. In other words, if you are married with no children, it would take the couple to earn $117,800 from a day job in order to end up with the same amount of net income they can achieve with “only” $92,500 in qualified dividend income.
For the sake of simplicity, and to illustrate a point about the tax efficiency of dividends, I have compared salary only income versus dividend only income. The tax code is so complicated, that it would probably take me years and hundreds of pages before I can explain every single possible scenario affecting those sample single and married individuals.
I claim that the dividend income is the most efficient form of income in the US, because it can increase over time to compensate for inflation. With municipal bonds, you do not pay any income tax, no matter how much you make. However, since your income is fixed, your “real” purchasing power is decreasing over time. As a result, you are worse off than with dividend stocks over extended periods of time.
I should also mention that ordinary dividend income is taxed like ordinary income. Luckily, this type of dividends are not taxed at the FICA level. Examples of ordinary dividend income includes the income sent your way by Real Estate Investment trusts, net of any depreciation for example. Each REIT has a different tax picture, which also varies every year. I didn’t include these into my scenario above, because I didn’t want to overly complicate something that was already complicated. But feel free to play it out safely at home. If you do not believe me, you can check the website of National Retail Properties (NNN) at this link.
I purposefully also avoided included MLP distributions, because these are even hairier at tax time. These distributions might not even be taxable to you as long as your cost basis is above zero.
Foreign dividends are another type of income which is taxed usually as qualified dividends. The twist is that some governments withhold the tax at the source, which entitles you to a credit. Therefore, if you paid $15 in dividend taxes to Canada on your $100 dividend check from Canadian National Railway (CNI), you don’t also have to pay Uncle Sam $15 additional dollars in dividend income. You can essentially get a credit for this. If you are single earning under $46,250 in dividend income, you might even get a check in the mail for $15.
Full Disclosure: I am not a tax advisor, and this article should not be considered as individual tax advice. Please discuss your individual tax situation with a licensed CPA. I have no position in the companies listed above.
Relevant Articles:
- Best International Dividend Stocks
- My Retirement Strategy for Tax-Free Income
- How to Retire Early With Tax-Advantaged Accounts
- Six Dividend Paying Stocks I Purchased for my IRA
- Should income investors worry about higher dividend taxes?
However, I think I didn't stress enough the fact that most of my income in retirement would be coming from qualified dividends. This will be my bread and butter, because dividends provide the best tax-efficient method of income in the US.
Did you know that if you were single, and your taxable income does not exceed $36,250 in 2013, you would owe zero dollars in Federal taxes on your qualified dividend income? If you were married, filing jointly, you won’t owe a dime in taxes on qualified dividends at the Federal level as long as your taxable income does not exceed $72,500.
This means that if you are single, living on your own, and only claiming yourself as a dependent, you can essentially make $46,250 in annual qualified dividend income, and pay zero taxes on that. This includes the Standard Deduction of $6,100 and the Personal Exemption of $3,900. This calculation also assumes you have no other sources of income and no other deductions for the sake of simplicity and to illustrate the point. In order for you to generate so much in income, your portfolio would likely be worth anywhere between $1.321 million and $1.542 million at yields between 3% – 3.50%. If you made your selections wisely, your dividend income should at least keep up with inflation over time. With most dividend growth stocks, I expect a 6% annual dividend increase in the long run, ahead of the annual inflation rate of 3%.
This net dividend income for the single individual above is equivalent to $58,900 in salary earnings. In other words, if you are single, it would take you to earn $58,900 from a day job in order to end up with the same amount of net income that the same individual can achieve with “only” $46,250 in qualified dividend income. And you were wondering why Warren Buffett’s secretary is so vocal about her bosses taxes.
Let’s see how this translates for a married couple, filing jointly, without any kids, mortgages and student loans. They could essentially earn $92,500 in annual qualified dividend income, before owing a single cent to the Federal government in 2013. This includes two standard deductions and two personal exemptions in the tax return. In order for this couple to generate so much in income, their dividend growth portfolio would likely be worth anywhere between $2.643 million and $3.083 million at yields between 3% – 3.50%.
This net dividend income for the married individuals above is equivalent to $117,800 in salary earnings. In other words, if you are married with no children, it would take the couple to earn $117,800 from a day job in order to end up with the same amount of net income they can achieve with “only” $92,500 in qualified dividend income.
I claim that the dividend income is the most efficient form of income in the US, because it can increase over time to compensate for inflation. With municipal bonds, you do not pay any income tax, no matter how much you make. However, since your income is fixed, your “real” purchasing power is decreasing over time. As a result, you are worse off than with dividend stocks over extended periods of time.
I should also mention that ordinary dividend income is taxed like ordinary income. Luckily, this type of dividends are not taxed at the FICA level. Examples of ordinary dividend income includes the income sent your way by Real Estate Investment trusts, net of any depreciation for example. Each REIT has a different tax picture, which also varies every year. I didn’t include these into my scenario above, because I didn’t want to overly complicate something that was already complicated. But feel free to play it out safely at home. If you do not believe me, you can check the website of National Retail Properties (NNN) at this link.
I purposefully also avoided included MLP distributions, because these are even hairier at tax time. These distributions might not even be taxable to you as long as your cost basis is above zero.
Foreign dividends are another type of income which is taxed usually as qualified dividends. The twist is that some governments withhold the tax at the source, which entitles you to a credit. Therefore, if you paid $15 in dividend taxes to Canada on your $100 dividend check from Canadian National Railway (CNI), you don’t also have to pay Uncle Sam $15 additional dollars in dividend income. You can essentially get a credit for this. If you are single earning under $46,250 in dividend income, you might even get a check in the mail for $15.
Full Disclosure: I am not a tax advisor, and this article should not be considered as individual tax advice. Please discuss your individual tax situation with a licensed CPA. I have no position in the companies listed above.
Relevant Articles:
- Best International Dividend Stocks
- My Retirement Strategy for Tax-Free Income
- How to Retire Early With Tax-Advantaged Accounts
- Six Dividend Paying Stocks I Purchased for my IRA
- Should income investors worry about higher dividend taxes?
Tuesday, December 10, 2013
These three ideas can jeopardize your investing success
I have been writing about dividend investing on my website since 2008. This was a very tumultuous period for investors, which included sharp drops in prices through 2009, followed by a relentless recovery in stock prices ever since. As someone who gets a lot of interaction with regular investors through my website, I get to develop an understanding of popular investor sentiment almost at all times.
As a long term investor, I find overall investor sentiment to be counterproductive for me, because it removes my focus on what really matters for my investing strategy. In my strategy, I try to acquire tiny pieces of ownership at attractive valuations, in large established dividend growing companies . These companies usually have a product or service that is unique and which customers purchase repeatedly. Many of these products are essentials that people use on an everyday basis, and are therefore relatively immune to recessions. The goal is also to purchase businesses that I can understand, and that would still be there in 20 years, while maintaining a strong competitive position. I also try to determine whether there are any catalysts that would bring more earnings per share and hopefully more dividends in 10 – 20 years. I expect to hold on to these companies for decades, or until something material changes that would make me want to sell. As such, I do not try forecast the direction of the stock market. In order to make my living. I simply have to find enough quality businesses selling at fair prices, and put my capital there.
My success as an investor will depend on the overall level of success of the collection of businesses I partially own in my portfolio. For example, if Colgate Palmolive (CL) manages to sell more toothpaste in 20 – 30 years, it would likely earn more and pay higher dividends to me. In addition, if the rising number of babies in the US and China translates into the need for more diapers every year, Procter & Gamble (PG) would be able to sell more to new mothers. This is the type of things you should focus on as a long-term investor. In contrast, a lot of investors try to forecast interest rates, economic growth, quarterly earnings and so forth. This might be helpful for anyone who actively trades the markets, but is pretty useless for me as an investor in businesses.
Ever since the end of 2009, the common sentiment I have heard from investors is that stocks are too high. I have been hearing that at least several times per year since then. There is always “a reason” why stocks as a whole should not go up. So far in 2013, I have been hearing that non-stop. Two indicators that many investors seems to be using as a reason to avoid stocks these days are the market capitalization to GDP ratio, and the Schiller CAPE Ratio. The last item I will discuss are perma-bears, and the dangers they pose for long-term investors.
The market capitalization to GDP indicator is calculated by dividing the total US market capitalization to the level of GDP. Extremely high levels are supposed to have predicted the 1929 stock market collapse. However, I do not subscribe to this black magic for a few reasons. The first is that the increase in this ratio might not mean anything, especially as we have an increased financialization of assets. Estimated wealth in the US is approximately 3- 4 times the level of GDP or Market capitalization. If all the office buildings or rental units are no longer owned by private landlords, but are owned by publicly traded companies listed on NYSE, this would increase the Market Cap to GDP ratio. Therefore, all the increase in Market Cap to GDP ratio would show is that most of the wealth is now listed on a stock exchange. The second reason I believe that the Market cap to GDP is not useful these days, is because a large portion of US company profits are generated outside the US. For example, the ten largest components of S&P 500 derive almost half of sales from outside the US. In reality, I am not sure why any change in the market capitalization to GDP would mean anything of value to the dividend investor. A dividend investor should look at individual companies, and how their business is doing, and not make a macro bet on things.
I also don’t follow Shillers Cyclically Adjusted P/E Ratio (CAPE), because it gives value to earnings which happened 10 years ago. For example, if a stock earned $50/share starting in 2004 for 5 years, but for past 5 years earns $100/share and EPS is relatively sustainable, should the stock be valued at 15 times times $75 (average of EPS over the past decade) or 15 times $100? This indicator has had stocks overvalued for several years since 2009, and currently is close to 25. In reality, S&P 500 has a P/E ratio of 18 or 19 times earnings, which got a little overstretched in 2013. Based on forward estimate however, the P/E ratio on stocks in general looks fair. However, as an individual investor, my goal is to pick individual stocks, not have opinions on everything that is publicly traded on a stock exchange.
To put it in layman terms, in my previous job, new hires started at $48,000/year. Approximately 10 years before, the starting salary was $36,000/year. During recruiting, the potential new hires never asked the recruiter what the salary was five or ten years ago. All they cared about is the income they will make this year.
I do agree that starting valuations have an impact on the returns an investor will generate. For example, if you paid 30 or 40 times this or next year’s earnings even for a blue chip stock like Coca-Cola (KO) or Wal-Mart Stores (WMT), you would not do very well. This is because your initial dividend yield will be ridiculously low, and the price you paid would have all the growth for the next decade already baked into it. In the case of Coca-Cola and Wal-Mart investors, who overpaid in 1999 – 2000, earned low returns over the subsequent decade. This was despite the fact that the underlying businesses produced stellar operating results during the same time period. In addition, one should focus on the current and future ability of the business to generate profits, and not focus on profits that were generated 5 or 10 years ago.
That being said, I can find fewer good candidates to buy today than a year ago. However, there are few alternatives to stocks today, especially when fixed income securities won’t cover even a minimal increase in inflation.
Another item I always choose to ignore are opinions from Perma-Bears. Perma-Bears are those highly intelligent analysts, who unfortunately always forecast doom and gloom. You can always find a perma-bear that would give you the reasons why stocks are going to crash by 50-80% - just pick a number. Now it is entirely possible that stock prices collapse and this triggers an economic contraction. However, the US economy is resilient and diversified, and US policy makers have managed to step up to the plate in difficult conditions to help out. Therefore, if we are lucky enough to get a stock market crash, this would be a short term opportunity for long-term investors to load up on quality companies at depressed prices. I believe that the future will bring in more people, more innovations, and a higher standard of living for humans. I see billions of people that are going to be lifted out of poverty over the 21st century. These people are very motivated to work hard and achieve their dreams, and lift themselves out of the poverty that previous generations lived under.
Every morning, several billion people wake-up, and ask themselves how to live better lives for themselves, their families and their communities. If you believe that social order as we know it will collapse, and you are stocking up on guns, ammunition and gold, then chances are you will never be wealthy. Even at the super unlikely event that this happens, you will not do well, because the guns and gold can and would be taken away from you by a stronger opponent. Even for those milder forecasts of a mere depression coupled with stock market crashes, these occur only a few times per century. Are you willing to be wrong for 30 years in a row and miss out on a few thousand percent of gains, for the ability to predict a mere 50% crash? If you look at a long-term chart of Dow Jones Industrial's over the past century, you would see the 1929 – 1932 crash as a mere blip on that chart.
Don’t be perma bull either. Be realist, and put money in opportunities where you stand to have a chance to make more than what you put in. Even in 1999-2000, there were pockets of opportunity for enterprising dividend investors. While difficult than a year ago, one can still find pockets of opportunity today also. You just have to look harder, and be able to capitalize on the rare selloffs.
There are some investors who have been patiently waiting for a 40-50% crash FOR FIVE YEARS, and thus have ended up missing out on the recovery. Even if stocks did crash by 40% tomorrow, their performance would still lag a buy and hold of an index fund. There are a few perma-bears, who supposedly forecasted the 1987 stock market crash. Over the past 26 years however, I think they have continued being bearish. I don’t think you should be bearish on America if you are a long term investor. I also do not understand how someone can afford to lose money for a quarter century, and still be quoted in mainstream media.
As I discussed in my article from yesterday, investors should be very careful about taking other's opinions at face value. You need to weigh in the credibility of this opinion, against relevant facts, before making a decision of whether it needs to be taken seriously or not.
Full Disclosure: Long CL, PG, KO, WMT
Relevant Articles:
- Check the Complete Article Archive
-Living off dividends in retirement
- Dividends and The Great Depression
- Dividend Cuts - the worst nightmare for dividend investors
- Six things I learned from the financial crisis
As a long term investor, I find overall investor sentiment to be counterproductive for me, because it removes my focus on what really matters for my investing strategy. In my strategy, I try to acquire tiny pieces of ownership at attractive valuations, in large established dividend growing companies . These companies usually have a product or service that is unique and which customers purchase repeatedly. Many of these products are essentials that people use on an everyday basis, and are therefore relatively immune to recessions. The goal is also to purchase businesses that I can understand, and that would still be there in 20 years, while maintaining a strong competitive position. I also try to determine whether there are any catalysts that would bring more earnings per share and hopefully more dividends in 10 – 20 years. I expect to hold on to these companies for decades, or until something material changes that would make me want to sell. As such, I do not try forecast the direction of the stock market. In order to make my living. I simply have to find enough quality businesses selling at fair prices, and put my capital there.
My success as an investor will depend on the overall level of success of the collection of businesses I partially own in my portfolio. For example, if Colgate Palmolive (CL) manages to sell more toothpaste in 20 – 30 years, it would likely earn more and pay higher dividends to me. In addition, if the rising number of babies in the US and China translates into the need for more diapers every year, Procter & Gamble (PG) would be able to sell more to new mothers. This is the type of things you should focus on as a long-term investor. In contrast, a lot of investors try to forecast interest rates, economic growth, quarterly earnings and so forth. This might be helpful for anyone who actively trades the markets, but is pretty useless for me as an investor in businesses.
Ever since the end of 2009, the common sentiment I have heard from investors is that stocks are too high. I have been hearing that at least several times per year since then. There is always “a reason” why stocks as a whole should not go up. So far in 2013, I have been hearing that non-stop. Two indicators that many investors seems to be using as a reason to avoid stocks these days are the market capitalization to GDP ratio, and the Schiller CAPE Ratio. The last item I will discuss are perma-bears, and the dangers they pose for long-term investors.
The market capitalization to GDP indicator is calculated by dividing the total US market capitalization to the level of GDP. Extremely high levels are supposed to have predicted the 1929 stock market collapse. However, I do not subscribe to this black magic for a few reasons. The first is that the increase in this ratio might not mean anything, especially as we have an increased financialization of assets. Estimated wealth in the US is approximately 3- 4 times the level of GDP or Market capitalization. If all the office buildings or rental units are no longer owned by private landlords, but are owned by publicly traded companies listed on NYSE, this would increase the Market Cap to GDP ratio. Therefore, all the increase in Market Cap to GDP ratio would show is that most of the wealth is now listed on a stock exchange. The second reason I believe that the Market cap to GDP is not useful these days, is because a large portion of US company profits are generated outside the US. For example, the ten largest components of S&P 500 derive almost half of sales from outside the US. In reality, I am not sure why any change in the market capitalization to GDP would mean anything of value to the dividend investor. A dividend investor should look at individual companies, and how their business is doing, and not make a macro bet on things.
Source: Barry Ritholz
Source: Multipl
To put it in layman terms, in my previous job, new hires started at $48,000/year. Approximately 10 years before, the starting salary was $36,000/year. During recruiting, the potential new hires never asked the recruiter what the salary was five or ten years ago. All they cared about is the income they will make this year.
I do agree that starting valuations have an impact on the returns an investor will generate. For example, if you paid 30 or 40 times this or next year’s earnings even for a blue chip stock like Coca-Cola (KO) or Wal-Mart Stores (WMT), you would not do very well. This is because your initial dividend yield will be ridiculously low, and the price you paid would have all the growth for the next decade already baked into it. In the case of Coca-Cola and Wal-Mart investors, who overpaid in 1999 – 2000, earned low returns over the subsequent decade. This was despite the fact that the underlying businesses produced stellar operating results during the same time period. In addition, one should focus on the current and future ability of the business to generate profits, and not focus on profits that were generated 5 or 10 years ago.
That being said, I can find fewer good candidates to buy today than a year ago. However, there are few alternatives to stocks today, especially when fixed income securities won’t cover even a minimal increase in inflation.
Another item I always choose to ignore are opinions from Perma-Bears. Perma-Bears are those highly intelligent analysts, who unfortunately always forecast doom and gloom. You can always find a perma-bear that would give you the reasons why stocks are going to crash by 50-80% - just pick a number. Now it is entirely possible that stock prices collapse and this triggers an economic contraction. However, the US economy is resilient and diversified, and US policy makers have managed to step up to the plate in difficult conditions to help out. Therefore, if we are lucky enough to get a stock market crash, this would be a short term opportunity for long-term investors to load up on quality companies at depressed prices. I believe that the future will bring in more people, more innovations, and a higher standard of living for humans. I see billions of people that are going to be lifted out of poverty over the 21st century. These people are very motivated to work hard and achieve their dreams, and lift themselves out of the poverty that previous generations lived under.
Every morning, several billion people wake-up, and ask themselves how to live better lives for themselves, their families and their communities. If you believe that social order as we know it will collapse, and you are stocking up on guns, ammunition and gold, then chances are you will never be wealthy. Even at the super unlikely event that this happens, you will not do well, because the guns and gold can and would be taken away from you by a stronger opponent. Even for those milder forecasts of a mere depression coupled with stock market crashes, these occur only a few times per century. Are you willing to be wrong for 30 years in a row and miss out on a few thousand percent of gains, for the ability to predict a mere 50% crash? If you look at a long-term chart of Dow Jones Industrial's over the past century, you would see the 1929 – 1932 crash as a mere blip on that chart.
Don’t be perma bull either. Be realist, and put money in opportunities where you stand to have a chance to make more than what you put in. Even in 1999-2000, there were pockets of opportunity for enterprising dividend investors. While difficult than a year ago, one can still find pockets of opportunity today also. You just have to look harder, and be able to capitalize on the rare selloffs.
There are some investors who have been patiently waiting for a 40-50% crash FOR FIVE YEARS, and thus have ended up missing out on the recovery. Even if stocks did crash by 40% tomorrow, their performance would still lag a buy and hold of an index fund. There are a few perma-bears, who supposedly forecasted the 1987 stock market crash. Over the past 26 years however, I think they have continued being bearish. I don’t think you should be bearish on America if you are a long term investor. I also do not understand how someone can afford to lose money for a quarter century, and still be quoted in mainstream media.
As I discussed in my article from yesterday, investors should be very careful about taking other's opinions at face value. You need to weigh in the credibility of this opinion, against relevant facts, before making a decision of whether it needs to be taken seriously or not.
Full Disclosure: Long CL, PG, KO, WMT
Relevant Articles:
- Check the Complete Article Archive
-Living off dividends in retirement
- Dividends and The Great Depression
- Dividend Cuts - the worst nightmare for dividend investors
- Six things I learned from the financial crisis
Subscribe to:
Posts (Atom)
