If you have followed any news stories over the past year, you might have been exposed to a lot of negative information about dividend paying stocks. I have rebutted some of them, such as the story about the end of the dividend craze. Others include the notion that rising interest rates are somehow so bad for dividend paying stocks, which it would put the end to dividend investing once and for all. The problem with those statements is that while interest rates affect the relative valuation of assets, they are just one input in valuation formulas.
I keep hearing that rising interest rates will mark the end of dividend growth investing. I am actually hoping that this talk results in lower entry prices for those investors like me who are in the accumulation age. But for other long term holders who are living off portfolios, I think that they should ignore this noise, and instead focus on enjoying the fruits of their growing income stream.
There are several reasons why I ignore this non-sense:
1) First of all, few people can predict interest rates with any accuracy. Actually, few people can actually predict anything with a reasonable success rate. I still remember how everyone was expecting hyper inflation in 2008 – 2009. I actually wrote an article about it at the time, and several readers told me how wrong I am, and how they were going to stop reading my website because of that. Before that, everyone was worried about the fall of the US dollar against other currencies, and by the fact that the World were running out of oil. So naturally, while I do agree that interest rates could start increasing over time, I cannot tell you what the timing and amount of this increase is going to be. Therefore the impact of rising interest rates might not affect companies as much as expected. Even if interest rates did increase, and cost of capital was raised for all of corporate America, it could impact the speculative companies with untested products or constant need of new capital to maintain operations. This could potentially deflate the ongoing bubble in some technology stocks today.
2) Second, as a dividend investor, I actually do not care about short term fluctuations in the value of my investment holdings or about my total return performance relative to a group of investors with other goals and objectives. As long as my total dividend payments are stable and growing above the rate of inflation, I would be a happy camper. My goal is to live off the dividend income from my portfolio when I retire, and not be at the mercy of Mr Market’s irrational fluctuations. Dividends are more stable than capital gains, which is why they are my preferred method of funding my lavish retirement. This is because they are the only direct link between a company’s underlying business performance, and investor returns.
3) Third, as I hinted above, I focus on dividend income over time. In order for me to remain retired, I require that the total amount of distributions from my retirement portfolio grow at or above the rate of inflation over time. While rising interest rates might cause some investors to prefer fixed income yields rather than the rising yields on cost of dividend paying stocks, I would not see that as a risk. Rather, I would view this as an opportunity to purchase quality merchandise at cheaper prices than available today. Investors should remember that fixed income securities might provide you them with a decent entry yield, and almost no risk in the case of US Government or Agency bonds. However, your purchasing power will erode over time due to inflation. With dividend paying stocks, especially those who have a culture of raising dividends, you have the chance to increase dividend income and maintain your standard of living.
4) Last, as a dividend investor, I focus my energies on individual stock selection and then building a diversified portfolio of income generating stocks over a long period of time. I focus on individual securities, how they earn money, check for competitive advantages. In this analysis I focus on catalysts that could provide these companies ways for earnings growth and dividend growth. After that, I focus on purchase of these securities at attractive valuations. I also balance the expected future growth in earnings and dividends, against the quality of earnings and business, and against valuation I am paying for this growth and quality. While rising interest rates may affect short term relative prices of shares and increase interest expense for companies, we should not forget that we are dealing with real businesses here. A diversified selection of businesses held for the long term will likely increase earnings, dividends and intrinsic values over time. Therefore, the potential impact of rising interest rates would be softened for the business that manages to grow the bottom line over time. Again, the goal is to focus on long-term business fundamentals for the companies you are selecting, rather than worry about short-term noise such as the direction of interest rates over the next year or two.
Some businesses such as Coca-Cola (KO) and Johnson & Johnson (JNJ) have strong predictability of cash flows and strong pricing and earnings powers. These are the types of businesses that manage to build a record of fifty years of consecutive dividend increases. Because I have a long-term investment horizon, I do not care if interest rates go up or down over the next five years, as long as dividends from my portfolio are higher than today for the next 30 years.
In other words, if Realty Income yields 6% today, but grows distributions by 4% over the next 20 years, I would gladly choose it over Treasury Bonds today. That is because in 20 years, even if you spend all your dividends each year, your yield on cost will be 12%. With US Treasury Bonds, you are stuck with the yield on cost you lock in today, for better or worse. Think about that, and think probabilistically, the next time you make an investment.
In conclusion, I believe that investors should develop a method of independent thinking and ignore short-term noise that has no relevance to their positions. If you have a set of solid investment guidelines, which describe your objectives, what securities you are looking to purchase and at what price, how to evaluate them and when to sell, you should be able to perform well over time. This set of basic guidelines will provide the opportunity hold on to your investment portfolio during any set of varying economic, market and business conditions that you will experience over your investing lifetime.
Full Disclosure: Long O, KO, JNJ
Relevant Articles:
- Complete List of Articles on Dividend Growth Investor Blog
- Rising interest rates affect all businesses, not just dividend paying ones
- Yield on Cost Matters
- Lower Entry Prices Mean Locking Higher Yields Today
- Dividends Offer an Instant Rebate on Your Purchase Price
Monday, January 13, 2014
Saturday, January 11, 2014
Best Dividend Investing Articles for 2013
The past year was the sixth year in which I have been sharing ideas on dividend investing on this site.
I have outlined the top five articles written in 2013, which readers found to be the most useful. I have also added a brief summary behind each article.
1) Best Dividend Stocks for 2013 and Beyond
I presented a list of 20 quality dividend paying companies, which were attractively priced, and are great long term holdings. Some of these companies like Walgreen (WAG) went up in price considerably, and I could only consider them great holds. Others like Phillip Morris International (PM) are available at attractive valuations today. After all, the name of the game is to select a quality company at a reasonable price, which grows earnings and raises dividends for you. Your job is to then hold on to that compounding machine, and let the power of compounding work for you.
2) Warren Buffett's Dividend Stock Strategy
In this article I analyzed some of Warren Buffett’s largest investments at Berkshire Hathaway. I found out that the Superinvestor likes to generate growing distributions from the companies he invests in, and then uses those to purchase more businesses that distribute excess cash to him. The similarities with what dividend growth investors do on a monthly basis are strikingly similar, which is why I believe that Buffett is a closet dividend investor.
3) Ten Dividend Paying Stocks I Purchased in my Roth IRA
Last year, I had the realization that I am paying too much in taxes. As such, I am trying to defer taxes as much as possible, by tapping every legally allowed way to put money in 401 (k), SEP IRA and Roth IRA. In this article I discussed ten companies which I purchased using Sharebuilder for my Roth IRA. The purpose of this series of articles on Roth IRA investing was that one could invest $5,500 over a three month period, make 25 – 30 individual investments, and pay $24 in total commission costs. By reducing investment and taxation costs to a minimum, the investor will keep more money for themselves. You can create you tax-free dividend compounding machine today by making a Roth IRA contribution, and won’t have to pay any taxes on income when you withdraw it at age 59 ½. By my estimates, a $5,500 investment today could generate approximately $200 in annual dividend income. If dividends grow by 6%-7%/year and are reinvested into securities yielding 3% - 4%, the annual income stream would grow to $1600 in 30 years and $3200 in 40 years.
4) Why Most Dividend Investors Never Succeed
In this article, I outlined a few behavior items that can prevent investors from achieving their investment objectives. I believe that most buy and hold dividend investors have an edge because of the relative passivity of their strategy. However I believe that succumbing to behavior issues could jeopardize investment success. While the article was more geared towards new investors, I think that those who have experience in dividend investing could benefit from reminding themselves about psychological pitfalls of investing in general.
5) Twenty Dividend Stocks I Recently Purchased for my IRA Rollover
The last article I am outlining lists twenty companies I purchased for my IRA. I rolled this account over from an old 401 (k) at Fidelity in the past year. The process took less than a day, as I kept the IRA at Fidelity. It was difficult to find 20 companies to put my money to work in at almost the same time, but I managed to pull it off. My retirement accounts are the only places where I automatically reinvest dividends.
It is very interesting that the readers like to hear more about purchases I have made, or specific companies I discuss, rather than income investing strategy. I actually believe that the strategy piece is the most important one, whereas individual stock selection is a result of having a sound investment plan.
6) A few other information resources I enjoyed covered an interview with Peter Lynch and a documentary about Sir John Templeton. You can find the links below.
Interview with Peter Lynch
Documentary about Sir John Templeton
Sir John Templeton and Peter Lynch
Thank you for reading Dividend Growth Investor. I hope the new year brings us a correction, which would allow us to get more dividend paying stocks for our bucks.
I have outlined the top five articles written in 2013, which readers found to be the most useful. I have also added a brief summary behind each article.
1) Best Dividend Stocks for 2013 and Beyond
I presented a list of 20 quality dividend paying companies, which were attractively priced, and are great long term holdings. Some of these companies like Walgreen (WAG) went up in price considerably, and I could only consider them great holds. Others like Phillip Morris International (PM) are available at attractive valuations today. After all, the name of the game is to select a quality company at a reasonable price, which grows earnings and raises dividends for you. Your job is to then hold on to that compounding machine, and let the power of compounding work for you.
2) Warren Buffett's Dividend Stock Strategy
In this article I analyzed some of Warren Buffett’s largest investments at Berkshire Hathaway. I found out that the Superinvestor likes to generate growing distributions from the companies he invests in, and then uses those to purchase more businesses that distribute excess cash to him. The similarities with what dividend growth investors do on a monthly basis are strikingly similar, which is why I believe that Buffett is a closet dividend investor.
3) Ten Dividend Paying Stocks I Purchased in my Roth IRA
Last year, I had the realization that I am paying too much in taxes. As such, I am trying to defer taxes as much as possible, by tapping every legally allowed way to put money in 401 (k), SEP IRA and Roth IRA. In this article I discussed ten companies which I purchased using Sharebuilder for my Roth IRA. The purpose of this series of articles on Roth IRA investing was that one could invest $5,500 over a three month period, make 25 – 30 individual investments, and pay $24 in total commission costs. By reducing investment and taxation costs to a minimum, the investor will keep more money for themselves. You can create you tax-free dividend compounding machine today by making a Roth IRA contribution, and won’t have to pay any taxes on income when you withdraw it at age 59 ½. By my estimates, a $5,500 investment today could generate approximately $200 in annual dividend income. If dividends grow by 6%-7%/year and are reinvested into securities yielding 3% - 4%, the annual income stream would grow to $1600 in 30 years and $3200 in 40 years.
4) Why Most Dividend Investors Never Succeed
In this article, I outlined a few behavior items that can prevent investors from achieving their investment objectives. I believe that most buy and hold dividend investors have an edge because of the relative passivity of their strategy. However I believe that succumbing to behavior issues could jeopardize investment success. While the article was more geared towards new investors, I think that those who have experience in dividend investing could benefit from reminding themselves about psychological pitfalls of investing in general.
5) Twenty Dividend Stocks I Recently Purchased for my IRA Rollover
The last article I am outlining lists twenty companies I purchased for my IRA. I rolled this account over from an old 401 (k) at Fidelity in the past year. The process took less than a day, as I kept the IRA at Fidelity. It was difficult to find 20 companies to put my money to work in at almost the same time, but I managed to pull it off. My retirement accounts are the only places where I automatically reinvest dividends.
It is very interesting that the readers like to hear more about purchases I have made, or specific companies I discuss, rather than income investing strategy. I actually believe that the strategy piece is the most important one, whereas individual stock selection is a result of having a sound investment plan.
6) A few other information resources I enjoyed covered an interview with Peter Lynch and a documentary about Sir John Templeton. You can find the links below.
Interview with Peter Lynch
Documentary about Sir John Templeton
Sir John Templeton and Peter Lynch
Thank you for reading Dividend Growth Investor. I hope the new year brings us a correction, which would allow us to get more dividend paying stocks for our bucks.
Friday, January 10, 2014
How to buy when there is blood on the streets
As dividend investors, we know that we need to purchase quality companies that sell at attractive valuations. We know that the companies to buy and hold are those that can deliver earnings and dividend growth for years to come. These dividends would meet our future expenses, and rise over time to compensate for the eroding value of the dollar. The one thing that many investors fail to take into account however, is that there are many times in the lives of a company, where it stumbles on its strategy execution. As a result, even a reliable dividend growth payer might face some uncertainty, that could make even its most loyal long-term investors lose sleep at night. These situations are usually the types of events that separate the winners from the losers in the game of long-term dividend investing.
Rather than lose sleep, the objective dividend investor should evaluate the underlying fundamentals with a cool head, and determine what to do. If the dividend cannot be increased over time, that would mean that the stock is a hold at best. However, if the dividend cannot and is not supported, this would most likely be a sell signal for a dividend growth investor. However, if there is still room for growth in earnings, that could trickle down into some dividend growth over time, then the stock is likely a buy at attractive valuations.
In previous articles I have discussed how lower entry prices usually result in higher dividend and capital returns over time for investors. That’s because purchasing a share of a dividend growth company at $40 will result in slightly faster compounding, than purchasing the same stock at $50. Unfortunately, few investors capitalize on opportunities when they are available at attractive prices. This is because in many situations, these opportunities look like the end of the dividend growth streak. For example, McDonald’s (MCD) didn't look so sexy between 2001 and 2003. The company had expanded too quickly, Americans were not very happy with the menu and the slow and rude service. Dividend growth slowed down as well, and the share price tumbled precipitously. Luckily, the company initiated a turnaround effort, remodeled stores and introduced new items, which led to pretty dramatic increase in earnings, dividends and share values. The message is to give the company you own the benefit of the doubt, and hold on for as long as possible, until you are proven wrong by the facts.
Johnson & Johnson (JNJ) was another company which faced recalls at the beginning of the decade, which spooked many dividend investors. However, the company maintained confidence in its long-term prospects, as evidenced by the increase in annual dividends. Investors who stuck with the company did have a few tumultuous years, but finally earnings per share are estimated to surpass the highs in 2010.
Right now, Target Corporation (TGT) seems to be the company that has a lot of negative publicity. The company has been unable to gain momentum in its expansion efforts in Canada. In addition, its point of sale (POS) terminals at stores have been breached, thus compromising the credit and debit cards of 40 million customers.
I see this stumble as a temporary opportunity to acquire shares of this retail giant at attractive valuations. Even if growth slows down, the company still has some room for growth in the US organically. In addition, its stores are much cleaner than rival Wal-Mart (WMT), plus it has a very loyal base of customers who love the shopping experience.
As the company is stumbling however, it is getting increasingly difficult to hold the stock. I am sure that there are thousands of investors out there who are second guessing their decision to put their money in Target. It is very difficult to have bought a stock, and then to have negative headlines about it. However, as your dividend checks clear in your brokerage account, you get some sort of a positive reinforcement that business is still getting done at Target, and the company is still earning billions of dollars every year. I do not have a crystal ball, but based on my evaluation of the situation, I plan on adding more to the stock in the coming months.
I recently added some shares of Target (TGT) commission-free using my Loyal3 account. If the shares go lower from here, I would likely add again. Unfortunately, I would only have approximately two-three opportunities to add the stock in the coming 2014. I would try to spread them out across the year accordingly. If the shares rise above $69 however, I would likely abstain from making any further purchases.
Over the past month, I have driven by several Target locations in my area, and have noticed that parking lots look full most of the time. As a result, I am fairly confident that any weakness in sales and traffic trends might be temporary, if not largely overblown.
I think the best way to take advantage of temporary weakness in stock prices is through the meticulous process of dollar cost averaging your way into attractively priced stocks every single month. A dividend investor who puts money to work every month won't buy at the bottom, but would have the discipline to put money to work, when everyone else is scared. This puts the odds of success heavily into his or her favor.
Full Disclosure: Long TGT, MCD, JNJ, WMT
Relevant Articles:
- Check the Complete Article Archive
- How to buy dividend stocks with as little as $10
- Target Corporation (TGT) - A high growth, attractively valued stock
- Wal-Mart Stores (WMT): A high dividend growth giant
- How to be a Dividend Winner
Rather than lose sleep, the objective dividend investor should evaluate the underlying fundamentals with a cool head, and determine what to do. If the dividend cannot be increased over time, that would mean that the stock is a hold at best. However, if the dividend cannot and is not supported, this would most likely be a sell signal for a dividend growth investor. However, if there is still room for growth in earnings, that could trickle down into some dividend growth over time, then the stock is likely a buy at attractive valuations.
In previous articles I have discussed how lower entry prices usually result in higher dividend and capital returns over time for investors. That’s because purchasing a share of a dividend growth company at $40 will result in slightly faster compounding, than purchasing the same stock at $50. Unfortunately, few investors capitalize on opportunities when they are available at attractive prices. This is because in many situations, these opportunities look like the end of the dividend growth streak. For example, McDonald’s (MCD) didn't look so sexy between 2001 and 2003. The company had expanded too quickly, Americans were not very happy with the menu and the slow and rude service. Dividend growth slowed down as well, and the share price tumbled precipitously. Luckily, the company initiated a turnaround effort, remodeled stores and introduced new items, which led to pretty dramatic increase in earnings, dividends and share values. The message is to give the company you own the benefit of the doubt, and hold on for as long as possible, until you are proven wrong by the facts.
Johnson & Johnson (JNJ) was another company which faced recalls at the beginning of the decade, which spooked many dividend investors. However, the company maintained confidence in its long-term prospects, as evidenced by the increase in annual dividends. Investors who stuck with the company did have a few tumultuous years, but finally earnings per share are estimated to surpass the highs in 2010.
Right now, Target Corporation (TGT) seems to be the company that has a lot of negative publicity. The company has been unable to gain momentum in its expansion efforts in Canada. In addition, its point of sale (POS) terminals at stores have been breached, thus compromising the credit and debit cards of 40 million customers.
I see this stumble as a temporary opportunity to acquire shares of this retail giant at attractive valuations. Even if growth slows down, the company still has some room for growth in the US organically. In addition, its stores are much cleaner than rival Wal-Mart (WMT), plus it has a very loyal base of customers who love the shopping experience.
As the company is stumbling however, it is getting increasingly difficult to hold the stock. I am sure that there are thousands of investors out there who are second guessing their decision to put their money in Target. It is very difficult to have bought a stock, and then to have negative headlines about it. However, as your dividend checks clear in your brokerage account, you get some sort of a positive reinforcement that business is still getting done at Target, and the company is still earning billions of dollars every year. I do not have a crystal ball, but based on my evaluation of the situation, I plan on adding more to the stock in the coming months.
I recently added some shares of Target (TGT) commission-free using my Loyal3 account. If the shares go lower from here, I would likely add again. Unfortunately, I would only have approximately two-three opportunities to add the stock in the coming 2014. I would try to spread them out across the year accordingly. If the shares rise above $69 however, I would likely abstain from making any further purchases.
Over the past month, I have driven by several Target locations in my area, and have noticed that parking lots look full most of the time. As a result, I am fairly confident that any weakness in sales and traffic trends might be temporary, if not largely overblown.
I think the best way to take advantage of temporary weakness in stock prices is through the meticulous process of dollar cost averaging your way into attractively priced stocks every single month. A dividend investor who puts money to work every month won't buy at the bottom, but would have the discipline to put money to work, when everyone else is scared. This puts the odds of success heavily into his or her favor.
Full Disclosure: Long TGT, MCD, JNJ, WMT
Relevant Articles:
- Check the Complete Article Archive
- How to buy dividend stocks with as little as $10
- Target Corporation (TGT) - A high growth, attractively valued stock
- Wal-Mart Stores (WMT): A high dividend growth giant
- How to be a Dividend Winner
Wednesday, January 8, 2014
Achieve Financial Independence with Dividend Paying Stocks
My dividend retirement plan will be achieved at the time when my dividend income exceeds my monthly expenses. In a previous post I mentioned that I am close to covering approximately 50% of my expenses from my portfolio distributions. While achieving financial independence is important, maintaining and growing your dividend income for several decades after that, is even more important.
In order to achieve and maintain financial independence, I generally try to follow several common sense principles.
1) I try to purchase quality dividend stocks at attractive valuations
2) I try to purchase quality dividend stocks which have sustainable distributions
3) I try to purchase quality companies that will grow earnings and dividends
4) I try to diversify my portfolio by holding at least 30 companies in as many industries as possible
5) I have an exit plan for each stock I purchase
6) I continuously study the lists of consistent dividend payers and analyze potential portfolio additions regularly
7) I analyze the companies I own at least once per year in a great detail
I define quality companies as those that have some sort of competitive advantages or wide-moats with strong pricing power. The companies typically have strong brand names, are market leaders in their niches, have patents or geographic monopoly in certain areas, or are the lowest cost provider of goods/services. Other characteristics of quality companies include high switching costs to move to a competitors.
I typically try to acquire such companies when they have achieved at least a decade of consistent dividend growth and trade for less than 20 times earnings. If their dividend yield is above 2.50% and they have a sustainable dividend payout, that makes me determined to study the company’s financials more in depth. I essentially try to determine whether the company would be able to achieve earnings growth over time, whether organically or through acquisitions. There are several companies in my portfolio such as Clorox (CLX), ONEOK Partners (OKS) and Coca-Cola (KO) which have outlined strategies to hit specific earnings targets within a defined period of time. Once I learn as much as possible about a company, and I have determined that it is a quality company that has a great chance of growing earnings and dividends and which is also attractively priced at the moment, I log on to my brokerage account and buy shares.
I would then hold on to these shares until one of these three events happens. The event that typically makes me want to sell stock has been dividend cuts or eliminations. I automatically sell after an event like that, and try to reinvest proceeds into another company that is attractively priced. This is where my continuous research of the list of dividend growth stocks comes in handy, because it enables me to have a list of 20 - 30 stocks at all times that could fit my criteria for inclusion in my portfolio. The average retirement could last for two – three decades. Over the course of this period, one could reasonably expect that the composition of their income portfolio would be different in year 31 in comparison with the portfolio composition in year one. If a company that I own is not in buy territory anymore, I do not sell its shares, but hold on to them. I would only consider selling if the company is severely overvalued and I have found similar prospects that would provide me with a better income growth over time. One such example was when I replaced most of my position in Con Edison (ED) with shares of ONEOK Partners (OKS).
I try to maintain a portfolio of at least 30 individual dividend paying stocks, which should be spread out between as many sectors that make sense. However, I would not add stocks in a dying sector such as newspapers or cyclical stocks such as General Motors (GM) or Ford (F) just for the sake of diversification. I now hold over 40 individual stocks in a material to my portfolio way. Each of those has varying portfolio weights, because some of the companies have been attractively priced early in my accumulation process, but have been overpriced ever since. As a result, I have allocated new funds and dividends generated by my portfolio into the best picks at the time funds were available. Contrary to popular belief, it does not take a lot of time to keep up with a dividend portfolio consisting of 40 -50 individual issues. This is because as a long-term investor, I purchase shares after doing a large amount of research behind each idea. As a result, I get to update my knowledge through my annual stock analysis of a stock. I gather data by looking at annual and quarterly reports, analysts’ reports and general news. As a long term investor, one notices that there are not a lot of things that materially change from year to year. For example, Wal-Mart (WMT) has been a retailer for over forty years, and McDonald’s (MCD) has been a fast-food company for many decades as well. It is true that each year these companies are facing different challenges ahead, but at their core they are very much unchanged. This is another reason why investors should spend a lot of time upfront educating themselves how a company generates money.
In addition, I also try to diversify, in order to decrease my reliance on the dividend stream from a few bad apples. In a concentrated portfolio of 10 securities which is equally weighted, a dividend elimination by one of the companies will lead to a 10% decrease in total dividend income. In a portfolio of 40 stocks, if one company eliminated distributions, it would result in only 2.50% decrease in dividend income. At the end of the day, even if the remaining stocks managed to grow dividends by 11%, my total dividend income would be unchanged. In the second portfolio, if the remaining companies managed to raise disitrbutions by at least 2.50% my total dividend income would be unchanged for the year. Given the fact that historical dividend growth has been around 5% per year, I believe that it is much safer to assume that 10% growth is too optimistic. As a result, I would much rather have my portfolio generate a stream of income coming from many stocks rather than few.
Full disclosure: Long all stocks mentioned above
Relevant Articles:
- Dividend Investing Goals for 2013
- My dividend crossover point
- Dividend Paying Stocks for Retirement Income
- How long does it take to manage a dividend portfolio?
- Dividend Investors – Do not forget about total returns
In order to achieve and maintain financial independence, I generally try to follow several common sense principles.
1) I try to purchase quality dividend stocks at attractive valuations
2) I try to purchase quality dividend stocks which have sustainable distributions
3) I try to purchase quality companies that will grow earnings and dividends
4) I try to diversify my portfolio by holding at least 30 companies in as many industries as possible
5) I have an exit plan for each stock I purchase
6) I continuously study the lists of consistent dividend payers and analyze potential portfolio additions regularly
7) I analyze the companies I own at least once per year in a great detail
I define quality companies as those that have some sort of competitive advantages or wide-moats with strong pricing power. The companies typically have strong brand names, are market leaders in their niches, have patents or geographic monopoly in certain areas, or are the lowest cost provider of goods/services. Other characteristics of quality companies include high switching costs to move to a competitors.
I typically try to acquire such companies when they have achieved at least a decade of consistent dividend growth and trade for less than 20 times earnings. If their dividend yield is above 2.50% and they have a sustainable dividend payout, that makes me determined to study the company’s financials more in depth. I essentially try to determine whether the company would be able to achieve earnings growth over time, whether organically or through acquisitions. There are several companies in my portfolio such as Clorox (CLX), ONEOK Partners (OKS) and Coca-Cola (KO) which have outlined strategies to hit specific earnings targets within a defined period of time. Once I learn as much as possible about a company, and I have determined that it is a quality company that has a great chance of growing earnings and dividends and which is also attractively priced at the moment, I log on to my brokerage account and buy shares.
I would then hold on to these shares until one of these three events happens. The event that typically makes me want to sell stock has been dividend cuts or eliminations. I automatically sell after an event like that, and try to reinvest proceeds into another company that is attractively priced. This is where my continuous research of the list of dividend growth stocks comes in handy, because it enables me to have a list of 20 - 30 stocks at all times that could fit my criteria for inclusion in my portfolio. The average retirement could last for two – three decades. Over the course of this period, one could reasonably expect that the composition of their income portfolio would be different in year 31 in comparison with the portfolio composition in year one. If a company that I own is not in buy territory anymore, I do not sell its shares, but hold on to them. I would only consider selling if the company is severely overvalued and I have found similar prospects that would provide me with a better income growth over time. One such example was when I replaced most of my position in Con Edison (ED) with shares of ONEOK Partners (OKS).
I try to maintain a portfolio of at least 30 individual dividend paying stocks, which should be spread out between as many sectors that make sense. However, I would not add stocks in a dying sector such as newspapers or cyclical stocks such as General Motors (GM) or Ford (F) just for the sake of diversification. I now hold over 40 individual stocks in a material to my portfolio way. Each of those has varying portfolio weights, because some of the companies have been attractively priced early in my accumulation process, but have been overpriced ever since. As a result, I have allocated new funds and dividends generated by my portfolio into the best picks at the time funds were available. Contrary to popular belief, it does not take a lot of time to keep up with a dividend portfolio consisting of 40 -50 individual issues. This is because as a long-term investor, I purchase shares after doing a large amount of research behind each idea. As a result, I get to update my knowledge through my annual stock analysis of a stock. I gather data by looking at annual and quarterly reports, analysts’ reports and general news. As a long term investor, one notices that there are not a lot of things that materially change from year to year. For example, Wal-Mart (WMT) has been a retailer for over forty years, and McDonald’s (MCD) has been a fast-food company for many decades as well. It is true that each year these companies are facing different challenges ahead, but at their core they are very much unchanged. This is another reason why investors should spend a lot of time upfront educating themselves how a company generates money.
In addition, I also try to diversify, in order to decrease my reliance on the dividend stream from a few bad apples. In a concentrated portfolio of 10 securities which is equally weighted, a dividend elimination by one of the companies will lead to a 10% decrease in total dividend income. In a portfolio of 40 stocks, if one company eliminated distributions, it would result in only 2.50% decrease in dividend income. At the end of the day, even if the remaining stocks managed to grow dividends by 11%, my total dividend income would be unchanged. In the second portfolio, if the remaining companies managed to raise disitrbutions by at least 2.50% my total dividend income would be unchanged for the year. Given the fact that historical dividend growth has been around 5% per year, I believe that it is much safer to assume that 10% growth is too optimistic. As a result, I would much rather have my portfolio generate a stream of income coming from many stocks rather than few.
Full disclosure: Long all stocks mentioned above
Relevant Articles:
- Dividend Investing Goals for 2013
- My dividend crossover point
- Dividend Paying Stocks for Retirement Income
- How long does it take to manage a dividend portfolio?
- Dividend Investors – Do not forget about total returns
Monday, January 6, 2014
Should you sell after yield drops below minimum yield requirement?
The year 2013 has been characterized by stock prices hitting all-time highs throughout the year. As a result, many dividend investors hold shares of quality companies where rising prices have pushed yields below their minimum yield criteria. The question on the minds of most investors is whether it would make sense to sell these companies, and purchase shares of other quality dividend stocks that have higher yields.
Let’s walk through the example of selling a company that grows dividends at a high rate, but currently yields 2%. That could be Becton Dickinson (BDX) or Colgate Palmolive (CL). For the sake of walking through the example, let’s assume that the funds will be invested in Consolidated Edison (ED), which is a higher yielding electric utility.
When a dividend investor sells their shares at a gain, they have to pay taxes on the profit. Depending on the length of time the shares were held for, the gain could be taxed as ordinary income or at more preferential capital gains taxes. Either way, when you sell appreciated stock and pay taxes, you are left with a lower amount of capital to reinvest.
The other factor to take into account is not only the current yield, but realistic growth projections as well. If you sell a perfectly good quality company that you are well familiar with, simply because current yields are a little low, and you purchase shares in a company which might or might not perform as well as the first company, you just create reinvestment risk.
If you sell Becton Dickinson (BDX) that yields 2%, and buy Consolidated Edison (ED) that yields twice as much, you double your current yield and dividend income. However, you will be missing out on future dividend growth, and thus your dividend income might lose purchasing power over time. Over the past five years, Becton Dickinson has grown dividends by 13.50%/year, while Con Edison has boosted them by about 1%/annum. If Becton Dickinson increases dividends by 10%/year for the next 14 years however, a $1000 investment in the stock today could generate $80 in annual dividend income. With Con Edison, a $1000 investment today will likely generate less than $50 in annual dividend income. The caveat is that future growth is uncertain however, but so is the sustainability of high current yields.
The next factor you have to take into account is your investment horizon. Your investment timeframe should be 20-30 years. Even if you are 60-70 years old today, you might still have to plan for a 20-30 years of retirement. You don’t want to chase yields today by buying stocks solely based off yield. These might not maintain purchasing power or might offer a higher risk of a dividend cut or freeze. This would downgrade your standard of living in the last part of your retirement, when you are less likely to be able to cover the shortfall by finding and holding a job.
Even if you sold Becton Dickinson and bought something else like Chevron (CVX), you are still taking a reinvestment risk. The risk is that in 10-15 years, the amount of dividends that Becton Dickinson’s will pay will be higher than the dividends that Chevron will pay. This could happen if Becton Dickinson increases dividends faster than Chevron during that time period. Further, if oil prices fall in 5 years, Chevron might not even increase dividends at all.
Your goal is to avoid situations where you are essentially compounding mistakes. When all is set and done in 20 years, do you think you would be better off doing nothing or selling and buying something else? If you sold a perfectly good dividend grower, that grew earnings and dividends like clockwork, you paid a tax on gains. This provided you with less money to invest than in the first place. You then purchased shares in a company where you don’t know if the dividend income from this position would be higher or lower than the dividend income from the original position in 20 – 30 years.
The next factor to think about is that replacing appreciated shares simply because the yield is low, for a higher yielding security, should take into account past and projected growth in earnings and dividends. An investor should look for growth at reasonable prices, and should not focus solely on the dividend income at all costs, while ignoring capital gains. This is because a company that cannot grow earnings and dividends today, will likely be unable to grow share prices over time. This is important, because your capital is losing purchasing power over time. In contrast, a company like Becton Dickinson has a growth kick that can result in growing earnings and dividends, which could eventually translate into higher prices. Most equities share a portion of earnings with shareholders in the form of dividends, and then reinvest the rest, in order to grow and maintain the business. A company like Con Edison, which pays out a very high portion of income to shareholders will be unable to grow quickly enough. As a result, its earnings power might not translate into growth in dividends and stock prices, that can maintain purchasing power of your income and capital.
The nest factor is that chasing yield for sake of yield is a very very dangerous thing. Most investors who start investing for dividends always seem to be attracted to the highest yielding securities out there. This is a mistake, because they are usually not taking into consideration the sustainability of the dividend payment. Most of these investors do not do a very good homework in understanding the business model of a high yielding company, and are focusing only on the high yield aspect of it. What good is a 16% annual dividend yield, if the dividend payment is cut by 80 or 90% in the next year? You would have been better off with a company yielding 2 – 3% in the first place, that has the capability and desire grows dividends over time. The issue with selling an appreciated company that still has potential, for a higher yielding one, is a slippery slope in yield chasing. Once you sell start selling the lowest yielding components of your stock portfolio, without accounting for such factors as sustainability, growth, and understanding of the business, you are becoming essentially a yield chasing investor. In reality, yield should be the last factor in your fundamental analysis.
The last factor on selling is mostly a blend between my personal experiences as a dividend investor and academic studies on the performance of individual investors. According to academic studies, individual investors routinely underperform their benchmarks by as much as 9% per year. This is caused by frequent trading in their portfolios. Based on my own experiences, I can vouch to these findings 100%. When I look at some of the sales I have done, most of them have been pretty disastrous. I have essentially managed to sell a stake in a company that was growing well, and might have looked overvalued relative to another company.
However, after a few years, I calculate that I would have been better off simply holding on to the original security, without the hassle of extra taxes, paperwork, commissions and strains on my already filled schedule. When I sell I am usually worse off. I have realized that I would have been better off just doing nothing, and not tinkering with my portfolio. The point is when you reach out for yield you are sacrificing growth potential and altering the risk profile of your portfolio. You should be aware of that, and be ok to accept lower growth and capital gains that could bring more dividend dollars in the future, for the higher immediate dividend income that will produce less in future dividends and capital gains.
All of this doesn’t mean you should never sell a stock. If it is really overvalued, cuts dividends, or if something material changes, you might be better off selling and going someplace else. However, you need to think about some of the factors explained in this article, in your decision making process on selling.
The urge to do something is the thing that will cost you in the long run. If fundamentals are fine, there is decent EPS growth, DPS growth and you still expect it to continue, your job is to sit tight on investment and let the company do the compounding for you. Sitting is the toughest part of investing, especially in an era where you are bombarded with information on investments all the time. Sitting on an investment, and holding for the long term, might after all be the best strategy for ordinary investors.
Full Disclosure: Long BDX, CL, ED, CVX
Relevant Articles:
- Why would I not sell dividend stocks even after a 1000% gain?
- Replacing dividend stocks sold
- Why I am replacing ConEdison (ED) with ONEOK Partners
- Active Dividend Growth Investing
- When to sell my dividend stocks?
Let’s walk through the example of selling a company that grows dividends at a high rate, but currently yields 2%. That could be Becton Dickinson (BDX) or Colgate Palmolive (CL). For the sake of walking through the example, let’s assume that the funds will be invested in Consolidated Edison (ED), which is a higher yielding electric utility.
When a dividend investor sells their shares at a gain, they have to pay taxes on the profit. Depending on the length of time the shares were held for, the gain could be taxed as ordinary income or at more preferential capital gains taxes. Either way, when you sell appreciated stock and pay taxes, you are left with a lower amount of capital to reinvest.
The other factor to take into account is not only the current yield, but realistic growth projections as well. If you sell a perfectly good quality company that you are well familiar with, simply because current yields are a little low, and you purchase shares in a company which might or might not perform as well as the first company, you just create reinvestment risk.
If you sell Becton Dickinson (BDX) that yields 2%, and buy Consolidated Edison (ED) that yields twice as much, you double your current yield and dividend income. However, you will be missing out on future dividend growth, and thus your dividend income might lose purchasing power over time. Over the past five years, Becton Dickinson has grown dividends by 13.50%/year, while Con Edison has boosted them by about 1%/annum. If Becton Dickinson increases dividends by 10%/year for the next 14 years however, a $1000 investment in the stock today could generate $80 in annual dividend income. With Con Edison, a $1000 investment today will likely generate less than $50 in annual dividend income. The caveat is that future growth is uncertain however, but so is the sustainability of high current yields.
The next factor you have to take into account is your investment horizon. Your investment timeframe should be 20-30 years. Even if you are 60-70 years old today, you might still have to plan for a 20-30 years of retirement. You don’t want to chase yields today by buying stocks solely based off yield. These might not maintain purchasing power or might offer a higher risk of a dividend cut or freeze. This would downgrade your standard of living in the last part of your retirement, when you are less likely to be able to cover the shortfall by finding and holding a job.
Even if you sold Becton Dickinson and bought something else like Chevron (CVX), you are still taking a reinvestment risk. The risk is that in 10-15 years, the amount of dividends that Becton Dickinson’s will pay will be higher than the dividends that Chevron will pay. This could happen if Becton Dickinson increases dividends faster than Chevron during that time period. Further, if oil prices fall in 5 years, Chevron might not even increase dividends at all.
Your goal is to avoid situations where you are essentially compounding mistakes. When all is set and done in 20 years, do you think you would be better off doing nothing or selling and buying something else? If you sold a perfectly good dividend grower, that grew earnings and dividends like clockwork, you paid a tax on gains. This provided you with less money to invest than in the first place. You then purchased shares in a company where you don’t know if the dividend income from this position would be higher or lower than the dividend income from the original position in 20 – 30 years.
The next factor to think about is that replacing appreciated shares simply because the yield is low, for a higher yielding security, should take into account past and projected growth in earnings and dividends. An investor should look for growth at reasonable prices, and should not focus solely on the dividend income at all costs, while ignoring capital gains. This is because a company that cannot grow earnings and dividends today, will likely be unable to grow share prices over time. This is important, because your capital is losing purchasing power over time. In contrast, a company like Becton Dickinson has a growth kick that can result in growing earnings and dividends, which could eventually translate into higher prices. Most equities share a portion of earnings with shareholders in the form of dividends, and then reinvest the rest, in order to grow and maintain the business. A company like Con Edison, which pays out a very high portion of income to shareholders will be unable to grow quickly enough. As a result, its earnings power might not translate into growth in dividends and stock prices, that can maintain purchasing power of your income and capital.
The nest factor is that chasing yield for sake of yield is a very very dangerous thing. Most investors who start investing for dividends always seem to be attracted to the highest yielding securities out there. This is a mistake, because they are usually not taking into consideration the sustainability of the dividend payment. Most of these investors do not do a very good homework in understanding the business model of a high yielding company, and are focusing only on the high yield aspect of it. What good is a 16% annual dividend yield, if the dividend payment is cut by 80 or 90% in the next year? You would have been better off with a company yielding 2 – 3% in the first place, that has the capability and desire grows dividends over time. The issue with selling an appreciated company that still has potential, for a higher yielding one, is a slippery slope in yield chasing. Once you sell start selling the lowest yielding components of your stock portfolio, without accounting for such factors as sustainability, growth, and understanding of the business, you are becoming essentially a yield chasing investor. In reality, yield should be the last factor in your fundamental analysis.
The last factor on selling is mostly a blend between my personal experiences as a dividend investor and academic studies on the performance of individual investors. According to academic studies, individual investors routinely underperform their benchmarks by as much as 9% per year. This is caused by frequent trading in their portfolios. Based on my own experiences, I can vouch to these findings 100%. When I look at some of the sales I have done, most of them have been pretty disastrous. I have essentially managed to sell a stake in a company that was growing well, and might have looked overvalued relative to another company.
However, after a few years, I calculate that I would have been better off simply holding on to the original security, without the hassle of extra taxes, paperwork, commissions and strains on my already filled schedule. When I sell I am usually worse off. I have realized that I would have been better off just doing nothing, and not tinkering with my portfolio. The point is when you reach out for yield you are sacrificing growth potential and altering the risk profile of your portfolio. You should be aware of that, and be ok to accept lower growth and capital gains that could bring more dividend dollars in the future, for the higher immediate dividend income that will produce less in future dividends and capital gains.
All of this doesn’t mean you should never sell a stock. If it is really overvalued, cuts dividends, or if something material changes, you might be better off selling and going someplace else. However, you need to think about some of the factors explained in this article, in your decision making process on selling.
The urge to do something is the thing that will cost you in the long run. If fundamentals are fine, there is decent EPS growth, DPS growth and you still expect it to continue, your job is to sit tight on investment and let the company do the compounding for you. Sitting is the toughest part of investing, especially in an era where you are bombarded with information on investments all the time. Sitting on an investment, and holding for the long term, might after all be the best strategy for ordinary investors.
Full Disclosure: Long BDX, CL, ED, CVX
Relevant Articles:
- Why would I not sell dividend stocks even after a 1000% gain?
- Replacing dividend stocks sold
- Why I am replacing ConEdison (ED) with ONEOK Partners
- Active Dividend Growth Investing
- When to sell my dividend stocks?
Subscribe to:
Posts (Atom)
