How to be an Intelligent Dividend Investor

Ben Graham is one of the most successful investors of all time. He is the father of value investing, and the mentor of super investor Warren Buffett. He is also the author of the bible on value investing “Security Analysis”, as well as the book “The Intelligent Investor”. Ben Graham’s strategy focused on purchasing undervalued companies, and then selling them when prices reached his objective.

Graham was adamant about investing in companies that pay dividends. He believed that conservative investors should only consider companies that have paid a dividend every year for at least the last 20 years. He argued that dividends are a sign that a company is profitable (dividends are paid from profits, after all) and that they also offer investors a return even if the company's stock does not perform well.

Ben Graham quotes in his book "The Intelligent Investor" that:

One of the most persuasive tests of high quality is an uninterrupted record of dividend payments going back over many years. We think that a record of continuous dividend payments for the last 20 years or more is an important plus factor in the company's quality rating. Indeed the defensive investor might be justified in limiting his purchases to those meeting this test.

Dividends represent a positive return on investment to shareholders. Because they are paid out of real earnings, they are the only fundamental link between company performance and investor returns. This is because stock prices can often ignore fundamental values for extended periods of time.

As a result, dividend investing is the perfect strategy for the intelligent investor to live off their nest egg. It is a nice edge for the investor with the long – term mindset of a business owner, who focuses on business profits, and is not afraid of stock prices that fall by 40 – 50% over a short period of time.

This business owner creates diversified portfolios that hold at least 30 - 40 securities, acquires partial ownership in those businesses over time and tried to pay fair prices for the securities.

What dividend investors do is a variation of value investing, with a quality twist. While Graham would focus on generating one-time profits from buying undervalued securities, dividend investors focus on recognizing value through the receipt of dividends. This dividend income unlocks value in the shares they own, by essentially providing them with a sort of like a cash rebate on their original purchase, while also maintaining their ownership in the asset. This provides recurring returns for the dividend investor who had done all the initial work needed.

Think about this for a second. The strategy Graham and early Buffett used was focusing on spending the equivalent of several full-time employees per week, scanning thousands of opportunities in order to come up with a few undervalued securities. They would purchase them, and sell only after a target price is met. After that, the laborious process continued.

On the other hand, if you spend your time looking for quality dividend paying companies, and find a few at fair prices, your work is essentially done. You will generate a rising stream of dividends over time, in some cases for decades, while patiently holding on to the appreciating stock. If your company manages to grow earnings and dividends by 7 – 10% year, this would quietly compound your investment income and net worth over the years. True, you have to monitor those investments, but let’s be honest, companies do not change that much from year to year. As long as the story keeps up, you can afford to only check the company through quarterly and annual reports. In reality, only a small portion of the companies you own will turn out to grow dividends for a long period of time, and deliver the most in growth for your portfolio. A large part would grow and then freeze and resume dividend growth, while the rest would likely lead to small losses as they cut dividends due to changes in business environment.

In a later version of the Intelligent Investor, Graham discussed how his partnership was involved in acquiring 50% of GEICO in 1948 for $712,000. Later, the SEC required them to distribute the shares to the partners. By 1972, the value of that stock had zoomed to $400 million. Graham later admitted that the profits from this one deal far outstripped the profits of his partnership over two decades from following the laborious value investing principles.

Buffett also purchased $10,000 worth of Geico in 1951, only to dispose at a profit in the next year in order to buy Western Insurance at 2 times earnings. He netted $15,000 from the sale, and notes that in the subsequent 20 years, the value of the sold shares increased to $1.3 million.

This is why buy and hold for the long-term in fantastic businesses is so superior to active trading (the active outguessing of the markets). It therefore seems important to focus on great businesses, which can grow for decades after you purchase them. Such securities can be safely tucked in a vault, and the investor should only be reminded about them four times per year, as the dividends are deposited in their accounts. Check this list of 39 dividend champions I am considering for further research.

Full Disclosure: None

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Five Companies Showering Investors With More Cash

I expect that sometime around 2018, my forward dividend income will exceed my monthly expenses. I find dividends to be a more stable and dependable source of income, than capital gains. If I choose to live off dividends, and not have a job or other sources of income by the end of this decade, I want to make sure that I do not outlive my nest egg.

I purchase shares in companies that pay me to hold them and will increase those payments over time. When a company I hold rewards me with more cash, this shows me that my strategy works in achieving its expected goals and objectives. The news that a company I own raised dividends serves as a positive reinforcement tool.

In the past week, there were several companies that raised dividends. I have highlighted several which have managed to boost distributions for at least five years in a row. I have also focused only on those I already own, or find interesting for further research. The companies include:

Exxon Mobil Corporation (XOM) explores for and produces crude oil and natural gas in the United States, Canada/South America, Europe, Africa, Asia, and Australia/Oceania. The company boosted its quarterly dividend by 5.80% to 73 cents/share. This marked the 33th consecutive annual dividend increase for this dividend champion. The ten year dividend growth rate is 9.80%/year. Shares are slightly overvalued at 22.30 times forward earnings and a yield of 3.30%. I would consider the stock on dips below $80/share. Check my analysis of Exxon Mobil.

International Business Machines Corporation (IBM) provides information technology (IT) products and services worldwide. The company boosted its quarterly dividend by 18.20% to $1.30/share. This marked the 20th consecutive annual dividend increase for this dividend achiever. The ten year dividend growth rate is 19.80%/year. Shares are attractively valued at 10.90 times forward earnings and a yield of 3%. I find the stock attractively valued, and might consider adding shares to my position there. Check my analysis of IBM.

W.W. Grainger, Inc. (GWW) operates as a distributor of maintenance, repair, and operating (MRO) supplies; and other related products and services that are used by businesses and institutions primarily in the United States and Canada. The company boosted its quarterly dividend by 8.30% to $1.17/share. This marked the 44th consecutive annual dividend increase for this dividend champion. The ten year dividend growth rate is 18.20%/year. Shares are attractively valued at 19.80 times forward earnings and a yield of 1.90%. I would be interested in adding to my position in the stock on weakness. Check my analysis of W.W. Grainger.

Wells Fargo & Company (WFC) provides retail, commercial, and corporate banking services to individuals, businesses, and institutions. The company raised its quarterly dividend from 35 to 37.50 cents/share. This marked the fifth consecutive annual dividend increase. The stock is attractively valued at 13.30 times forward earnings and yields 2.70%. Check my analysis of Wells Fargo for more details. Wells Fargo is an example of a situation where my assessment was wrong in May 2013, but I changed my mind after reviewing my analysis a couple of months later. I should refresh my analysis on the company.

American Water Works Company, Inc. (AWK), through its subsidiaries, provides water and wastewater services in the United States and Canada. The company operates through two segments, Regulated Businesses and Market-Based Operations. The company boosted its quarterly dividend by 9.70% to 34 cents/share. This marked the 8th consecutive annual dividend increase for American Water Works. The five year dividend growth rate is 8.10%/year. Currently, the stock is selling at 20.90 times forward earnings and yield 2.50%. The stock seems overvalued at present, and I need to add it to my list for further research.

Full Disclosure: Long XOM, IBM, GWW, WFC

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Johnson & Johnson (JNJ): A Quality Dividend King At An Attractive Valuation

Johnson & Johnson (NYSE:JNJ), together with its subsidiaries, is engaged in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments: Consumer, Pharmaceutical, and Medical Devices & Diagnostics. This dividend king has paid dividends since 1944 and has managed to increase them for 53 years in a row.

The company's latest dividend increase was announced in April 2015 when the Board of Directors approved a 7.10% increase in the quarterly dividend to 75 cents /share. The company's peer group includes Novartis (NYSE:NVS), Pfizer (NYSE:PFE) and Roche Holdings (RHHBY).

Over the past decade this dividend growth stock has delivered an annualized total return of 7.20% to its shareholders.

The company has managed to deliver 7.20% average increase in annual EPS over the past decade. Johnson & Johnson is expected to earn $6.14 per share in 2015 and $6.42 per share in 2016. In comparison, the company earned $5.70/share in 2014.

Johnson & Johnson also has managed to reduce number of shares outstanding. Between 2004 and 2015, the number of shares declined from 2,996 million to 2,826 million.

Johnson & Johnson has a diversified product line across medical devices, consumer products and drugs, which should serve it well in the future. This makes the company largely immune from economic cycles. In addition, the company has strong competitive advantages due to its scale, leadership role in various diverse healthcare segments, breadth of product offerings in its global distributions channels, continued investment in R&D, switching costs to users of its medical devices, as well as its stable financial position. The company generates 70% of revenues from products where it is number one or number two in the respective field. The ability to generate strong cash flows, have enabled Johnson & Johnson to reward shareholders with a higher dividends for 53 consecutive years.

Future profits growth could come from new product offerings, which are the result of continued investment in research and development, and through strategic acquisitions. The company spends approximately 11% on R&D, and generates a quarter of its revenue from products launched in the past five years. In the Pharmaceuticals segment, the company expects 10 major filings and 25 line extensions expected between 2013 and 2017. Approximately thirty major filings are expected between 2014-2016 in the Devices segment.

Johnson & Johnson is also expanding its business through strategic acquisitions. For example, the acquisition of Synthes, is expected to generate significant synergies for Johnson & Johnson and make it a leader in fast growing trauma market. This also allowed the company to use its overseas cash without having to pay the steep repatriation taxes. Emerging market growth and opportunities for cost restructurings should further help the company in squeezing out extra profits in the long run.

Sales in drugs like Simponi, Stelara, Zytiga, Xaralto and Olysio should more than offset the generic erosion from older drugs which are losing their patent protection. The fact that the company has exposure to other healthcare segments besides pharmaceuticals makes it a much safer play on the healthcare sector than pure pharma companies. I like the fact that there is diversity in the revenue generating behind each of the large segments. The three segments include Pharmaceutical with 43% of sales, Medical Devices & diagnostics with 37% of sales and the Consumer segment with approximately 20% of sales.

The annual dividend payment has increased by 9.60% per year over the past decade, which is higher than the growth in EPS.

A 10% growth in distributions translates into the dividend payment doubling every seven years on average. If we check the dividend history, going as far back as 1977, we could see that Johnson & Johnson has actually managed to double dividends every five and a half years on average.

In the past decade, the dividend payout ratio increased from 38.70% in 2004 to a high of 64.50% in 2011, before decreasing to 48.40%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

The return on equity has decreased from 29% in 2004 to 22.70% in 2014. This is still a very high return on equity however. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time. Given the fact that the amounts in this indicator are still high these days, I do not view this decline as a major warning sign.

Currently, the stock is attractively valued at 17.80 times forward earnings and a current yield of 2.70%. The only reason I am hesitating to add more shares is because the company is one my five largest holdings.

Full Disclosure: Long JNJ

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What makes Consumer Staples the Perfect Dividend Growth Companies?

Most consumer staples are also called defensive companies, because their earnings and dividends do not decline by much during recessions. During economic recoveries however, their earnings and dividends tend to increase also. Because they are mostly mature and large companies, growth expectations are low, which usually leads to low valuations.

The thing that truly appeals to me in consumer staples includes the recurring nature of their revenues, which are generated from a wide number of products that customers love and buy regularly. Most consumer staples offer products with strong recognizable brands, for which customers are willing to pay a slight premium for. A customer, who is used to Gillette razorblades and shaving crème or foam for years, is not going to downgrade their experience merely in order to save a few dollars, but end up with cuts all over their faces. If you have used Colgate toothpaste for years, chances are very high that you would keep purchasing a tube every month or so. The nature of the products that consumer staple companies offer, satisfy basic human needs, which are satisfied only when the branded product is exhausted. Once it is all used up, the consumer needs to go ahead and purchase the product again, thus ensuring a repeatable stream of sales for the company for decades to come from each consumer it wins over.

Consumer staple companies also benefit from strong distribution networks and economies of scale in production. They have wide moats. The distribution networks help the products to be easily accessible to the everyday consumer, and increase the likelihood of a repeated sale. The economies of scale allow companies to allocate their costs over a larger pool of product, thus resulting in negligible per unit in additional cost. For example, a company like Procter & Gamble (PG) has a better staying power than an upstart consumer-staples company, because P&G can reach out tens of millions of consumers in the US through advertising, as it already generates billions in revenues and already has millions of customers buying its products. The global scale of manufacturing also makes it cheaper to make its products, relative to a smaller competitor.

Furthermore there are always plenty of opportunities for growth, driven either through acquisitions or international expansion. In addition, the general level of increase in populations over time also leads to an organic growth kicker for consumer staples.

The fact that consumer staple products are relatively inelastic, meaning that people use those in good times and bad, translates into a stable stream of recurring revenues for these companies. This translates into stable cash flow generation, that provides the fuel behind dividend payments, share buybacks and acquisitions.

If you think about it, as long as people use hygiene products such as toothpaste and shampoos, eat food like ice-cream, cookies, jelly and canned soup, chances are that consumer staple companies should do well over time. Even if you get a consumer staple company whose customer base grows by 1%/year, you can generate very decent returns over time. This is because the company would be able to pass on rising costs to consumers, deploy some excess cash flows to repurchase some stock on a regular basis, make strategic acquisitions, and make operations more efficient. If you add in a small starter yield of 2 – 3% today, chances are that these factors described previously could easily translate into a minimum very conservative annual earnings per share growth of 6% - 7% for decades.

Some of the huge macro trends that Consumer Staples are riding include the increasing prosperity in the emerging market world, where over a billion people would be lifted out of poverty and join the middle class within a couple decades. In addition, some demographics trends that no one is paying attention to includes the baby boom in the US, as well as the potential for a baby boom in China, as the one child per couple policy seems to be phased out by the government. Even the population ageing in developed countries such as Japan or those Western European ones could be a boom for consumer staples. As people age, they would want to do so in dignity, which could only translate into more sales for the likes of Johnson & Johnson (JNJ), Procter & Gamble (PG) etc.

The time to purchase these companies is when valuations are low, and avoid overpaying, as this would mean that the next decade of growth is already baked in the stock price. The perfect time to purchase could be when there is a temporary snafu at the company, such as the Tylenol scare for Johnson & Johnson in 1983 or the 2010 recalls again at Johnson & Johnson (JNJ). The financial crisis of 2007 – 2009, also created an environment where quality companies such as Procter & Gamble (PG), Clorox (CLX), Colgate-Palmolive (CL) and PepsiCo (PEP), to name a few, were on sale at some of the lowest valuations in years.

After you purchase those companies, your job is to sit patiently and collect those growing dividends. Only if prices become terribly overvalued, north of 30 times forward earnings should you consider thinking about trimming. So far, even if you held on through the 1972 Nifty Fifty bubble, or the 1999 – 2000 bubble, the rising earnings tide on those companies eventually bailed out the long-term investor. Just be mindful that if you sold a company that raises earnings and dividends like clockwork at 30 – 40 times earnings, chances are that any replacements you find might look cheaper, but wont offer the same level of quality.

Unfortunately, many consumer staples companies I like are overvalued. A few which are fairly valued today include:

Johnson & Johnson (JNJ), together with its subsidiaries, researches and develops, manufactures, and sells various products in the health care field worldwide. This dividend king has raised distributions for 53 years in a row. In the past decade, Johnson & Johnson has managed to boost dividends by 9.70%/year. The stock currently sells for 16.50 times forward earnings and yields 3%. Check my analysis of Johnson & Johnson for more information about the company.

Altria Group, Inc. (MO), through its subsidiaries, manufactures and sells cigarettes, smokeless products, and wine in the United States and internationally. This dividend champion has raised distributions for 45 years in a row. In the past decade, Altria has managed to boost dividends by 11.60%/year. The stock currently sells for 18.60 times forward earnings and yields 4.10%. Check my analysis of Altria information about the company.

Diageo plc (DEO) manufactures and distributes premium drinks such as Johnnie Walker, Crown Royal, Buchanan’s, J&B, Baileys, Smirnoff, Captain Morgan, Guinness, Shui Jing Fang, and Yenì Raki.. The company has raised dividends for 15 years in a row. In the past decade, the company has managed to boost dividends by 5.80%/year. Currently, the stock is selling for 20.20 times forward earnings and yields 3%. Check my analysis of Diageo for more details.

Full Disclosure: Long JNJ, CLX, PG, CL, PEP, MO, DEO,

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Four Quality Dividend Machines Hiking Distributions

Over the past week, there were four quality dividend paying companies, which announced that they are raising dividends for their shareholders. As a long-term shareholder, I like it when I am essentially paid to hold companies. I like it even better when that company I own regularly increases the amount of cash they send my way. I also view the near term rate of change in dividend hikes as a management indication about their expectations for earnings growth. One of the easiest ways for a time-starved investor like myself to monitor those dividend hikes on companies I own is my broker Interactive Brokers. I receive notifications about dividend payments that were just approved, and quarterly results that are about to be released.

In the past week, there were four companies that raised dividends, which also attracted my attention. I have shares in the first three. The last one is a company I have been monitoring.

Unilever (UL) increased its quarterly dividend by 6% to 30.20 eurocents/share. This marked the 20th consecutive annual dividend increase for this international dividend achiever. The ten year dividend growth rate is 6.20% /year. The stock slightly overvalued at 21.80 times forward earnings and yields 2.90%. Check my analysis of Unilever.

Ameriprise Financial, Inc. (AMP), through its subsidiaries, provides various financial products and services to individual and institutional clients in the United States and internationally. The company raised its quarterly dividends by 15.50% to 67 cents/share. This marked the tenth consecutive dividend increase for this dividend achiever. The five year annual dividend growth is 27.20%/year, which is normal for companies in the initial phases of dividend growth. The shares are selling for 13.10 times forward earnings and yield 2.10%. Check my analysis of Ameriprise Financial. I decided to make a small addition to my position last week.

Johnson & Johnson (JNJ), together with its subsidiaries, researches and develops, manufactures, and sells various products in the health care field worldwide. It operates in three segments: Consumer, Pharmaceutical, and Medical Devices. The company raised its quarterly dividend by 7.10% to 75 cents/share. This marked the 53rd consecutive annual dividend increase for this dividend king. The ten year dividend growth is 9.70%/year. The shares are selling for 16.50 times forward earnings and yield 3%. Unfortunately, Johnson & Johnson is one of my largest positions, which is why I may refrain from putting more capital there. Check my analysis of Johnson & Johnson.

Costco Wholesale Corporation (COST), together with its subsidiaries, operates membership warehouses. The company raised its quarterly dividend by 12.70% to 40 cents/share. This marked the 12th consecutive annual dividend increase for this dividend achiever. The ten year dividend growth rate for Costco is 16.40%/year. The stock is over valued at 28.30 times forward earnings and yield 1.10%. I have been following Costco for several years and really like the business, but I never really saw a good valuation to initiate a position in it.

Full Disclosure: Long AMP, JNJ, UL

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