My Bet With Warren Buffett - Year Two Results

Two years ago, I made a bet with Warren Buffett. This was a continuation of the bet that Warren Buffett had done with a hedge fund manager over the preceding decade.

Per the original bet, Buffett believed that index funds would do better than hedge funds over the next decade. He believed that, because hedge funds are very expensive to their investors. Hedge funds usually charge investors a 2% fee for assets under management, coupled with a 20% performance fee. In other words, if a hedge fund generates a 10% return on investment for a given year, 2% of that return goes to the hedge fund manager, in addition to any recurring fees for a total outlay of 4%. When you hold shares through a low cost index fund, you have much lower costs of investing. Of course, when you buy and hold shares directly through a commission free brokerage, you have even lower costs than the average fund.

Needless to say, Buffett won the bet. But I think that he won the bet because of the high costs of hedge funds. Hedge funds have a very high hurdle rate to succeed, because of their high costs. Let's look at a situation where the average index fund on S&P 500 returns 10%/year, and a hedge fund charges a 2% performance fee, as well as a 2% management fee. In order for the hedge fund to generate a net return of 10% after fees, it needs to generate a gross return of 15.40%. If the hedge fund generates a return of 10% before fees, investors would end up paying close to 4.20%/year in fees alone.

The irony of the bet is that the most vocal index fund fans would have lost the bet to Buffett as well. Anyone who held fixed income funds, or international and emerging market funds would have done much worse than someone who simply held on to the S&P 500 between 2007 and 2017. This is a fact that is seldom mentioned about this bet. Perhaps Buffett is not only good at picking stocks, but at picking index funds too.

It makes sense that if you pay high fees, your investment returns will be reduced. For example, if you buy shares of Johnson & Johnson (JNJ) today, you will generate a dividend yield of 2.50%. If you paid someone a 2% fee, you will end up with a dividend yield of only 0.50%.

I decided to make my own bet with Warren Buffett, in an effort to challenge assumptions, and share anything I learn in the process. Of course, Buffett doesn't know about this bet, and it is highly probable that he doesn't know I exist. But I will do this bet anyways.

I believe that noone knows in advance what the best investments of the future are going to be. The only thing you can control is your savings rate, the types of investments you make, your holding period and the investment costs you incur. This is the real reason why index funds are so popular - they have low costs, since they do not employ expensive manager to select investments. They are also cheap, because they do not turnover their portfolios frequently.

I wanted to select an investment portfolio that is adequately diversified, and which anyone can build in five minutes or less. There is no accounting knowledge required, just some initial capital and basic computer literacy that almost everyone in the world today possesses.

I decided to invest equal amounts in the 30 companies in the Dow Jones Industrials Average at the end of 2017. My strategy was to reinvest dividends automatically in the companies that produced them, keep any spin-offs, and not sell any company (unless I am forced to, due to an acquisition). If a company was dropped from the index, I kept it, for as long as it is publicly traded. Since there are commission free brokers everywhere, the cost is zero. If held in a Roth IRA, there are no tax costs either.

The goal of this portfolio is to be as passive as possible, because investment turnover is costly to long-term returns. This is a very passive portfolio, which will be selected, and tucked in safely for the long-run. The idea behind this passive portfolio stems from the idea for the coffee can portfolio. When you buy quality blue chip companies, which are leaders in their industries, you are putting the odds of success in your favor. After all, a group of companies with earnings power and strong competitive position is likely to continue doing well for a few decades down the road, even as things change over time.

My analysis of the Corporate Leaders Trust, showed me that a portfolio of blue chip stocks can produce great long-term returns, even if no new securities are selected for 80 years. The Corporate Leaders Trust is a mutual fund that was launched in 1935. The fund invested in a portfolio of 30 companies, which was unchanged for the next 85 years. No new securities were selected, and all securities were held for as long as they kept paying dividends. When companies were acquired for stock, the stock in the acquirer was held. When a company was acquired for cash or when it was sold due to a dividend cut, the dollars were allocated in the remaining portfolio companies. A lot of blue chip stocks generate earnings, and have the scale to continue succeeding in the long-run. In addition, companies often go through mergers, spin-offs and acquisitions, which can rejuvenate an otherwise passive portfolio, but doesn't require any additional input from the investment analyst. The lack of activity also ensures that any behavioral costs are minimized.

My analysis of the performance of the original companies in the S&P 500 also reiterated the idea that it pays to buy and hold companies, and not sell no matter what. Jeremy Siegel calculated that if someone put an equal amount of money in the original 500 securities of the S&P 500 index in 1957, and never sold, they would have done better than the S&P 500 index itself over the next half a century. That's because the portfolio was held static, dividends were reinvested for decades, each company received an initial equal weighting, and because all spin-offs were kept.

For example, a lot of investors know that Eastman Kodak went to zero in 2011 after the company became bankrupt. It is a little known fact that it spun-off Eastman Chemicals (EMN) in 1994. As a result, an investor who put $100 in Eastman Kodak in 1957, who held on to their stock and any spin-offs would have ended up with $640. This calculation assumes reinvesting dividends back into the security that produced them in the first place. It is surprising that the investor actually made money, despite the fact that their original thesis was wrong as Kodak went to zero. Had they reinvested dividends strategically into other dividend paying stocks would have even further reduced risk, and increased returns. It just goes to show you that things can turn out for the better, even if an investment is doomed. That's the same lesson that shareholders of Sears and General Motors can attest to.

The important thing to remember is that we are talking about long-term returns and long-term investing. There will be year to year fluctuations in total returns and relative returns.

That is my cue that last year, the portfolio did well, but not as well as S&P 500. It looks like the portfolio is up 23.93% since the end of 2017. (through 12/31/2019)

The S&P 500 is up by 25.45% over the same period, from 12/29/2017 to 12/31/2019.

In the first year of the bet, the portfolio was down 1.63% versus a loss of 4.38% for the S&P 500.

You can see the returns by security below. These are life-to-date returns since the launch.

This year presented one of the most challenging math problems I have ever seen in my life. That is the split of DowDupont (DWDP) into three separately traded companies. The company itself was formed in 2017 by merging Dow Chemical and DuPont, only to be split up two years later.

On April 1, 2019, shareholders received one share of Dow (DOW) for every three shares of Dow Dupont they had held. This means that I have to allocate 1/3rd of the worth of the investment to Dow from that date forward (0.33562 to be exact), with 2/3rds to DuPont (0.66438 to be exact for DuPont). (Source)

On June 1, 2019, shareholders received one share of Corteva for every three shares of Dow Dupont they held. I am not sure how this happened, but 74.13195% of the net worth is attributed to DuPont and the remaining 25.86805% to Corteva. DowDupont then did a 1:3 reverse stock split to turn itself into DuPount. (Source)

In both cases, there were fractional shares, that I presumed were converted to shares of the new entity being spun-off. In reality, fractional shares were converted to cash for shareholders. However, I am presuming we are dealing with a million dollar portfolio here, and a fractional share here and there can be cashed in and then reinvested for a net effect of a fractional share. So to keep things consistent, the fractional shares were kept.

All of this activity has just made accountants and bankers richer, as it definitely took away from the ability of management and employees to focus on the business instead. A $1 investment in Dow Dupont at the end of 2017 has resulted in owning shares of Dupont (DD), Dow (DOW) and Corteva (CTVA), and a total loss of 30%. This also increased the number of securities in this passive portfolio from 30 to 32.

I also kept the valuation ratios and dividend yields for each company as of 12/29/2017. Last year, the companies with a P/E above 20 had done better to-date, than the companies with a P/E below 20. By the end of 2019 however, the life-to-date returns on companies with a P/E below 20 is slightly higher than the average, and the returns on companies with a P/E above 20. Is this a trend, or are we all being fooled by randomness by the cyclical changes in investor fashion of growth versus value?

There were three other bloggers, who were brave enough to get into a 10 year bet. Those include:

Carl from 1500days.com. He selected four technology companies. He has been able to ride the wave of technology for the past decade. He is the clear winner so far - his portfolio is up 30.77% since the launch. His portfolio was up 2.80% in 2018 as well.

Carl is a great stock investor. The problem is that he has allowed to be convinced by others that he is going to be mediocre in the future. As a result, he has been selling stock in companies, and buying index funds with the proceeds. But the stock he has been selling has done much better than the index funds he has been buying. If Carl wins this contest, he may realize that he has squandered millions of dollars in potential returns by selling the best companies in the world, and buying investments that didn't do as well.

Ben from suredividend.com selected the Dividend Aristocrats Index, which is a wise choice. The dividend aristocrats lost 2.73% in 2018, but gained 27.97% in 2019 for a life-to-date return of 24.48%. Source: S&P Global

Joe from retireby40.org, selected the S&P 500. In a sense, he is the yardstick against we measure ourselves.

Let's circle back again in one year, and see how things are progressing in year 3?

Thank you for reading!

Relevant Articles:

- My Bet With Warren Buffett
- My Bet With Warren Buffett – Year One Results
- The Perfect Dividend Portfolio
- Time in the market is your greatest ally in investing
- The Coffee Can Portfolio

Seven Notable Dividend Increases From Last Week

I review the list of dividend increases every week, as part of my portfolio monitoring process. I leverage several of my dividend investing resources for this effort.

I started by reviewing the list of all dividend increases for the week. I then narrowed the list down to the companies that have managed to boost dividends for at least ten years in a row. I also focused on companies that had a meaningful combination of yield and dividend growth.

The companies for this week’s review include:

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company leases its retail properties primarily to regional and national retail chain store operators.

The monthly dividend company increased its monthly dividend to 23.25 cents/share, which is a 3.10% increase over the dividend paid during the same time last year. During the past decade, Realty Income has managed to raise dividends at an annualized rate of 4.70%. Realty Income is a newly minted dividend champion, as it has increased dividends for 25 years in a row.

Funds from Operations is the metric used to evaluate the fundamental performance of REITs. Realty Income has managed to boost FFO form $1.84/share in 2008 to $3.12/share in 2018. The REIT estimates FFO/share for 2019 to be in the range of $3.26 to $3.31/share.

The REIT is overvalued at 23 times forward FFO right now. Realty Income yields 3.65%. Realty Income may be worth reviewing on dips below $66/share ( 20 times FFO) or on dips below $70/share ( 4% yield). Check my analysis of Realty Income for more information about the REIT.

Fastenal Company (FAST) engages in the wholesale distribution of industrial and construction supplies in the United States, Canada, and internationally. It offers fasteners, and other industrial and construction supplies under the Fastenal name.

Fastenal hiked its quarterly dividend by 13.60% to 25 cents/share. This marked the 22nd year of consecutive annual dividend increases for this dividend achiever. Fastenal has managed to grow dividends at an annualized rate of 17.10% during the past decade.

Between 2008 and 2019, the company managed to grow earnings from 47 cents/share to $1.38/share.
The company is expected to earn $1.45/share by 2020.

The stock seems richly priced at 25.40 times forward earnings. Fastenal yields 2.70% however, which is a nice yield, coupled with a nice dividend growth. Check my analysis of Fastenal for more information about the company.

Consolidated Edison, Inc. (ED) engages in regulated electric, gas, and steam delivery businesses in the United States.

Con Edison raised its quarterly dividend by 3.40% to 76.50 cents/share. This was the 46th consecutive annual dividend increase for stockholders of this dividend champion. Con Edison has managed to grow dividends at an annualized rate of 2.30% during the past decade.

Earnings went from $4.37/share in 2008 to $4.42/share in 2018. The company is expected to earn $4.52/share in 2020.

Con Edison is richly valued at 20 times forward earnings, and yields 3.40%. Given the low yield, and the low dividend growth, I view Con Edison as a hold at best.

Alliant Energy Corporation (LNT) operates as a utility holding company that provides regulated electricity and natural gas services in the Midwest region of the United States. It operates through three segments: Electric, Gas, and Other.

The company just hiked its quarterly dividend by 7% to 38 cents/share, marking the 17th consecutive annual dividend increase for this dividend achiever. The company has managed to boost distributions at an annualized rate of 6.60% during the past decade.

The company managed to grow earnings between 2008 and 2018 from $1.30/share to $2.19/share in 2018. The company is expected to earn $2.42/share in 2020.

The company is overvalued at 23.60 times forward earnings, and offers a dividend yield of 2.65%. I like the growth in earnings per share, but would prefer a lower entry valuation as a start.

CMS Energy Corporation (CMS) operates as an energy company primarily in Michigan. The company operates in three segments: Electric Utility, Gas Utility, and Enterprises.

CMS The company increased its quarterly dividend by 6.50% to 40.75 cents/share. This marked the 13th consecutive annual dividend increase for this dividend achiever. Over the past decade, CMS Energy has managed to boost distributions at an annualized rate of 11.80%.

CMS Energy managed to boost earnings from $1.20/share in 2008 to $2.32/share in 2018.
The company is expected to generate $2.67/share in 2020.

The stock is overvalued at 24.60 times forward earnings, and yields 2.50%. The valuation is high for a utility, despite the earnings growth over the past decade. I would prefer a better entry valuation as a start.

Enterprise Products Partners L.P. (EPD) provides midstream energy services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil, petrochemicals, and refined products. The company operates through four segments: NGL Pipelines & Services, Crude Oil Pipelines & Services, Natural Gas Pipelines & Services, and Petrochemical & Refined Products Services.

The partnership increased its quarterly distribution to 44.50 cents/unit, which is an increase of 2.30% over the distribution paid during the same time last year. During the past decade, the partnership has managed to boost distributions at an annualized rate of 5%. The partnership has managed to hike distributions for 21 years in a row.

Enterprise Products Partners yields 6.20% today. It is one of the best managed pipeline MLPs out there. However, it is likely that it would convert to a corporation at some point in the near future, which could trigger taxable events for limited partners.

ONEOK, Inc. (OKE) engages in the gathering, processing, storage, and transportation of natural gas in the United States. It operates through Natural Gas Gathering and Processing, Natural Gas Liquids, and Natural Gas Pipelines segments.

ONEOK increased its quarterly dividend to 93.50 cents/share, which represents an increase of 8.7% over the distribution paid during the same time last year. ONEOK has managed to boost dividends for 17 years in a row and spots a ten-year annualized dividend growth rate of 17.30%.
ONEOK yields 4.80% today.

This is a list of companies for further review. Most seem attractive as businesses, but that doesn’t mean that they should be invested in at any price, regardless of valuation.

Relevant Articles:

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Northrop Grumman (NOC) Dividend Stock Analysis

Northrop Grumman Corporation (NOC) operates as a security company. It provides various systems, products, and solutions in autonomous systems, cyber, space, strike, and logistics and modernization, as well as in command, control, communications and computers, intelligence, surveillance, and reconnaissance (C4ISR) to customers worldwide. The company operates Aerospace Systems, Innovation Systems, Mission Systems, and Technology Services segments.

Northrop Grumman is a dividend achiever with a 16 year track record of annual dividend increases.

The last dividend increase happened in May 2019, when the Board of Directors approved a 10% hike to its quarterly dividend to $1.32/share.

During the past decade, the company has managed to increase distributions at an annualized rate of 12.70%.

Between 2009 and 2018, the company has managed to grow its earnings from $5.21/share to $18.49/share. The company is expected to generate $20.35/share in 2019.

Long-term growth will be closely tied to defense spending by its largest customer – the US government. The US government accounts for 82% of revenues. While there will be short-term hiccups along the way, I believe that defense spending should only increase in the long-term. The world is going to continue to be a hostile place, and increased spending may be necessary to maintain peace and manage conflicts. Aging military equipment needs replacement and/or repair with the potential for an upgrade. A lot of contracts are provided after competitive bidding, which is why it is a good idea to spread my defense company bets, rather than have all my eggs in one basket.

Growth could also be derived from strategic acquisitions, which could be bolt-on ones or in areas with higher expected growth. A good example of the latter is the acquisition of Orbital-ATK in 2018, which brings in higher growth potential.

Demand for its strategic programs could lead to increased revenues down the road, notably the B-21 bomber and the subcontracting work on Lockheed Martin’s F-35 system. Unique expertise in certain defense areas (e.g. fighter aircraft radars) could be lucrative for Northrop when it comes to winning contracts, and earning solid margins on them.

The Information Systems segment could deliver above average growth due to the long-term trends around increased demand on cybersecurity and intelligence systems.

Earnings growth due to share repurchases will be more muted over the next decade, given the much higher valuations than those at the beginning of the decade.

The tax cut from 2017 drove earnings per share growth in 2018, given the decrease in tax rates for corporations. A rise in tax rates by the middle of next decade could hurt earnings per share.

The massive growth in earnings per share has been helped by share buybacks, as Northrop Grumman has been very active on this front. Between 2009 and 2019, the number of shares outstanding has declined from 323 million to 171 million. Share buybacks had a better chance or reducing the number of shares outstanding quickly when the P/E ratios were lower at the beginning of the decade. During the latter part of the decade, with valuations increasing, it is getting harder to get the same result in share count reduction and corresponding EPS increase. Share price declines are good for share buybacks.

Between 2009 and 2019, the dividend payout ratio has decreased from 32% to 25%. The company has largely managed its dividend payout ratio in a tight range between 24% and 32% of earnings.

I find the stock to be fairly valued at 18.70 times forward earnings. The yield is a little low at 1.40% today, but the distribution is expected to grow at a higher rate.

I invested in the stock in late December through my premium Newsletter, in order to diversify my defense contractor exposure. That was before the events at the beginning of the year resulted in take-off for all defense companies. I may add to other defense contractors going forward, subject to availability of funds and subject to good valuations.

If the stock is available at better entry valuations, that would only increase forward returns of course. I would not chase the stock higher however.

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Calculating Organic Dividend Growth

One of the goals behind my dividend growth portfolio is to buy shares in companies which grow dividends over time. Dividend growth protects purchasing power of retirement income, and in many cases is expected to grow above the growth in the consumer price index. I want dividend income to grow on its own, without having to add new funds, or reinvesting dividends. This concept referred to as organic dividend growth. This will be helpful when I live off dividend income in retirement.

For the purposes of this dividend portfolio newsletter you are reading, I want to generate a target monthly dividend income.

In my model, I have forecasted the following variables:

1) Initial dividend yield of 3%
2) Annualized Dividend Growth of 6%
3) Investing roughly $1.000/month
4) Reinvesting dividends strategically

The first variables will be dependent on market conditions and ability to identify quality companies at attractive valuations. It is possible that stock prices get even higher from here, which would make it very difficult to find quality companies with a 3% yield, on average. Alternatively, if security prices start decreasing, it would be very easy to find securities yielding over 3%.

The second variable is dependent on the companies executing on their plans. If we selected dividend growth stocks well, they would continue growing dividends by around 6%/year, or better. The rate of dividend growth is not going to be linear, and it would fluctuate somewhat. However, I expect it to grow over long periods of time at an annualized rate of 6%/year. This means that all else being equal, and without adding new money or reinvesting dividends, a 6% dividend growth rate would translate into dividends doubling every twelve years. If I manage to get a 7% annualized dividend growth, my organic dividend income will double every decade. At a 10% dividend growth, portfolio income will double every seven years.

Organic dividend growth is important, because we want dividend income to be growing in retirement, when dividend checks are spent paying for living expenses. Dividend growth keeps purchasing power of the dividend income intact, which helps us maintain a standard of living in retirement, when we are less likely to be able to add new money to the portfolios.

Reinvesting dividends also helps in growing the dividend income stream. However, it is dependent on the conditions available in step one. The investing of new money will grow our dividend income at a ratable pace, but the rate of growth will be dependent on points 1 and 2 above. Since I do not plan to sell, I won’t be replacing lower yielding securities with higher yielding securities, in order to boost income. Theoretically, I can grow dividend income by actively trading and selling my winners to add to the losers ( or to other higher yielding companies). I do not believe in active trading, and my experience has shown me that selling one company to buy another has usually been a mistake. I would have been better off not second guessing anything on average, and just sitting tightly.

This is the point where I want to mention that there is a trade-off between dividend yield and dividend growth.

On aggregate, there are three types of companies from a dividend yield/dividend growth trade-off perspective.

The first type includes companies that grow dividends at a slower pace, but offer higher dividend yields today.

The second type includes companies that grow dividends at a more moderate pace, but offer medium dividend yields today.

The third type includes companies that grow dividends at a faster rate, but offer smaller initial yields today.

These guidelines are pretty much based on common sense. If a company yields 1%, it makes sense that we would expect it to generate high dividend growth over time. Alternatively, a company like AT&T (T) with a close to 6% dividend yield today will not be able to double dividends every five years.

As usual, there are exceptions to these guidelines. But on aggregate, it is a useful way to categorize companies, when evaluating them. Since we own diversified portfolios, these guidelines are evident when we start stratifying portfolio components into groups.

I am stating this because the availability of dividend companies will vary from year to year. It is possible that if the stock market continues increasing in value, I may end up focusing on higher yielding but lower growing companies for a period of time, because that will be what is available to invest in. Alternatively, I may decide to focus on lower yielding companies with high dividend growth expectations, if I see those as attractively valued today. In all cases, I will review the financials, and determine if dividends are safe, before putting any money at risk.

The next question is how to calculate organic dividend growth. Just calculating the average rate of change for each portfolio holding is a simple and easy way. However, this way may ignore the fact that a dividend portfolio is usually not equally weighted.

Another possible method could be to compare actual dividend income growth from year to year, while ignoring the impact of investment contributions done during the year. This method may ignore the impact of dividend reinvestments as well. For example, a portfolio consisting of 1 share of Altria on December 31, 2017 would have generated an annual dividend income of $2.86/share in 2018. The same share would have generated an annual dividend income of $3.28/share in 2019. Obviously, this works best for comparing static positions that have been held for longer than one full calendar year.

The drawback to this method is that if Altria doesn’t announce any raises in 2020, it would still pay $3.36/share, which would translate into a growth of a little less than 3%, when no growth occurred really.

A third method could include looking at portfolio positions at year end, and determining what the forward dividend income would be during the year. In the case of Altria, at the end of 2017, you would have expected annual dividend income for 2018 to be at least $2.64/share. The quarterly dividend was 66 cents/share, multiplied times four.

By the end of 2018, the quarterly dividend is 80 cents/share, translating into expected dividend income of $3.20/share. By the end of 2019, the quarterly dividend is 84 cents/share, translating into expected dividend income of $3.36/share.

Obviously, organic dividend growth matters for retirees who plan to live off distributions in retirement. While there are multiple ways to calculate it, the end result is having income that grows at or above the rate of inflation, and maintains its purchasing power.

Relevant Articles:

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Years’ worth of dividends - the most useless metric ever

Some investors get absolutely furious the second someone mentions the term yield on cost. I am very surprised when investors seldom have anything against the metric for "years worth of dividends received". This metric is usually mentioned during a situation when an investor is sitting at a healthy gain after having purchased a stock at much lower prices. The saying goes that if this investor sold, they could obtain several years worth of dividends by simply realizing their capital gain.

This metric is typically used to justify selling a good company at a (what is believed to be at the time) high price. Investors who focus only on capturing “several years worth of dividends” through the gain on their investment, are treading in dangerous waters. This could lead to them cutting short the profits on the stocks they purchased, and holding on to companies that might not be performing as well, especially if they haven’t delivered any gains.

I am not a fan of selling companies in general, and subscribe to a philosophy of buying and holding, and doing nothing else. Selling is usually a mistake, compounded by the fact that the next company usually does worse than the original investment sold. The mistake is further compounded by taxes paid, and commissions. Patience is important is long-term investing. My largest mistake has been selling for any reason, on average. Of course, I have been forced to sell with buyouts, and with dividend cuts, but any other reason has been a mistake. It has been a mistake for most other investors as well on aggregate, despite the "good reasons" they may have had.

Cutting the tree that produces fruit is never a good idea, especially if you replace it with a tree that might grow faster and is much bigger, but has a higher risk of catching a disease and dying.

I think problem is that this metric ignores capital gain contributions to total returns. This metric also forgets that a company that can grow dividends and earnings could end up paying more dividends down the road than a company with a higher dividend that is static. I have also found out that companies that can manage to grow earnings over time are less likely to cut dividends.

It is true that you can sell a stock that generates $100/year in dividends purchased at $1000 for a $2000 gain. But what you are missing out is that you locked dividends “for 20 years”, but might have missed out on future appreciation and dividend income growth. While it is secondary to income, appreciation potential is important as well.

As investors, we do not know in advance whether the company we are buying with the proceeds will do better than the company that you just sold at a gain worth"several years worth of dividends". The problem is further magnified by the fact that we end up teaching ourselves to trade the portfolio actively, which could result in missed opportunities, investing costs (taxes and up to 2019 commissions) and time. Your goal as a dividend growth investor is to assemble a portfolio of quality blue-chip companies to hold for the long-term. These are recession resistant businesses that will pay you more money over time. Your goal is to hold them, not trade them actively, which is something that few can do with any consistent success.

The years worth of dividend sold saying bothers me, because it reminds me of the useless saying that "nobody went broker taking a profit". The issue with this saying is that noone became rich by constantly taking profits. By constantly cutting the flowers by selling your winners, and watering the weeds by adding to your losers, you are guaranteeing yourself a life of investing mediocrity.

I view myself as a farmer, who plants lots of seeds in the ground, hoping that a few will be big enough winners to compensate for the seeds that turn out to be rotten. That's why I diversify, buy over time, and try to hold for as long as possible, in order to break-even and then earn a profit over time.

I will try to illustrate the ridiculousness of the saying behind "years worth of dividends" with an actual example from my portfolio. This is Brown-Forman, which became a dividend aristocrat in 2009, after raising dividends for 25 years in a row.

Back in 2010, I purchased shares of Brown-Forman (BF.B) for a split adjusted cost of $15.99/share. The company was expected to pay 32 cents/share, for a roughly 2% yield. I also received a special dividend of 26.67 cents/share - Brown-Forman is a shareholder friendly business, that is recession resistant, and is backed by a family whose fortunes are dependent on this business growing.

By the end of 2011, the stock was selling at $19.84/share, the stock had paid 35 cents/share and I had 11 years worth of dividends in appreciation.

By the end of 2012, the stock was selling at $24.83/share, the company had paid 38 cents/share in regular dividends and $1.60/share in special dividends.

In 2013, the stock closed at $29.66/share. The company paid 42 cents/share, and my gain amounted to over 32 years worth of dividends. Should I have sold by then? I was asking myself this question at the time, as the stock was selling above 20 times earnings and other companies were selling for less than that. Had I sold, I would have altered the risk profile of my portfolio, and I would have likely reached for yield that would have temporarily increased dividend income, but ultimately left me with less dividends over time.

By 2014, I was reading how great Brown-Forman was, which pushed the price up to $34.84/share. I received a little over 47 cents/share, and my gain was equivalent to 40 years worth of annual dividends. The stock was yielding roughly 1.50%. I could have sold it, and bought Con Edison at $68.50/share and a yield of 3.70%. That would have more than doubled dividend income. Con Edison would go on and pay $13.86 in dividends through 2019, and its share price would go on to $89.94/share ( or 7 times annual dividends at the annual rate of $2.96/share - my head hurts from this circular thinking). I wrote the prolific article, after a reader question - Should you sell after yield drops below minimum yield requirement?

In 2015, Brown-Forman's share price reached $40.05/share, the dividend paid was a little over 51 cents/share. At an unrealized capital gain of 47 years worth of dividends, I should definitely reconsider this, right? After all, there is a high chance that I won't be around by 2062. But I keep on holding on.

By the end of 2016, Brown-Forman sells at $35.21/share. The company paid a dividend of a little over 55 cents/share, but the yield is still low at 1.56%. My yield on cost is 3.40%, which I could have easily achieved by selling and switching to Diageo (DEO). Of course, if I sell today, I would pay a tax on my capital gains, and have $32.33/share after tax. Now I am down to only 35 years worth of dividends. Perhaps I should have just cashed in those chips, right? I was watching Brexit, and hoping that Diageo (DEO) would fall below $100/share - the problem was that the stock did not go down. Which in hindsight was great, since I didn't get to sell Brown-Forman. I just added to Diageo with new cash later.

By 2017, I am really glad I didn't sell, because Brown-Forman is now selling for $54/share and paid almost 60 cents/share in dividends to me. That's a P/E of 39.40, and a yield of 1.10%. I have an unrealized gain of 63 years worth of dividends. However, there are clouds on the horizon. Constellation Brands (STZ) wants to acquire Brown-Forman, but is rejected. I realized that having quality companies I own get acquired is a real risk behind dividend investing, that noone talks about.

It is 2018, and the stock is down to $47.58/share, but the company has paid 64 cents/share in regular dividends and a dollar per share in special dividends. The stock is at 32 times earnings but I keep holding on. Oh wait, the gain is now only 49 years worth of dividends, down from 63 years worth of dividends in 2017.

I am writing this post at the end of 2019, with Brown-Forman sitting pretty at $67.94/share. The company paid a dividend of 67 cents/share, and the forward annual dividend is at almost 70 cents/share. That's 74 years worth of dividends, for the lucky reader who made it to this paragraph. Your meticulousness and attention to detail would be rewarded with successful long-term dividend investing. Let's talk again in 2093 about that.

I have recovered a little over 42.50% of my original purchase price with dividends alone. If history is of any guidance, I expect more earnings growth, which will trigger more dividend growth, and growth in the intrinsic value of the company. I would continue holding on to the stock, which is at 37 times forward earnings.

Earnings per share increased from 81 cents in 2009 to $1.73/share in 2018. The company is expected to earn $1.82/share in 2019. While we may argue that the valuation is very high at 37 times forward earnings, we should not forget that we are discussing a high quality asset. If Brown-Forman were to be acquired, it would most probably be taken over at 30 - 32 times earnings.

Those earnings will likely double every decade. Therefore, for a long-term investor with a 30 year holding period, you may do just fine. At 7%/year, the earnings per share for 2049 could jump to $14/share. At a P/E of 20, this translates into a share price of $280. If dividends per share also grow by 7%/year, Brown-Forman will pay $5.30/share in 2049. You would have collected almost $71 in dividends during the span of these 30 years. The multiple compression will be a headwind to returns in the first few years of holding the stock, so this will affect investors who lack patience and bail out after "the stock goes nowhere for extended periods of time".

Not every company will reward you as well as Brown-Forman. But on average, a diversified portfolio of dividend aristocrats, held for the long-term, would likely surprise on the upside in terms of dividend income growth and capital appreciation.

I focus on companies that have competitive advantages, which will allow them to generate higher earnings over time. This will translate into more dividends for me. Some companies may end getting sold, due to an acquisition or a dividend cut, but I will hold until then. I have learned the hard way that selling for any other "reason" is usually a mistake.

I could sell Brown-Forman today, and get 74 years worth of dividends from my capital gain. Actually it will be lower, around 63 years, because I would have to pay a 15% tax on long-term capital gains if I sold. By selling, I would be losing on the future inflation adjusted stream of dividends provided by this dividend champion. The company is led by a shareholder friendly management, as evident by the special dividends, the growth of earnings and the dividend track record. I can always buy into Diageo, which is cheaper, but whose growth is lower. Plus, Diageo has a lower chance of getting acquired.

Theoretically, I could replace Brown-Forman with is cheaper one that has a higher expected growth. But I would alter the risk profile of the portfolio that way. And I would not know if the other company is cheaper because it is more cyclical, or because its growth would be non-existent down the road.

As discussed before, selling a good quality company, and replacing it with another has been a mistake on average in my investing.

Thus, focus on quality, and hold on to it. I stay put, and continue holding.

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