There are different ways to weight a dividend portfolio. I am going to examine the three most popular methods in this article. Then I am going to reflect on the method I use.
The first method is weighting portfolios based on market capitalization, and then adjusting weights based on free floats. The logic is that as a company becomes more valuable, it should have a higher weight in a portfolio, whereas a company that is less prosperous should have lower weights since its capitalization is lower. This method is preferred by many index funds, as it makes it easier to just buy a basket of several hundred or thousand securities, and then passively hold them. It is viewed as a self-cleansing mechanism, where prosperous companies gain higher weightings, while less prosperous companies are eventually flushed out. The dangers behind this method is that a speculative company with no material profits and elevated valuations could get a higher weighting due to stock price being bid up by speculators. This happened with a lot of indexes such as the S&P 500 during the tech boom in the late 1990s, when they added companies like Yahoo! (YHOO) at several hundred times forward earnings. The results were disastrous, and pulled down the expected returns for all index investors. On one side, it is a good idea to give higher weighting to the companies that are prospering. On the other side however, you could end up in a dangerous situation where the most successful companies will get large and command a large piece of the pie. However, these large companies might end up dominating that portfolio. In fact, the 50 largest components of S&P 500 account for 47% of the portfolio. Apple (AAPL) accounts for almost 4% of the portfolio. Through July of 2015, just six companies in the S&P 500 accounted for most of the index gains. I wonder if this is a repeat of 1999 - 2000, or not.
Wednesday, September 30, 2015
Monday, September 28, 2015
Dividend Companies I am Considering in October
The stock market has been showing signs of weakness this quarter. Little did I know that the stock market will go down so quickly after I wrote my article titled " are you ready for the next bear market" back in early August of this year.
For those of us who are in the accumulation stage, this is welcome news, since it means that future dividend income is available at lower cost today. To paraphrase Warren Buffett, whether it comes to socks or stocks, everyone loves a good sale.
For whatever reason, the environment today feels a lot like we are going to see lower prices in the foreseeable future, as long as the S&P 500 stays below 2000 points. After all, the stock market only started going down one or two months ago (though many cyclical companies had been drifting lower before that). It is interesting to note that through July of this year, most of the gains on the S&P 500 came from just six stocks. So we might actually see further weakness in major stock indices from here.
We have all been trained to buy on weakness over the past 6 years. If this doesn’t work for this correction, and it actually does turn into an actual bear market, I wonder how many will abandon stocks altogether
For those of us who are in the accumulation stage, this is welcome news, since it means that future dividend income is available at lower cost today. To paraphrase Warren Buffett, whether it comes to socks or stocks, everyone loves a good sale.
For whatever reason, the environment today feels a lot like we are going to see lower prices in the foreseeable future, as long as the S&P 500 stays below 2000 points. After all, the stock market only started going down one or two months ago (though many cyclical companies had been drifting lower before that). It is interesting to note that through July of this year, most of the gains on the S&P 500 came from just six stocks. So we might actually see further weakness in major stock indices from here.
We have all been trained to buy on weakness over the past 6 years. If this doesn’t work for this correction, and it actually does turn into an actual bear market, I wonder how many will abandon stocks altogether
Friday, September 25, 2015
Does Market Capitalization Matter in dividend investing?
One criticism of Dividend Growth Investing is that it focuses exclusively on large cap stocks. The common complaint is that if you buy a small cap today, it can grow out to be as big as Johnson & Johnson (JNJ), Coca-Cola (KO), Exxon-Mobil (XOM), or Wal-Mart (WMT) etc.
In theory this sounds like a great idea. The problem of course is that this complaint completely ignores reality and facts. The reality is that when each of the companies I mentioned above became dividend achievers ( meaning that they had regularly increased dividends for at least ten consecutive years in a row), they were big companies already. Yet somehow, they managed to grow earnings and dividends for decades. This is the beauty of a stable company which has a successful business model that showers shareholders with cash each year.
In reality, if you were able to buy each of those companies when they just became dividend achievers, you would have banked a boatload of dividends. Plus, there would have been a pretty sizeable growth in share prices over time.
I looked at each company at the time they became dividend achievers. I calculated the returns as of September 21, 2015, assuming that someone put $100 at the end of the year in which they achieved that status. Check the table below. It is interesting that those companies that were already deemed as large-caps at the time delivered phenomenal results to investors. For example, a $100 investment in Exxon at the end of 1992, with dividends reinvested, would have turned to $891.73. That investment would be generating $35.48 in annual dividend income. This means that the investor of 2015 will be getting their original investment in cash every three years.
In theory this sounds like a great idea. The problem of course is that this complaint completely ignores reality and facts. The reality is that when each of the companies I mentioned above became dividend achievers ( meaning that they had regularly increased dividends for at least ten consecutive years in a row), they were big companies already. Yet somehow, they managed to grow earnings and dividends for decades. This is the beauty of a stable company which has a successful business model that showers shareholders with cash each year.
In reality, if you were able to buy each of those companies when they just became dividend achievers, you would have banked a boatload of dividends. Plus, there would have been a pretty sizeable growth in share prices over time.
I looked at each company at the time they became dividend achievers. I calculated the returns as of September 21, 2015, assuming that someone put $100 at the end of the year in which they achieved that status. Check the table below. It is interesting that those companies that were already deemed as large-caps at the time delivered phenomenal results to investors. For example, a $100 investment in Exxon at the end of 1992, with dividends reinvested, would have turned to $891.73. That investment would be generating $35.48 in annual dividend income. This means that the investor of 2015 will be getting their original investment in cash every three years.
Wednesday, September 23, 2015
Financial Independence Is Easier to Model with Dividends
The biggest advantage of dividend growth investing is the ability to set a goal, and track progress towards that goal. This is because dividend income is more stable than stock prices, which makes it easier to check how I am doing relative to my goals. Stock values on the other hand are much more volatile, which makes reliance on them for retirement planning much more speculative in nature. If noone can forecast stock prices accurately, then how can someone rely on stock prices for their retirement planning?
Let’s look at two different scenarios. Imagine, that in the first scenario, the goal is to have $500,000 in 20 years. Based on the 4% rule, you will sell 4% of your assets per year and hope that you will not be retiring at the top of a major bull market ( like the one we had in 1999 - 2000). You save some money every year, and the stock market generally rises. By year 19, your portfolio is worth more than half a million dollars. You decide to wait for another year, in order to beef up your portfolio. Unfortunately, this happens to be the first year of a bear market, where stock prices fall by 30% in the first year, and then 20% in the next one. Are you ready to retire, or not? You seemed ready and above target in year 19, but in year 20 you seem to be behind your goal. You decide to keep on working for an unknown amount of time until the stock market rebounds.
In the second scenario, the goal is to generate an annual income of $20,000 in 20 years. You save the same amount of money, reinvest dividends, and could not care less if markets are up or down. You can afford that, because dividends are more stable than capital gains, and go up almost every year. The only time dividends on the S&P 500 fell significantly over the past 90 years was during the Great Depression of 1929- 1932 and during the Great Recession of 2008. Since 1960, the only significant decrease in annual dividend income was in 2008. That is a success ratio of over 98%. I define significant as any decrease in annual dividend income that is larger than 4%.
Let’s look at two different scenarios. Imagine, that in the first scenario, the goal is to have $500,000 in 20 years. Based on the 4% rule, you will sell 4% of your assets per year and hope that you will not be retiring at the top of a major bull market ( like the one we had in 1999 - 2000). You save some money every year, and the stock market generally rises. By year 19, your portfolio is worth more than half a million dollars. You decide to wait for another year, in order to beef up your portfolio. Unfortunately, this happens to be the first year of a bear market, where stock prices fall by 30% in the first year, and then 20% in the next one. Are you ready to retire, or not? You seemed ready and above target in year 19, but in year 20 you seem to be behind your goal. You decide to keep on working for an unknown amount of time until the stock market rebounds.
In the second scenario, the goal is to generate an annual income of $20,000 in 20 years. You save the same amount of money, reinvest dividends, and could not care less if markets are up or down. You can afford that, because dividends are more stable than capital gains, and go up almost every year. The only time dividends on the S&P 500 fell significantly over the past 90 years was during the Great Depression of 1929- 1932 and during the Great Recession of 2008. Since 1960, the only significant decrease in annual dividend income was in 2008. That is a success ratio of over 98%. I define significant as any decrease in annual dividend income that is larger than 4%.
Monday, September 21, 2015
Dividend Stocks I Purchased In the Past Month
I like to keep my investing simple. I purchase shares in companies I believe to be attractively valued, when I see a track record of raising dividends and having the fundamentals to support further dividend increases. For each dollar that I invest in, I end up earning anywhere between 2 to 4 cents per year in dividend income alone. The initial amount will then grow above the rate of inflation over time. It is that simple – for each dollar I put to work today, I earn an average lifetime income of 3 cents right from the start. To reach financial independence, I need to both cut costs and increase the level of passive dividend income to meet those expenses.
I have been on this journey for eight years now. It is becoming a second nature by now:
1) Earn money,
2) Think of ways to earn more money,
3) Save Money
4) Think of ways to save more/cut expenses
5) Invest those savings wisely
6) Keep thinking how to be a more impactful investor
7) Reinvest dividends during accumulation stage
I have been on this journey for eight years now. It is becoming a second nature by now:
1) Earn money,
2) Think of ways to earn more money,
3) Save Money
4) Think of ways to save more/cut expenses
5) Invest those savings wisely
6) Keep thinking how to be a more impactful investor
7) Reinvest dividends during accumulation stage
Friday, September 18, 2015
Two Recent Dividend Increases from my Dividend Machine
Two of the companies I own announced their intentions to hike their dividends. As a dividend growth investor, this is always good news. The companies included:
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes, other tobacco products, and other nicotine-containing products.
The company raised its quarterly dividend by a paltry 2% to $1.02/share. This was the lowest rate of increase since the spinoff in 2008. It was much lower than the five year dividend growth rate of 12%/year. It was disappointing to many investors. This marked the 7th consecutive annual dividend increases nevertheless. The new yield is close to 5%.
As I mentioned in my analysis of the company however, this should not have been unexpected given the lack of earnings growth in the past few years and the rising dividend payout ratio. While I am bullish on the company for the long-term, I cannot ignore the data that has been showing me that things are not going according to plan. I will keep holding on to this position, because I believe that management will ultimately turn things around. Of course, in the meantime, I will redirect dividends elsewhere.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes, other tobacco products, and other nicotine-containing products.
The company raised its quarterly dividend by a paltry 2% to $1.02/share. This was the lowest rate of increase since the spinoff in 2008. It was much lower than the five year dividend growth rate of 12%/year. It was disappointing to many investors. This marked the 7th consecutive annual dividend increases nevertheless. The new yield is close to 5%.
As I mentioned in my analysis of the company however, this should not have been unexpected given the lack of earnings growth in the past few years and the rising dividend payout ratio. While I am bullish on the company for the long-term, I cannot ignore the data that has been showing me that things are not going according to plan. I will keep holding on to this position, because I believe that management will ultimately turn things around. Of course, in the meantime, I will redirect dividends elsewhere.
Thursday, September 17, 2015
Survivorship bias in Dividend Investing - Part 2
This is the second part on suvivorship bias in dividend investing. In part 1, I laid the grounds that investors who put their money to work in dividend growth stocks are not suffering by survivorship bias ( despite the efforts of greedy money managers to portray ordinary investors in a negative light)
I wonder if the same type of logical analysis on survivorship bias is performed by investors who are encouraged to invest in US Equity markets, when they are told how an investment in the S&P 500 or Dow Jones Industrials average would have performed over the past 10, 20, or 50 years. If you consider the event of purchasing shares of Johnson & Johnson (JNJ) due to its history as an example of survivorship bias, then you should not be using historical data on S&P 500 or Dow Jones Industrials average over the past 50 years either in order to prove your point about equity investing. Somehow, this point is lost on so many investors. When discussing long-term returns on equities over the past two centuries, you often hear about the US or UK stock performance. However, you never hear about the performance of a Chinese stock investor or a Russian stock investor from the middle of the 19th century till now. My great-grandfather was born and lived in Eastern Europe more than 100 years ago, saved almost his entire salary working in the coal mines and invested his savings in agricultural land. Unfortunately for him, the communists nationalized his land when they came to power. If he were in the US, he would have died a rich man after decades of compounding. Too bad he weren't.
I wonder if the same type of logical analysis on survivorship bias is performed by investors who are encouraged to invest in US Equity markets, when they are told how an investment in the S&P 500 or Dow Jones Industrials average would have performed over the past 10, 20, or 50 years. If you consider the event of purchasing shares of Johnson & Johnson (JNJ) due to its history as an example of survivorship bias, then you should not be using historical data on S&P 500 or Dow Jones Industrials average over the past 50 years either in order to prove your point about equity investing. Somehow, this point is lost on so many investors. When discussing long-term returns on equities over the past two centuries, you often hear about the US or UK stock performance. However, you never hear about the performance of a Chinese stock investor or a Russian stock investor from the middle of the 19th century till now. My great-grandfather was born and lived in Eastern Europe more than 100 years ago, saved almost his entire salary working in the coal mines and invested his savings in agricultural land. Unfortunately for him, the communists nationalized his land when they came to power. If he were in the US, he would have died a rich man after decades of compounding. Too bad he weren't.
Wednesday, September 16, 2015
Survivorship bias in Dividend Investing
Survivorship bias is the logical error of concentrating on the people or things that "survived" some process and inadvertently overlooking those that did not because of their lack of visibility. This can lead to false conclusions in several different ways.
In this article I am going to discuss two areas which some investors believe are examples of survivorship bias. I believe one of them is an example, while the other is not.
Basically the danger of survivorship bias is that investors make up their mind on what works or doesn’t, using an isolated example, without even bothering to consider any factual evidence. This is dangerous because those investors would then search only for ideas supporting their conclusions, and reject those that do not do so. Therefore, investors might end up missing out on important information, because they only focused on the facts that supported their original ideas in the first place.
For example, I have been reading statements from many investors about how profitable it is to be buying stocks after dividend cuts. Common examples provided are General Electric and Wells Fargo, which would have returned several hundred percent since cutting dividends in 2009. Furthermore, dividends have increased since those cuts, thus resulting in high yields on cost for investors that were smart enough to buy in 2009 (this writer was not that smart to buy at the bottom, though I have my doubts that those who claim to have bought at the bottom are telling the truth (the sole exception that is verified is Warren Buffett and Charlie Munger)).
In this article I am going to discuss two areas which some investors believe are examples of survivorship bias. I believe one of them is an example, while the other is not.
Basically the danger of survivorship bias is that investors make up their mind on what works or doesn’t, using an isolated example, without even bothering to consider any factual evidence. This is dangerous because those investors would then search only for ideas supporting their conclusions, and reject those that do not do so. Therefore, investors might end up missing out on important information, because they only focused on the facts that supported their original ideas in the first place.
For example, I have been reading statements from many investors about how profitable it is to be buying stocks after dividend cuts. Common examples provided are General Electric and Wells Fargo, which would have returned several hundred percent since cutting dividends in 2009. Furthermore, dividends have increased since those cuts, thus resulting in high yields on cost for investors that were smart enough to buy in 2009 (this writer was not that smart to buy at the bottom, though I have my doubts that those who claim to have bought at the bottom are telling the truth (the sole exception that is verified is Warren Buffett and Charlie Munger)).
Monday, September 14, 2015
How I Manage to Monitor So Many Companies
One of the many questions I receive from readers relates to time spent managing my dividend portfolio. The truth is that I have multiple short-cuts, which I utilize to get the right information for me. The other truth is that I try to be efficient with my time.
There are several resources I utilize for doing research.
- My broker
My broker Interactive Brokers is a very helpful tool I utilize. I receive notifications about upcoming dividend payments, which essentially provides a signal when dividends are raised. In addition, I receive notifications of upcoming dividend payments and upcoming quarterly releases on the companies I own. A very helpful tool is the fact that I receive my paper annual reports mailed to me. The months of March through May are characterized by receiving a lot of paper annual reports.
The most helpful thing I learned about monitoring companies, I learned from studying Warren Buffett. The Oracle of Omaha essentially purchased a few shares in many companies, in order to receive their annual reports and significant shareholder correspondence. When you own a small piece of a company, it is much easier to monitor that business. This knowledge will accumulate over time, and would make you ready to act when the right opportunity presents itself.
There are several resources I utilize for doing research.
- My broker
My broker Interactive Brokers is a very helpful tool I utilize. I receive notifications about upcoming dividend payments, which essentially provides a signal when dividends are raised. In addition, I receive notifications of upcoming dividend payments and upcoming quarterly releases on the companies I own. A very helpful tool is the fact that I receive my paper annual reports mailed to me. The months of March through May are characterized by receiving a lot of paper annual reports.
The most helpful thing I learned about monitoring companies, I learned from studying Warren Buffett. The Oracle of Omaha essentially purchased a few shares in many companies, in order to receive their annual reports and significant shareholder correspondence. When you own a small piece of a company, it is much easier to monitor that business. This knowledge will accumulate over time, and would make you ready to act when the right opportunity presents itself.
Thursday, September 10, 2015
Is time spent learning dividend investing worth it? (Part 2)
This is the second and final part on the article from Tuesday. Please refer to the first part that was posted on Tuesday.
I believe that most of the accumulation of knowledge with dividend investing is upfront. This means that the time spent learning about a company such as Johnson & Johnson (JNJ) is in the initial phases of the research process. Time spent updating the story should not take nearly as much time as the time to learn about the company initially, Dividend investing is appealing, because after spending time accumulating knowledge about a company, and building a portfolio of good ones at cheap prices, I am essentially getting paid a growing amount of dividend for decades afterwards, even if I don’t lift my finger after that.
With a passive portfolio of dividend paying stocks, you are going to save a ton on annual management fees. If you bought mutual funds, even low cost index ones, you can end up paying tens or hundreds of thousands of dollars in fees. Even a 0.10% annual fee could be a lot when you manage say $1 million today or $10 million one day. As discussed above, if you use a financial adviser, you would end up paying at least 1% for the "advise" and the high fee mutual funds that go along ( or maybe even pick up some costly annuity) But if you learn how to invest your own money, and devise a plan to accomplish your goals, you will save a ton in costs. If you stick to your plan through thick or thin, you will be able to accomplish your goals. For the do it yourself dividend investor, there are ways to minimize commissions to the minimum, so theoretically it is possible today to buy blue chip stocks for practically no cost and hold them for decades. This is essentially what an index fund on the S&P 500 index fund does. It holds stakes in well-known companies such as Exxon Mobil (XOM), Apple (AAPL), Johnson & Johnson (JNJ), Coca-Cola (KO), but it charges an annual fee for this service. Since those companies are well-known, I have found it easier for me to just buy them outright and avoid paying the annual management fee. The only place where I actively invest through index funds is in my workplace 401 (k) plan. For the majority of workers out there, who confine their investing to their workplace 401 (k) plan, low cost indexing is possibly the best approach due to tax efficiency and employer match. Even then, learning about types of contributions and plans, minimizing fees, investment options available, and asset rollovers, can be tremendously beneficial.
I believe that most of the accumulation of knowledge with dividend investing is upfront. This means that the time spent learning about a company such as Johnson & Johnson (JNJ) is in the initial phases of the research process. Time spent updating the story should not take nearly as much time as the time to learn about the company initially, Dividend investing is appealing, because after spending time accumulating knowledge about a company, and building a portfolio of good ones at cheap prices, I am essentially getting paid a growing amount of dividend for decades afterwards, even if I don’t lift my finger after that.
With a passive portfolio of dividend paying stocks, you are going to save a ton on annual management fees. If you bought mutual funds, even low cost index ones, you can end up paying tens or hundreds of thousands of dollars in fees. Even a 0.10% annual fee could be a lot when you manage say $1 million today or $10 million one day. As discussed above, if you use a financial adviser, you would end up paying at least 1% for the "advise" and the high fee mutual funds that go along ( or maybe even pick up some costly annuity) But if you learn how to invest your own money, and devise a plan to accomplish your goals, you will save a ton in costs. If you stick to your plan through thick or thin, you will be able to accomplish your goals. For the do it yourself dividend investor, there are ways to minimize commissions to the minimum, so theoretically it is possible today to buy blue chip stocks for practically no cost and hold them for decades. This is essentially what an index fund on the S&P 500 index fund does. It holds stakes in well-known companies such as Exxon Mobil (XOM), Apple (AAPL), Johnson & Johnson (JNJ), Coca-Cola (KO), but it charges an annual fee for this service. Since those companies are well-known, I have found it easier for me to just buy them outright and avoid paying the annual management fee. The only place where I actively invest through index funds is in my workplace 401 (k) plan. For the majority of workers out there, who confine their investing to their workplace 401 (k) plan, low cost indexing is possibly the best approach due to tax efficiency and employer match. Even then, learning about types of contributions and plans, minimizing fees, investment options available, and asset rollovers, can be tremendously beneficial.
Wednesday, September 9, 2015
Is time spent learning dividend investing worth it?
I believe that time spent learning the ropes behind dividend growth investing is worth it. In this article I will discuss why I believe that to be the case. As usual, I will use my experience as a successful dividend investor for this article. In my case, learning about investing has provided me with tangible benefits of being three years away from achieving financial independence, after starting my journey in the middle of 2007. I also have gained intangible benefits to learning such as using knowledge acquired in investing to advance in my work or to find a better paying job. An even better intangible benefit has been the ability to connect with other investors, through this online community called Dividend Growth Investor.
As a person I enjoy learning. When you learn a skill there is never a guarantee that you will earn anything from that knowledge. But there is never a guarantee for anything in life either.
The time you spend learning is not wasted – knowledge accumulates like compound interest. When I spent four years obtaining a college degree I didn’t know if I would find a job afterwards. I paid money to obtain that degree, spent time acquiring knowledge and worked hard to achieve and maintained a high GPA. At the same time I worked 40 - 60 hours/week at several minimum paying jobs in order to pay for my degree, and in order to avoid getting any debt in the process. Would I have been better off spending 40 - 60 hours/week only working those minimum paying jobs and investing the difference? No way I would have been better of this way – this is the reason I decided to study hard, so that I have the opportunity to earn more than a minimum wage salary. While I had no idea whether anyone would hire me after graduating, I decided to make a calculated bet, and take the plunge. This investment in knowledge paid off for me. I believe that it can help anyone who is willing to invest in themselves.
As a person I enjoy learning. When you learn a skill there is never a guarantee that you will earn anything from that knowledge. But there is never a guarantee for anything in life either.
The time you spend learning is not wasted – knowledge accumulates like compound interest. When I spent four years obtaining a college degree I didn’t know if I would find a job afterwards. I paid money to obtain that degree, spent time acquiring knowledge and worked hard to achieve and maintained a high GPA. At the same time I worked 40 - 60 hours/week at several minimum paying jobs in order to pay for my degree, and in order to avoid getting any debt in the process. Would I have been better off spending 40 - 60 hours/week only working those minimum paying jobs and investing the difference? No way I would have been better of this way – this is the reason I decided to study hard, so that I have the opportunity to earn more than a minimum wage salary. While I had no idea whether anyone would hire me after graduating, I decided to make a calculated bet, and take the plunge. This investment in knowledge paid off for me. I believe that it can help anyone who is willing to invest in themselves.
Friday, September 4, 2015
The value of dividend growth in retirement planning
Some regular readers might remember that in my retirement planning, I estimate that I will be able to allocate my capital at yields between 3- 4% and dividend growth between 6 – 7%. If I am lucky, the above numbers will result in roughly doubling of dividend income every seven years or so. This means that if I had a dividend portfolio that generated $1000 in annual dividend income today, I could reasonably expect that through meticulous and opportunistic reinvestment of dividends and through the power of dividend growth, I will be able to double this to $2000/year in seven years.
In order to generate $1000 in annual dividends, one needs anywhere from $40,000 invested at 2.50% to $25,000 invested at an yield of 4%. Of course, in a somewhat efficient marketplace for common stocks, investors who require higher current yields today tend to forego some of the expected dividend growth. On the other hand, some are fine sacrificing some current yield today, in order to capture estimated dividend growth in the future. As discussed previously, there is a trade-off between dividend yield and dividend growth. The balance is determined based on investors reasonable expectations against the realities of opportunities available at the time.
I buy dividend growth stocks, because I want to earn dividend income that grows over time. When this annual rate of dividend growth is above the annual rate of inflation, this means that I have maintained purchasing power of my income. However, I have heard arguments that one could maintain the purchasing power of their dividend income, provided they reinvested the dividend back into securities that pay high dividend yields. Therefore, if you own a stock yielding 4% that never increases dividends, but you reinvest dividends at same or other security yielding 4% at the moment, your income will increase by 4% for the year. If inflation is below 4%, you would have essentially slightly increased purchasing power.
In order to generate $1000 in annual dividends, one needs anywhere from $40,000 invested at 2.50% to $25,000 invested at an yield of 4%. Of course, in a somewhat efficient marketplace for common stocks, investors who require higher current yields today tend to forego some of the expected dividend growth. On the other hand, some are fine sacrificing some current yield today, in order to capture estimated dividend growth in the future. As discussed previously, there is a trade-off between dividend yield and dividend growth. The balance is determined based on investors reasonable expectations against the realities of opportunities available at the time.
I buy dividend growth stocks, because I want to earn dividend income that grows over time. When this annual rate of dividend growth is above the annual rate of inflation, this means that I have maintained purchasing power of my income. However, I have heard arguments that one could maintain the purchasing power of their dividend income, provided they reinvested the dividend back into securities that pay high dividend yields. Therefore, if you own a stock yielding 4% that never increases dividends, but you reinvest dividends at same or other security yielding 4% at the moment, your income will increase by 4% for the year. If inflation is below 4%, you would have essentially slightly increased purchasing power.
Wednesday, September 2, 2015
Preventing Blind Spots in Dividend Investing
In a previous article I described why dividend investors should look beyond typical dividend growth screens. I am basically finding that investors who take the time to study the numbers for every individual business one at a time, are much more likely to uncover hidden gems. I believe that investors who rely on pure quantitative screens, might develop blind spots that would prevent them from identifying hidden opportunities.
For example, investors who blindly followed the S&P Dividend Aristocrats index in 2007, would have sold their shares of Altria (MO), right before it more than tripled in value. The index committee erroneously thought that when a company splits in three, its past record no longer matters, even if original shareholders were earning higher dividend income from the shares of companies they received. For any smart dividend growth investor, this would not have caused them to sell, but to simply hold on and enjoy the growing stream of cash dividends every year.
In another example, I have the list of stocks in my portfolio input into Yahoo! Finance. When I have spare funds to invest in dividend stocks, I might go to Yahoo! and look at valuation metrics of companies I own. As I was reviewing the valuation of my portfolio holdings, I noticed that some of the companies I own seem very overvalued on the surface.
For example, investors who blindly followed the S&P Dividend Aristocrats index in 2007, would have sold their shares of Altria (MO), right before it more than tripled in value. The index committee erroneously thought that when a company splits in three, its past record no longer matters, even if original shareholders were earning higher dividend income from the shares of companies they received. For any smart dividend growth investor, this would not have caused them to sell, but to simply hold on and enjoy the growing stream of cash dividends every year.
In another example, I have the list of stocks in my portfolio input into Yahoo! Finance. When I have spare funds to invest in dividend stocks, I might go to Yahoo! and look at valuation metrics of companies I own. As I was reviewing the valuation of my portfolio holdings, I noticed that some of the companies I own seem very overvalued on the surface.
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