With many stocks close to all-time-highs, it is getting increasingly difficult to find places where to park new cash. Luckily, the companies below not only fit the characteristics of dividend growth stocks, but they are also attractively priced. It is crucial to acquire solid companies only when they are fairly priced Putting new money to work at overvalued prices could lead to mediocre results for the first five – ten years of your investment. The companies boosting dividends include:
Johnson & Johnson (JNJ), together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. This dividend king raised quarterly distributions by 8.20% to 66 cents/share. This marked the 51st consecutive annual dividend increase for the company. Despite the recent run, the company is attractively priced at 15.70 times forward earnings and a yield of 3.10%. The dividend is adequately covered, and has been raised by 11.70%/year over the past decade. I added to my position in Johnson & Johnson in April. Check my analysis of Johnson & Johnson.
Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. This dividend champion raised quarterly distributions by 11.10% to $1/share. This marked the 26th consecutive annual dividend increase for Chevron. The stock is trading at 9.70 times forward earnings, has an adequately covered dividend and yields 3.40%. The company has managed to boost annual distributions by 9.60%/year over the past decade. I recently added to my position in Chevron in April. Check my analysis of Chevron.
Exxon Mobil Corporation (XOM) engages in the exploration and production of crude oil and natural gas, and manufacture of petroleum products. This dividend champion raised quarterly distributions by 10.50% to 63 cents/share. This marked the 31st consecutive annual dividend increase for Exxon. Over the past decade, Exxon has managed to boost annual dividends by 9%/year. The stock trades at 11 times forward earnings, yields 2.90% and has a sustainable dividend coverage. Back in 2012 I replaced Exxon Mobil with ConocoPhillips (COP), because Exxon seemed stingier than its peers with dividend payments. Instead, the company has been one of the most active share repurchases in the US for several years in a row.
Ameriprise Financial, Inc. (AMP), through its subsidiaries, provides a range of financial products and services in the United States and internationally. The company boosted quarterly dividends by 15.60% to 52 cents/share. This was the second dividend increase over the past year, bringing the total increase to 48.605 since the second quarter of 2012. The company has only raised distributions for 7 years, and has been public since 2005. It was spun off from American Express (AXP) in 2005, and since then it has managed to boost earnings from $2.32/share to $4.70/share by 2012. Forward earnings expectations are for $6.60/share in 2013 and $7.26/share by 2014, which means that Ameriprise Financial would have no problem becoming a dividend achiever by 2015. I like the fact that the company is attractively valued at 11.10 times forward earnings, yields 2.80% and has a sustainable dividend coverage. I plan on analyzing the stock before committing any funds to it.
These four stocks are a testament that income investors can find quality companies at reasonable valuations even in this overheated market. By looking through the list of dividend increases, I was once again able to uncover a hidden dividend gem, Ameriprise Financial, which has the potential to pay dividends in my portfolio for the next 20 years.
Full Disclosure: Long JNJ, CVX, COP
Relevant Articles:
- Dividend Champions - The Best List for Dividend Investors
- How to invest when the market is at all time highs?
- The Dividend Kings List Keeps Expanding
- Spring Cleaning My Dividend Portfolio
- How to Uncover Hidden Dividend Gems
Monday, April 29, 2013
Saturday, April 27, 2013
Dividend Investing Articles to Enjoy: 4/27/2013
For your weekend reading enjoyment, I have highlighted a few interesting articles from the archives, which I find to be relevant today. The first five articles have been written and posted on this site, while the last five have been selected from several dividend writers over the past week.
Articles
Articles
- Dividend Champions - The Best List for Dividend Investors
- My Entry Criteria for Dividend Stocks
- Four Dividend Stocks safer than US Treasuries
- Avoid Dividend Cutters at All Costs
- How to invest in dividend stocks
Other articles
- Why I love dividend growth investing
- Oneok Partners LP (OKS) MLP Analysis
- Stock Valuation Method - Discounted Cash Flow
- An Investment in Exxon Mobil Stock
- Dividend Stocks are Not Bond Substitutes
- My new favorite site
Thanks everyone for reading my site. On Monday, I am posting a list of four attractively priced stocks to consider. Then on Tuesday, I would post a list of companies I purchased for my rollover 401 (k) in April.
Friday, April 26, 2013
Dividend Growth: Freedom Through Passive Income Book Review
Several months ago, Mike from Dividend Guy Blog sent me his book and asked me for a review. I did not receive any compensation for this review, other than a free copy of the US version of his dividend investing book. As a somewhat moderately read site, I do from time to time receive books for review. The first review I have done was on the book from Derek Foster, Stop Working.
Overall I believe that this book would be useful for investors who already have some background on the basics of dividend investing. As I read through it, I kept notes of things that I liked about, as opportunities for improvement. The book is called Dividend Growth: Freedom Through Passive Income US Edition
. The book is also available for Kindle.
I liked that he shared his screening method for identifying dividend paying companies for further research. I was impressed that his screening method also looked for increases in revenues and net income, and not just dividends.
I also liked his discussion on how tricky calculating the dividend payout ratio is. The price to earnings ratio was another ratio whose calculation is tricky. The formulas themselves are not difficult to implement, but what makes it tricky is whether one uses trailing, forward or normalized earnings and dividends. The book stresses that investors need to make sure to double check every detail about companies researched before you invest. The book also stresses that it is important to invest for the long term, and that investors should ignore negative headlines completely.
There were a few typos, which made it confusing to me as a reader at times. A better editing would have been extremely helpful to get his points across.
The one thing I had never seen before however is the visualization of stock characteristics using quadrants. Mike uses quadrants to visualize dividend yield and dividend payout ratios. This visual method makes it pretty easy to spot good opportunities that could be screened through the next quadrants. He also runs his stock picks through other quadrants, where he looks at five year net income growth and P/E ratios as well as dividend yield versus dividend growth for companies being researched. Few dividend analysts ever focus on earnings growth, which is the fuel behind dividend growth, and therefore one of the most important ingredients behind future dividend increases. Overall I found an interesting new method to visually show information to make my point in presenting dividend ideas.
Mike also stresses on the importance of building diversified dividend portfolios. He focuses on sector diversification, geographic diversification. If you want to build a dividend machine that would regularly distribute money to pay for your retirement, implementing diversification is a very important tool to use.
The author is a financial advisor and a self-confessed active trader in his previous investing strategies. This is fine, but one can definitely notice that with his references to the CAPM, moving averages, selling a stock that went up 30%, and stock betas. However, I have found that active traders who become dividend investors tend to have valuable insights on investor psychology. One trait that I have is that I tend to have an itchy finger whenever I have cash in the brokerage account. I rush to buy, especially since there are so many opportunities I do not want to miss.
The author also discusses reading quarterly reports in order to make certain that the company is still performing according to expectations. The book then discusses how companies which do not meet the investment criteria anymore should be sold. While dividend investors should keep up with important material information affecting their holdings, it is debatable whether they should act on temporary noise that quarterly results represent. I do agree however with the premise that investors should monitor stocks and sell the ones whose long-term prospects are not bright anymore. I also disagree on the fact that dividend investors should use stop losses. Your dividend portfolio is not an actively traded portfolio, but a long-term income producing one. A stop loss would have led to realizing losses in quality companies like Johnson & Johnson (JNJ) and Procter & Gamble (PG) during the 2008 – 2009 financial crisis, despite the fact that these companies managed to increase profits and dividends during this tumultuous period.
I did find the overview of Canadian income stocks to be helpful, since most Canadian dividend paying stocks tend to pay a stable and growing distribution over time. The book also mentioned that US based income investors need to be aware of withholding taxes in taxable accounts. I also found the review of Real Estate Investment Trusts to be very descriptive and useful as well. It discussed the positive, negatives, tax implications, FFO etc. The Fin Viz screening method is not very useful when it comes to REITs however, which is why a reference to the dividend champions list would have been very helpful. I would encourage Mike however to add a primer on Master Limited Partnerships in his next edition of his book.
The last portion of the book discusses different stages of investing depending on level of experience and amount of funds at hand. The book recommends that investors with less than a certain amount of money should focus on dividend ETF’s to keep costs low and be diversified while they are getting a grip on dividend investing. Once this threshold is increased however, investors should focus on purchasing individual dividend paying stocks.
The biggest plus of this book is that it offers what other similar books offer, at a much lower price. The book sells for $14.99. You could also find the book on Kindle: Dividend Growth: Freedom Through Passive Income
. It could be helpful tool to use because it includes several important aspects of dividend investing available in one resource. Overall I believe that this book will appeal to investors who have at least some background on dividend investing.
Full Disclosure: Long JNJ, PG,
Relevant Articles:
- Diversified Dividend Portfolios – Don’t forget about quality
- Buy and Hold means Buy and Monitor
- Best Canadian Dividend Stocks
- Five Things to Look For in a Real Estate Investment Trusts
- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- Book Review: Stop Working
Overall I believe that this book would be useful for investors who already have some background on the basics of dividend investing. As I read through it, I kept notes of things that I liked about, as opportunities for improvement. The book is called Dividend Growth: Freedom Through Passive Income US Edition
. The book is also available for Kindle.I liked that he shared his screening method for identifying dividend paying companies for further research. I was impressed that his screening method also looked for increases in revenues and net income, and not just dividends.
I also liked his discussion on how tricky calculating the dividend payout ratio is. The price to earnings ratio was another ratio whose calculation is tricky. The formulas themselves are not difficult to implement, but what makes it tricky is whether one uses trailing, forward or normalized earnings and dividends. The book stresses that investors need to make sure to double check every detail about companies researched before you invest. The book also stresses that it is important to invest for the long term, and that investors should ignore negative headlines completely.
There were a few typos, which made it confusing to me as a reader at times. A better editing would have been extremely helpful to get his points across.
The one thing I had never seen before however is the visualization of stock characteristics using quadrants. Mike uses quadrants to visualize dividend yield and dividend payout ratios. This visual method makes it pretty easy to spot good opportunities that could be screened through the next quadrants. He also runs his stock picks through other quadrants, where he looks at five year net income growth and P/E ratios as well as dividend yield versus dividend growth for companies being researched. Few dividend analysts ever focus on earnings growth, which is the fuel behind dividend growth, and therefore one of the most important ingredients behind future dividend increases. Overall I found an interesting new method to visually show information to make my point in presenting dividend ideas.
Mike also stresses on the importance of building diversified dividend portfolios. He focuses on sector diversification, geographic diversification. If you want to build a dividend machine that would regularly distribute money to pay for your retirement, implementing diversification is a very important tool to use.
The author is a financial advisor and a self-confessed active trader in his previous investing strategies. This is fine, but one can definitely notice that with his references to the CAPM, moving averages, selling a stock that went up 30%, and stock betas. However, I have found that active traders who become dividend investors tend to have valuable insights on investor psychology. One trait that I have is that I tend to have an itchy finger whenever I have cash in the brokerage account. I rush to buy, especially since there are so many opportunities I do not want to miss.
The author also discusses reading quarterly reports in order to make certain that the company is still performing according to expectations. The book then discusses how companies which do not meet the investment criteria anymore should be sold. While dividend investors should keep up with important material information affecting their holdings, it is debatable whether they should act on temporary noise that quarterly results represent. I do agree however with the premise that investors should monitor stocks and sell the ones whose long-term prospects are not bright anymore. I also disagree on the fact that dividend investors should use stop losses. Your dividend portfolio is not an actively traded portfolio, but a long-term income producing one. A stop loss would have led to realizing losses in quality companies like Johnson & Johnson (JNJ) and Procter & Gamble (PG) during the 2008 – 2009 financial crisis, despite the fact that these companies managed to increase profits and dividends during this tumultuous period.
I did find the overview of Canadian income stocks to be helpful, since most Canadian dividend paying stocks tend to pay a stable and growing distribution over time. The book also mentioned that US based income investors need to be aware of withholding taxes in taxable accounts. I also found the review of Real Estate Investment Trusts to be very descriptive and useful as well. It discussed the positive, negatives, tax implications, FFO etc. The Fin Viz screening method is not very useful when it comes to REITs however, which is why a reference to the dividend champions list would have been very helpful. I would encourage Mike however to add a primer on Master Limited Partnerships in his next edition of his book.
The last portion of the book discusses different stages of investing depending on level of experience and amount of funds at hand. The book recommends that investors with less than a certain amount of money should focus on dividend ETF’s to keep costs low and be diversified while they are getting a grip on dividend investing. Once this threshold is increased however, investors should focus on purchasing individual dividend paying stocks.
The biggest plus of this book is that it offers what other similar books offer, at a much lower price. The book sells for $14.99. You could also find the book on Kindle: Dividend Growth: Freedom Through Passive Income
. It could be helpful tool to use because it includes several important aspects of dividend investing available in one resource. Overall I believe that this book will appeal to investors who have at least some background on dividend investing.Full Disclosure: Long JNJ, PG,
Relevant Articles:
- Diversified Dividend Portfolios – Don’t forget about quality
- Buy and Hold means Buy and Monitor
- Best Canadian Dividend Stocks
- Five Things to Look For in a Real Estate Investment Trusts
- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- Book Review: Stop Working
Thursday, April 25, 2013
When to sell my dividend stocks?
Investors always look for the perfect formula that would enable them to purchase the best stocks at bargain prices, which would provide large capital gains over time and an increasing stream of dividend gains. One could line up one or several indicators in order to reach a buy decision. Selling a stock however, is what could ultimately determine whether you succeed or fail in the long run.
As a buy and hold dividend investor, I try to pick stocks that trade at reasonable levels, and then dollar cost average my way into the position. My holding period is forever, as long as certain prerequisites are met. I don’t set target prices at which to exit, as most often than not the market is either going to blast through this level and never look back. Furthermore setting target prices at which to sell at would imply that I know when to sell high and that this “high” price will not be reached again the foreseeable future.
There are several conditions that could make me sell the stock I am holding.
- Company is bought out by another company for cash or stock or it is taken private
- The stock takes a very high portion of my portfolio, relative to other positions
- Company slashes or eliminates its dividend.
- Company is overvalued relative to future growth prospects and current yield.
I will focus my attention on selling when a stock that I own cuts or suspends its dividends. One of the main reasons why I would enter into a dividend stock is because I believe that the dividend would be increased over time, bringing my yield on cost upward to a comfortable double digit level. If a company maintains its dividend payment, without cutting it, I would still hold on to the stock. When the dividend is cut or suspended however, my goal of generating an increasing stream of dividend income is no longer valid. Thus, selling my whole position in this company is the best decision to make. Bank of America (BAC), Citigroup (C) and General Motors (GM) are three good examples that selling right after a dividend cut is a good strategy.
Next week I will discuss why I disagree with the notion that selling after a dividend cut is an example of buy high sell low.
Relevant Articles:
- What Dividend Growth Investing is all about?
- Best Dividends Stocks for the Long Run
- Dividends and The Great Depression
- Dividend Portfolio Investing for monthly income
This article was included in the Carnival of Wealth, Slump Busted Edition
As a buy and hold dividend investor, I try to pick stocks that trade at reasonable levels, and then dollar cost average my way into the position. My holding period is forever, as long as certain prerequisites are met. I don’t set target prices at which to exit, as most often than not the market is either going to blast through this level and never look back. Furthermore setting target prices at which to sell at would imply that I know when to sell high and that this “high” price will not be reached again the foreseeable future.
There are several conditions that could make me sell the stock I am holding.
- Company is bought out by another company for cash or stock or it is taken private
- The stock takes a very high portion of my portfolio, relative to other positions
- Company slashes or eliminates its dividend.
- Company is overvalued relative to future growth prospects and current yield.
I will focus my attention on selling when a stock that I own cuts or suspends its dividends. One of the main reasons why I would enter into a dividend stock is because I believe that the dividend would be increased over time, bringing my yield on cost upward to a comfortable double digit level. If a company maintains its dividend payment, without cutting it, I would still hold on to the stock. When the dividend is cut or suspended however, my goal of generating an increasing stream of dividend income is no longer valid. Thus, selling my whole position in this company is the best decision to make. Bank of America (BAC), Citigroup (C) and General Motors (GM) are three good examples that selling right after a dividend cut is a good strategy.
Next week I will discuss why I disagree with the notion that selling after a dividend cut is an example of buy high sell low.
Relevant Articles:
- What Dividend Growth Investing is all about?
- Best Dividends Stocks for the Long Run
- Dividends and The Great Depression
- Dividend Portfolio Investing for monthly income
This article was included in the Carnival of Wealth, Slump Busted Edition
Wednesday, April 24, 2013
Opportunity Costs for Dividend Investors
Some investors believe that holding overvalued dividend stocks represents a lost opportunity cost. However, an overvalued dividend stock with rising earnings and dividends can remain overvalued, and investors who sit tight would reap the big rewards.
What is opportunity cost if you thus sold Coca-Cola (KO) in 1991 or on 1995 and purchased Enron stock with the proceeds? Coca-Cola traded at a P/E exceeding 30 at the high points in both years. However, selling at the high in 1991 of $10 would have been a mistake. In addition, selling at the high of 1995 of $20 might have been a mistake also. The reason why it was a mistake was because the company managed to boost earnings rapidly during the period. Only after it went through a rough patch between 1998 - 2002, did stock prices stall.
Many other quality companies were getting overvalued at the time, which made uncovering quality stocks trading at fair prices difficult. I went through the old stock manuals, and most of the companies that looked attractive in the 1996- 1998 period were financials like Bank of America (BAC), and big oil such as Chevron (CVX) and Exxon (XOM).
To paraphrase Buffett, an individual investor would likely get 20 truly exceptional ideas over their lifetime. If you identified Coca-Cola (KO) as a great company in 1989, but either never acted on it or didn’t allow the business the chance to show you improving fundamentals after you bought shares, you would have lost one of your chances in life. Luckily, you always get a second chance, or in Buffett’s theory 19 more to go.
That being said, there is a nuanced approach to dividend growth investing that lets you keep options open. It’s the common sense approach that sometimes for whatever reason you can sell companies. If Coca-Cola trades at 50 times earnings, it might be due for a correction if growth expectations are reduced to even a modest 10% increase in earnings. If other quality companies also trade at a P/E of 40-50, the wise thing might still be to hold on to Coca-Cola. However, if one can find hidden dividend gems that are not only cheaper, but in the buy zone then a replacement might be in store.
I generally try to be a buy and hold investor, with regular monitoring, whose holding period is usually forever. However, from time to time I tend to sell positions in companies which do not make sense. For example, I sold Con Edison (ED) in 2012 and replaced it with Oneok Partners (OKS). I also sold Universal (UVV) and Cincinnati Financial (CINF) and purchased Phillips Morris International (PM) and five Canadian banks in 2013. Most recently I sold Universal Healthcare Investors Realty Trust (UHT) and purchased Digital Realty (DLR) and Omega Healthcare (OHI).
I essentially replaced lower growth companies with higher growth stocks that also had equivalent, if not higher yields at the time of replacement. However, the danger of this exercise is in getting carried away. If all you do is sell lower yielding but higher growth stocks for higher yielding stocks, this could increase risk in portfolios. Investors who purchased a higher yield stock might have taken on more risk, and actually worsened their investment situation. The risk is in terms of diversification, and not playing to different scenarios. For example, why own Chevron (CVX) when you can own Kinder Morgan Partners (KMP). Both are perfectly great companies to own, but I would be much safer owning both rather than just one of them.
When I replaced companies, the first issue I had was that growth was very low and that the price had risen to unsustainable levels relative to similar assets. At the rate of growth of Con Edison (ED), it would have taken me 72 years for my distributions to double. When the yield went from 6% to 4%, I decided to sell and purchase ONEOK (OKS), which yielded 4.50% and grew distributions above the rate of inflation. As a result, my dividend income increased by 10%, simply by making the switch. Whether ONEOK actually does better than Con Edison, is yet to be seen. However, even if it performs just as well as Con Edison, I would have been worse off, because I had to pay capital gains taxes on the switch. If you compound those issues over time, this could be a serious detractor from long-term performance.
Currently, I own a position in Brown-Forman (BF-B). There is a quality of earnings, driven by the diverse products that generate strong demand in the US and internationally. The company seems to be doing a good job of growing the business, and rewarding shareholders with high dividends in the process. I believe that ten years from now, Brown-Forman would have at minimum doubled earnings per share. As a result, if it earns $6/share in 10 years, and trades at a P/E of 20, I would generate a good return on investment. The return would be good because I would receive a rising stream of dividends, which typically increase anywhere between 7% - 9%, which I can then use to purchase shares in other companies.
Currently, I do not see companies that are similar to Brown-Forman, which are fairly valued. As a result, I would have to buy a company that is in another industry. A few like International Business Machines (IBM) and Wells Fargo (WFC) come to mind. Both companies have much lower P/E ratios in comparison to Brown-Forman, and they also have higher yields. Comparing P/E ratios between companies from different sectors is similar to an apples to oranges example. For example, oil majors such as Chevron (CVX) or Exxon Mobil (XOM) usually trade at low P/E ratios. The question is, would replacing Brown-Forman with another company affect the risk profile of my portfolio negatively, and would a prudent business owner sell their stake simply because the value of their business is quoted higher?
My options include simply holding on to Brown-Forman (BF.B), and reinvesting dividends in other attractively valued opportunities. My second option includes selling and purchasing a company that is cheaper, such as International Business Machines (IBM) or Wells Fargo (WFC). The main concern is that I want to maximize return for the next 20 – 30 years. If I purchased IBM today, but it fails to increase earnings, while Brown-Forman continues its slow and steady growth, I would be kicking myself in 20 years. If I sold my position in Brown-Forman, I would also have to pay a capital gains tax, as my cost is $39.98/share. If I sold at $72/share, this would be equivalent to receiving $67/share after-tax. Given the fact that I like the company’s prospects, I will hold on for now but would closely monitor it if it goes above $80/share.
Unless your income stocks trade at ridiculous valuations such as 30 – 40 times earnings, it might be simply fine to hold on to them. Unfortunately, every situation is different. This is why a black and white approach is dangerous, while a more nuanced and selective approach is superior.
Full Disclosure: Long BF/B, KO, IBM, CVX, OKS, ED, PM, DLR, OHI
Relevant Articles:
- Buy and hold dividend investing is not dead
- Dividend Investing is not a black or white process
- Reinvest Dividends Selectively
- Does entry price matter to dividend investors?
- Coca-Cola Company (KO) Dividend Stock Analysis
This post was included in the Carnival of Personal Finance #408 – Disney World Edition
What is opportunity cost if you thus sold Coca-Cola (KO) in 1991 or on 1995 and purchased Enron stock with the proceeds? Coca-Cola traded at a P/E exceeding 30 at the high points in both years. However, selling at the high in 1991 of $10 would have been a mistake. In addition, selling at the high of 1995 of $20 might have been a mistake also. The reason why it was a mistake was because the company managed to boost earnings rapidly during the period. Only after it went through a rough patch between 1998 - 2002, did stock prices stall.
Many other quality companies were getting overvalued at the time, which made uncovering quality stocks trading at fair prices difficult. I went through the old stock manuals, and most of the companies that looked attractive in the 1996- 1998 period were financials like Bank of America (BAC), and big oil such as Chevron (CVX) and Exxon (XOM).
To paraphrase Buffett, an individual investor would likely get 20 truly exceptional ideas over their lifetime. If you identified Coca-Cola (KO) as a great company in 1989, but either never acted on it or didn’t allow the business the chance to show you improving fundamentals after you bought shares, you would have lost one of your chances in life. Luckily, you always get a second chance, or in Buffett’s theory 19 more to go.
That being said, there is a nuanced approach to dividend growth investing that lets you keep options open. It’s the common sense approach that sometimes for whatever reason you can sell companies. If Coca-Cola trades at 50 times earnings, it might be due for a correction if growth expectations are reduced to even a modest 10% increase in earnings. If other quality companies also trade at a P/E of 40-50, the wise thing might still be to hold on to Coca-Cola. However, if one can find hidden dividend gems that are not only cheaper, but in the buy zone then a replacement might be in store.
I generally try to be a buy and hold investor, with regular monitoring, whose holding period is usually forever. However, from time to time I tend to sell positions in companies which do not make sense. For example, I sold Con Edison (ED) in 2012 and replaced it with Oneok Partners (OKS). I also sold Universal (UVV) and Cincinnati Financial (CINF) and purchased Phillips Morris International (PM) and five Canadian banks in 2013. Most recently I sold Universal Healthcare Investors Realty Trust (UHT) and purchased Digital Realty (DLR) and Omega Healthcare (OHI).
I essentially replaced lower growth companies with higher growth stocks that also had equivalent, if not higher yields at the time of replacement. However, the danger of this exercise is in getting carried away. If all you do is sell lower yielding but higher growth stocks for higher yielding stocks, this could increase risk in portfolios. Investors who purchased a higher yield stock might have taken on more risk, and actually worsened their investment situation. The risk is in terms of diversification, and not playing to different scenarios. For example, why own Chevron (CVX) when you can own Kinder Morgan Partners (KMP). Both are perfectly great companies to own, but I would be much safer owning both rather than just one of them.
When I replaced companies, the first issue I had was that growth was very low and that the price had risen to unsustainable levels relative to similar assets. At the rate of growth of Con Edison (ED), it would have taken me 72 years for my distributions to double. When the yield went from 6% to 4%, I decided to sell and purchase ONEOK (OKS), which yielded 4.50% and grew distributions above the rate of inflation. As a result, my dividend income increased by 10%, simply by making the switch. Whether ONEOK actually does better than Con Edison, is yet to be seen. However, even if it performs just as well as Con Edison, I would have been worse off, because I had to pay capital gains taxes on the switch. If you compound those issues over time, this could be a serious detractor from long-term performance.
Currently, I own a position in Brown-Forman (BF-B). There is a quality of earnings, driven by the diverse products that generate strong demand in the US and internationally. The company seems to be doing a good job of growing the business, and rewarding shareholders with high dividends in the process. I believe that ten years from now, Brown-Forman would have at minimum doubled earnings per share. As a result, if it earns $6/share in 10 years, and trades at a P/E of 20, I would generate a good return on investment. The return would be good because I would receive a rising stream of dividends, which typically increase anywhere between 7% - 9%, which I can then use to purchase shares in other companies.
Currently, I do not see companies that are similar to Brown-Forman, which are fairly valued. As a result, I would have to buy a company that is in another industry. A few like International Business Machines (IBM) and Wells Fargo (WFC) come to mind. Both companies have much lower P/E ratios in comparison to Brown-Forman, and they also have higher yields. Comparing P/E ratios between companies from different sectors is similar to an apples to oranges example. For example, oil majors such as Chevron (CVX) or Exxon Mobil (XOM) usually trade at low P/E ratios. The question is, would replacing Brown-Forman with another company affect the risk profile of my portfolio negatively, and would a prudent business owner sell their stake simply because the value of their business is quoted higher?
My options include simply holding on to Brown-Forman (BF.B), and reinvesting dividends in other attractively valued opportunities. My second option includes selling and purchasing a company that is cheaper, such as International Business Machines (IBM) or Wells Fargo (WFC). The main concern is that I want to maximize return for the next 20 – 30 years. If I purchased IBM today, but it fails to increase earnings, while Brown-Forman continues its slow and steady growth, I would be kicking myself in 20 years. If I sold my position in Brown-Forman, I would also have to pay a capital gains tax, as my cost is $39.98/share. If I sold at $72/share, this would be equivalent to receiving $67/share after-tax. Given the fact that I like the company’s prospects, I will hold on for now but would closely monitor it if it goes above $80/share.
Unless your income stocks trade at ridiculous valuations such as 30 – 40 times earnings, it might be simply fine to hold on to them. Unfortunately, every situation is different. This is why a black and white approach is dangerous, while a more nuanced and selective approach is superior.
Full Disclosure: Long BF/B, KO, IBM, CVX, OKS, ED, PM, DLR, OHI
Relevant Articles:
- Buy and hold dividend investing is not dead
- Dividend Investing is not a black or white process
- Reinvest Dividends Selectively
- Does entry price matter to dividend investors?
- Coca-Cola Company (KO) Dividend Stock Analysis
This post was included in the Carnival of Personal Finance #408 – Disney World Edition
Monday, April 22, 2013
Kinder Morgan Rewards Both General and Limited Partners with Higher Income
Kinder Morgan is the largest midstream company in North America, with over 73,000 miles of pipelines and 180 terminals. The pipelines transport oil, natural gas, CO2 and other products. The terminals handle a variety of products such as gasoline, jet fuel, ethanol, coal, coke, steal and others.
As I outlined in an earlier article, there are three ways to invest in Kinder Morgan. The first and second way to invest are through purchasing the limited partnership units. With Kinder Morgan Partners (KMP), unitholders can earn distributions in cash, while for Kinder Morgan Management LLC (KMR), limited partners directly obtain i-units, instead of cash. Since there is no taxable event for holders of KMR, the i-units are a great tax efficient way to build a position in the partnership even in a taxable account. Before the IPO of Kinder Morgan Inc in 2011, my entire position in the partnership was in i-units. For example, if Kinder Morgan Partners (KMP) paid $1.30/unit in a given quarter, holders of Kinder Morgan Management LLC (KMR) would have received a partial share worth $1.30. If the price for KMR was $100, the KMR unitholder would have received 0.013 units.
Last, there are the general partnership interests in Kinder Morgan Partners, where Kinder Morgan Inc (KMI) is the vehicle to purchase. Kinder Morgan Inc also owns the general partner interest in El Paso Pipeline Partners (EPB). In addition, KMI also owns limited partnership interests in Kinder Morgan Partners, El Paso Pipeline Partners and Kinder Morgan Management LLC. I recently added to my position in Kinder Morgan Inc in my IRA.
Over the past week, Kinder Morgan approved distribution hikes for both the general and limited partners.
The limited partners of Kinder Morgan Partners (KMP) also received a distributions boost to $1.30/unit. This represented an 8% increase over the distribution paid in the corresponding quarter in 2012. This brings the current yield up to 5.70%. The partnership is projecting an increase in annual distributions to $5.28 for 2013. Since KMP is a master limited partnership, distributions are not eligible for preferential qualified dividend tax treatment. Because partnerships are pass-through entities whose income is taxed at the limited partner level and not the entity level, distributions from MLPs are slightly more complex to handle from a tax perspective. This is a big reason why many investors avoid them outright. Check my analysis of Kinder Morgan Partners.
The distributions to Kinder Morgan Management LLC (KMR) will be paid in additional KMR shares. I hold the i-shares because I am in the accumulation phase and it is an option to have less complicated and time-consuming tax returns. The i-shares usually trade at a discount to the limited partnership interests, which is why it is usually a better deal for long-term holders.
Kinder Morgan Inc (KMI) shareholders will receive a higher quarterly dividend by 2.70% to 38 cents/share. This was an increase of 19% over the distribution paid in the same quarter in 2012. This brings the current yield up to 3.90%. The company is projecting an increase in annual dividends to $1.57 for 2013. Since KMI is a corporation, the dividends are eligible for preferential qualified dividend tax treatment.
The partnership is able to grow distributions from new additions to its vast portfolio of fee-generating assets. I would strongly encourage investors to read through the press release. According to it, distributions are well covered in Q1, as DCF/unit was $1.46, for a DCF payout ratio of 89%. The partnership is a great vehicle for investors who are looking for high current income, with solid distributions growth. The K-1 forms make this investment slightly more challenging, although it leads to substantial tax deferral of distributions received for over a decade.
Kinder Morgan Inc is able to grow dividends faster, because of its incentive distribution rights (IDR). These IDR’s entitle the general partner to half of any incremental distributable cash flow above certain thresholds. This stock is perfect for investors who want high yields today, plus the possibility of high dividend growth. The stock is also perfect for investors who do not want to deal with the more complicated tax return that Kinder Morgan Partners would create.
Full Disclosure: Long KMI and KMR
Relevant Articles:
- Kinder Morgan Partners (KMP) for High Yield and Solid Distributions Growth
- Kinder Morgan Partners – One Company three ways to invest in it
- General vs Limited Partners in MLP's
- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- Six Dividend Paying Stocks I Purchased for my IRA
As I outlined in an earlier article, there are three ways to invest in Kinder Morgan. The first and second way to invest are through purchasing the limited partnership units. With Kinder Morgan Partners (KMP), unitholders can earn distributions in cash, while for Kinder Morgan Management LLC (KMR), limited partners directly obtain i-units, instead of cash. Since there is no taxable event for holders of KMR, the i-units are a great tax efficient way to build a position in the partnership even in a taxable account. Before the IPO of Kinder Morgan Inc in 2011, my entire position in the partnership was in i-units. For example, if Kinder Morgan Partners (KMP) paid $1.30/unit in a given quarter, holders of Kinder Morgan Management LLC (KMR) would have received a partial share worth $1.30. If the price for KMR was $100, the KMR unitholder would have received 0.013 units.
Last, there are the general partnership interests in Kinder Morgan Partners, where Kinder Morgan Inc (KMI) is the vehicle to purchase. Kinder Morgan Inc also owns the general partner interest in El Paso Pipeline Partners (EPB). In addition, KMI also owns limited partnership interests in Kinder Morgan Partners, El Paso Pipeline Partners and Kinder Morgan Management LLC. I recently added to my position in Kinder Morgan Inc in my IRA.
Over the past week, Kinder Morgan approved distribution hikes for both the general and limited partners.
The limited partners of Kinder Morgan Partners (KMP) also received a distributions boost to $1.30/unit. This represented an 8% increase over the distribution paid in the corresponding quarter in 2012. This brings the current yield up to 5.70%. The partnership is projecting an increase in annual distributions to $5.28 for 2013. Since KMP is a master limited partnership, distributions are not eligible for preferential qualified dividend tax treatment. Because partnerships are pass-through entities whose income is taxed at the limited partner level and not the entity level, distributions from MLPs are slightly more complex to handle from a tax perspective. This is a big reason why many investors avoid them outright. Check my analysis of Kinder Morgan Partners.
The distributions to Kinder Morgan Management LLC (KMR) will be paid in additional KMR shares. I hold the i-shares because I am in the accumulation phase and it is an option to have less complicated and time-consuming tax returns. The i-shares usually trade at a discount to the limited partnership interests, which is why it is usually a better deal for long-term holders.
Kinder Morgan Inc (KMI) shareholders will receive a higher quarterly dividend by 2.70% to 38 cents/share. This was an increase of 19% over the distribution paid in the same quarter in 2012. This brings the current yield up to 3.90%. The company is projecting an increase in annual dividends to $1.57 for 2013. Since KMI is a corporation, the dividends are eligible for preferential qualified dividend tax treatment.
The partnership is able to grow distributions from new additions to its vast portfolio of fee-generating assets. I would strongly encourage investors to read through the press release. According to it, distributions are well covered in Q1, as DCF/unit was $1.46, for a DCF payout ratio of 89%. The partnership is a great vehicle for investors who are looking for high current income, with solid distributions growth. The K-1 forms make this investment slightly more challenging, although it leads to substantial tax deferral of distributions received for over a decade.
Kinder Morgan Inc is able to grow dividends faster, because of its incentive distribution rights (IDR). These IDR’s entitle the general partner to half of any incremental distributable cash flow above certain thresholds. This stock is perfect for investors who want high yields today, plus the possibility of high dividend growth. The stock is also perfect for investors who do not want to deal with the more complicated tax return that Kinder Morgan Partners would create.
Full Disclosure: Long KMI and KMR
Relevant Articles:
- Kinder Morgan Partners (KMP) for High Yield and Solid Distributions Growth
- Kinder Morgan Partners – One Company three ways to invest in it
- General vs Limited Partners in MLP's
- Master Limited Partnerships (MLPs) – an island of opportunity for dividend investors
- Six Dividend Paying Stocks I Purchased for my IRA
Saturday, April 20, 2013
Great Links to Enjoy 4/20/2013
I tend to post anywhere between three to four articles to my site every week. I usually try to write at least one or two articles that contain timeless information concerning dividend investing. This could include information about my strategy, or other pieces of information, which could be useful to dividend investors.
Below, I have highlighted a few articles posted on this site, which many readers have found interesting:
Below, I have highlighted a few articles posted on this site, which many readers have found interesting:
- The Live off Dividends Retirement Plan
- Build your own Berkshire with dividend paying stocks
- My Dividend Retirement Plan
- When can you retire on dividends?
- Does entry price matter to dividend investors?
- How getting laid off was the best thing for my finances
- Why I Vastly Prefer Dividend Growth Investing To Index Funds
- The Overview of the Dividend Discount Model
- To Buy or Not To Buy Are We Heading Towards a Market Correction?
- Characteristics of Great Dividend Growth Stocks
- Reaching Critical Mass
Thank you for reading Dividend Growth Investor site. I am also on Twitter, if you are interested in following me on another platform, where I post about recent trades I have made.
Friday, April 19, 2013
Procter & Gamble (PG) Delivers a Dividend Boost to Investors
As a dividend investor my goal is to generate a sufficient stream of sustainable dividends from my income portfolio. I focus on dividends because this method is much less volatile than relying on capital gains and also is a more sustainable method to pay for expenses when compared to selling off shares. This was evident over the past week, when stocks dropped for the first time in several weeks.
At the same time, one of my core holdings, Procter & Gamble (PG), raised quarterly dividends by 7% to 60.15 cents/share. This marked the 57 consecutive annual dividend increase for the company. To put things in perspective, when the company started raising dividends, the US president was Eisenhower. The company has managed to boost dividends during nine recessions, several wars, a few oil price shocks, and nine bear markets. There are only fifteen companies in the world which have managed to boost dividends for over 50 years in a row. Check my analysis of the stock.
Over the past decade, P&G has enjoyed an increase in earnings per share from $1.95 in 2003 to $3.82 in 2012. The ten year dividend growth is 10.80%/annually. Currently the stock is trading at 17.90 times earnings, and yields 3%. The stock is close to being fully valued at the moment, based on FY 2013 expected earnings. I would consider adding to the stock on dips, although judging by the negative sentiment in the dividend community, I am not expecting any sizeable corrections.
As a dividend investor, I am not at all worried about stock market fluctuations, as long as I keep receiving my dividend income. In fact, if the market dropped by 50% tomorrow, or it was closed for the next five years, I would be relatively unaffected as long as my companies are fundamentally sound.
Full Disclosure: Long PG
Relevant Articles:
- Procter & Gamble (PG)- A dividend stock to hold forever
- The Dividend Kings List Keeps Expanding
- My Entry Criteria for Dividend Stocks
- Most Widely Held Dividend Growth Stocks
At the same time, one of my core holdings, Procter & Gamble (PG), raised quarterly dividends by 7% to 60.15 cents/share. This marked the 57 consecutive annual dividend increase for the company. To put things in perspective, when the company started raising dividends, the US president was Eisenhower. The company has managed to boost dividends during nine recessions, several wars, a few oil price shocks, and nine bear markets. There are only fifteen companies in the world which have managed to boost dividends for over 50 years in a row. Check my analysis of the stock.
Over the past decade, P&G has enjoyed an increase in earnings per share from $1.95 in 2003 to $3.82 in 2012. The ten year dividend growth is 10.80%/annually. Currently the stock is trading at 17.90 times earnings, and yields 3%. The stock is close to being fully valued at the moment, based on FY 2013 expected earnings. I would consider adding to the stock on dips, although judging by the negative sentiment in the dividend community, I am not expecting any sizeable corrections.
As a dividend investor, I am not at all worried about stock market fluctuations, as long as I keep receiving my dividend income. In fact, if the market dropped by 50% tomorrow, or it was closed for the next five years, I would be relatively unaffected as long as my companies are fundamentally sound.
Full Disclosure: Long PG
Relevant Articles:
- Procter & Gamble (PG)- A dividend stock to hold forever
- The Dividend Kings List Keeps Expanding
- My Entry Criteria for Dividend Stocks
- Most Widely Held Dividend Growth Stocks
Thursday, April 18, 2013
The right time to sell dividend stocks
With the market hitting fresh 17 month highs, investors have to look hard in order to find attractively valued opportunities. Plenty of stocks such as Aflac (AFL), Emerson Electric (EMR), 3M (MMM) and Realty Income (O) ,which in early 2009 rewarded enterprising dividend investors with their highest yields in a decade, are now yielding much less. Many stocks are also trading at rich valuations, which suggests that investors these days are willing to pay a premium for future growth.
The rapid increase in prices since March 2009 lows has many dividend investors wondering whether they should lock in some or all of their gains today. Investors who were able to purchase stocks in 2008 and 2009 might be sitting at gains, which seem equal to the dividend payments they could expect from a stock for several years to come. The issue with this thinking is that dividends typically increase over time on average while cash in the bank typically loses its purchasing power over time. As a result the investor who takes profits today might lose on any increases in dividends as well as on any future price gains. They would also have to find a decent vehicle to park their cash, which is getting harder and harder to find these days.
Because of the reasons stated above I would not consider selling even if my position went up 1000%. It would not be a wise idea to sell a stock which was purchased as a long term holding and its business hasn’t changed much. What is important is that the original yield on cost that has been locked with the purchase in 2008 or 2009 is there to stay, as long as the dividend is at least maintained. I would only consider selling when the dividend is cut. If a stock you purchased had a current yield of 8%, your yield on cost of is 8%. The nice part about this is that you keep receiving 8% on your original cost as long as the dividend is maintained. Then it doesn't really matter if the stock is currently yielding 1% or 2% - you still earn 8% on your cost. If the dividend payment is increased then your yield on cost rises as well. Companies like Johnson & Johnson (JNJ) or Abbott Labs (ABT) for example have low current yields of 3%, but their growing dividend payments produce substantial yields on cost over time.
If you were thinking of selling a stock which generates great yield on cost, you should remember that currently the market is overvalued. But the market could keep getting overvalued for a far longer period than you or I could remain sane. Retirees need income, and in the current low interest environment dividend stocks seem to be the perfect vehicle for an inflation adjusted source of income in retirement.
Back in the late 1980s Procter & Gamble (PG) yielded less than 3% for the first time in decades, which was much lower than the 4% average yield that investors received in the mid 1980s. In early 1991 the stock traded at 10.50, yielded 2.40%, and paid 6.25 cents/quarter. Although bonds yielded at least three times what P&G yielded at the time, they couldn’t provide rising income payments and the possibility for high capital gains as well. By early 1994 Procter & Gamble stock increased to $14, after a 2 to 1 stock split, paid 8.25 cents/quarter and yielded 2.20%. In early 1999 Procter & Gamble traded at $46.50 and had split 2:1 in 1997. The company paid out 14.25 cents/share but yielded only 1.30%. The yield on cost for the early 1991 investor was a more comfortable 5.50%. Fast forward to 2010 and Procter & Gamble is trading close to $64 and yielding 2.80%. The yield on cost on the original 1991 purchase is 16.80%. This example goes on to show that selling Procter & Gamble (PG) when it became overvalued, was not a very good idea, because the company kept generating higher earnings and kept increasing its dividend payment. While investors could have found other stocks to reinvest Procter & Gamble (PG) dividends or allocate any new cash, they would have been well off simply holding on to Procter & Gamble (PG) and other dividend raisers despite them being overvalued for extended periods of time.
Right now Procter & Gamble (PG) looks like it could again stay below 3% for the foreseeable future. This time I am planning on adding to my position around $59 ,even though it is not exactly trading at a 3% yield.
Full Disclosure: Long ABT, AFL, EMR, JNJ, MMM, O, PG
Note to Readers: This article was originally published on March 24, 2010. The basic ideas behind it however are still valid, three years later.
Relevant Articles:
- Is now the time to sell your dividend stocks?
- The right time to buy dividend stocks
- Best Dividends Stocks for the Long Run
- Dividend Investors are getting paid for waiting
The rapid increase in prices since March 2009 lows has many dividend investors wondering whether they should lock in some or all of their gains today. Investors who were able to purchase stocks in 2008 and 2009 might be sitting at gains, which seem equal to the dividend payments they could expect from a stock for several years to come. The issue with this thinking is that dividends typically increase over time on average while cash in the bank typically loses its purchasing power over time. As a result the investor who takes profits today might lose on any increases in dividends as well as on any future price gains. They would also have to find a decent vehicle to park their cash, which is getting harder and harder to find these days.
Because of the reasons stated above I would not consider selling even if my position went up 1000%. It would not be a wise idea to sell a stock which was purchased as a long term holding and its business hasn’t changed much. What is important is that the original yield on cost that has been locked with the purchase in 2008 or 2009 is there to stay, as long as the dividend is at least maintained. I would only consider selling when the dividend is cut. If a stock you purchased had a current yield of 8%, your yield on cost of is 8%. The nice part about this is that you keep receiving 8% on your original cost as long as the dividend is maintained. Then it doesn't really matter if the stock is currently yielding 1% or 2% - you still earn 8% on your cost. If the dividend payment is increased then your yield on cost rises as well. Companies like Johnson & Johnson (JNJ) or Abbott Labs (ABT) for example have low current yields of 3%, but their growing dividend payments produce substantial yields on cost over time.
If you were thinking of selling a stock which generates great yield on cost, you should remember that currently the market is overvalued. But the market could keep getting overvalued for a far longer period than you or I could remain sane. Retirees need income, and in the current low interest environment dividend stocks seem to be the perfect vehicle for an inflation adjusted source of income in retirement.
Back in the late 1980s Procter & Gamble (PG) yielded less than 3% for the first time in decades, which was much lower than the 4% average yield that investors received in the mid 1980s. In early 1991 the stock traded at 10.50, yielded 2.40%, and paid 6.25 cents/quarter. Although bonds yielded at least three times what P&G yielded at the time, they couldn’t provide rising income payments and the possibility for high capital gains as well. By early 1994 Procter & Gamble stock increased to $14, after a 2 to 1 stock split, paid 8.25 cents/quarter and yielded 2.20%. In early 1999 Procter & Gamble traded at $46.50 and had split 2:1 in 1997. The company paid out 14.25 cents/share but yielded only 1.30%. The yield on cost for the early 1991 investor was a more comfortable 5.50%. Fast forward to 2010 and Procter & Gamble is trading close to $64 and yielding 2.80%. The yield on cost on the original 1991 purchase is 16.80%. This example goes on to show that selling Procter & Gamble (PG) when it became overvalued, was not a very good idea, because the company kept generating higher earnings and kept increasing its dividend payment. While investors could have found other stocks to reinvest Procter & Gamble (PG) dividends or allocate any new cash, they would have been well off simply holding on to Procter & Gamble (PG) and other dividend raisers despite them being overvalued for extended periods of time.
Right now Procter & Gamble (PG) looks like it could again stay below 3% for the foreseeable future. This time I am planning on adding to my position around $59 ,even though it is not exactly trading at a 3% yield.
Full Disclosure: Long ABT, AFL, EMR, JNJ, MMM, O, PG
Note to Readers: This article was originally published on March 24, 2010. The basic ideas behind it however are still valid, three years later.
Relevant Articles:
- Is now the time to sell your dividend stocks?
- The right time to buy dividend stocks
- Best Dividends Stocks for the Long Run
- Dividend Investors are getting paid for waiting
Wednesday, April 17, 2013
High Yield Dividend Investing Misconceptions
One of the biggest misconceptions about dividend investing out there is that investors should change their strategy, depending on their age. I believe that this misconception comes from the traditional world of retirement planning, where advisers told clients to allocate higher and higher amounts to fixed income instruments as they got older.
Over the past 40 – 50 years, fixed income has tended to yield more than stocks. As a result, income hungry investors in retirement seeking current income purchased CD’s, bonds and other fixed income instruments. This chasing of yields exposed them to inflation risks. Unfortunately, investors who need yield at all costs typically do not have the foresight to look beyond the next five years. Had these investors simply followed the same investing strategy throughout their investing career, without adjusting for age, they should have done just fine. I believe that following the simple four percent rule should have been their benchmark for generating retirement income from a portfolio that includes stocks and bonds. As I mentioned in an earlier article, the four percent rule essentially relied on the dividend and interest income of a portfolio, which is what the traditional retirement industry has failed to understand. In another article I discussed that for my retirement I plan on relying on the dividend income from my portfolio, which yields around 4%. I would also rely on some interest income as well. I have followed the same investing principles for the past five years, and would follow them for the next fifty years ( hopefully).
Currently, I view the misconception that investors should invest differently depending on their age fully embraced by everyone. Any time I write an article outlining the dangers of focusing simply on yield, I always receive a backlash from a group of investors. The investors that always disagree with me are those who are anywhere between their 60s and 80s. It looks like these investors simply need the income, but it also seems that they are not giving much thought about whether this income is going to continue for the next 20 – 30 years. My article on the sustainability of Pitney Bowes (PBI) and Windstream (WIN) was not well received. I did notice that many investors were hopeful, although the factd spoke that these distributions are unsustainable.
Investors who make a mistake and get lucky are actually much worse off than investors who make a mistake and pay for it. If you leveraged yourself to the maximum in 1999 to purchase all the Altria (MO) stock that you could get, and you made money from this exercise, you learned a bad lesson. If you applied this lesson in leveraging your portfolio to purchase high yielding Canadian energy trusts in 2007, or US Banks in 2008, you would have lost everything. Investors who today are purchasing high yielding telecom stocks such as Frontier (FTR) or mREITS such as American Capital Agency (AGNC) without understanding their risks, might find out that they have been playing with fire in a few years.
These investments would likely generate high yields for the next five years. This might even continue for a longer period of time, if our yield starved investors get particularly lucky. However, I highly doubt that these companies would maintain their dividends for the next thirty years. If investors spend all the dividend income from these high yielding investments, they would be out of luck when the dividends are cut. However, looking at the brief history of these investments, I would much rather stick to traditional dividend paying stocks yielding 3 – 4 percent on average today. If a four percent yield is not sufficient for you, then chances are that you do not have enough money to retire. You might try to purchase some time by investing in securities yielding more than that, but you increase your risk of dividend cuts. If your portfolio consists of high dividend stocks yielding 8% on average, and dividends are cut by 50%, then you will need to find a job to cover the difference. Finding a job in your 70s and 80s is not an easy task however.
A company that cuts an unsustainably high dividend is usually punished by a steep decline in its stock price. Thus, investors experience the double whammy of lower income, and a depreciation in asset base. This is a problem, because if our investors need to replace the investment with something else, they would have less money to do so. This is a particular problem for situations where the dividend is eliminated completely. American Capital Strategies (ACAS) is a great example for this scenario. In 2008 the company cut dividends, which prompted a sell-off from $10/share to less than $1/share within 2 – 3 months.
Stocks are not inherently “bad investments” simply because they have high current yields. If these companies can afford to pay the dividend, and can grow earnings over time then these could be very good investments. However, high yielding companies which cut dividends over time, pay fluctuating dividends, have unsustainable payout ratios and are in declining industries are investments that should probably not be touched with a ten foot pole by individual yield hungry investors, without fully understanding what they are getting into.
The best way to invest your money is to focus on the best opportunities out there. The more experience I get with dividend investing, the more I realize that current yield should not be the most important factor in selecting investments. It should not even be in the top five reasons to select an investment. It is number six in my list of entry criteria. Investors who salivate over the high yields without understanding whether the business can grow revenues and earnings to pay for the dividend are committing a sin against their asset base. However, I am somewhat impacted by the four percent rule, in that I do believe that a portfolio that yields anywhere between three to four percent is the optimal solution in today’s market environment. I do own stocks whose yield is 1% such as Visa (V), as well as stocks whose yield is 6% such as Omega Healthcare (OHI). I just purchased the ones that made sense at the time.
In my portfolio, I screen the lists of dividend champions and dividend achievers every week, looking for attractively valued stocks to purchase or to research. I keep an open eye for attractively valued companies with room to grow distributions out of growing cash flow and earnings. After analyzing companies, I only invest in those ones where I can see earnings and dividend growth for the next two – three decades. For example, I expect that Coca-Cola (KO) would still be a company with recognizable brands that will be selling a product that customers desire and are willing to pay for.
Other companies that will be around over the next 20 -30 years include energy infrastructure plays such as Kinder Morgan (KMP) and Enterprise Product Partners (EPD). These companies create the infrastructure to store and transmit oil and natural gas across the US.
Full Disclosure: Long V, OHI, KO, KMP, EPD
Relevant Articles:
- Dividend Champions - The Best List for Dividend Investors
- Are these high yield dividends sustainable?
- Don’t chase High Yielding Stocks Blindly
- Four Percent Rule for Dividend Investing in Retirement
- Dividend Investing Misconceptions
This link was featured in the latest Carnival of Wealth
Over the past 40 – 50 years, fixed income has tended to yield more than stocks. As a result, income hungry investors in retirement seeking current income purchased CD’s, bonds and other fixed income instruments. This chasing of yields exposed them to inflation risks. Unfortunately, investors who need yield at all costs typically do not have the foresight to look beyond the next five years. Had these investors simply followed the same investing strategy throughout their investing career, without adjusting for age, they should have done just fine. I believe that following the simple four percent rule should have been their benchmark for generating retirement income from a portfolio that includes stocks and bonds. As I mentioned in an earlier article, the four percent rule essentially relied on the dividend and interest income of a portfolio, which is what the traditional retirement industry has failed to understand. In another article I discussed that for my retirement I plan on relying on the dividend income from my portfolio, which yields around 4%. I would also rely on some interest income as well. I have followed the same investing principles for the past five years, and would follow them for the next fifty years ( hopefully).
Currently, I view the misconception that investors should invest differently depending on their age fully embraced by everyone. Any time I write an article outlining the dangers of focusing simply on yield, I always receive a backlash from a group of investors. The investors that always disagree with me are those who are anywhere between their 60s and 80s. It looks like these investors simply need the income, but it also seems that they are not giving much thought about whether this income is going to continue for the next 20 – 30 years. My article on the sustainability of Pitney Bowes (PBI) and Windstream (WIN) was not well received. I did notice that many investors were hopeful, although the factd spoke that these distributions are unsustainable.
Investors who make a mistake and get lucky are actually much worse off than investors who make a mistake and pay for it. If you leveraged yourself to the maximum in 1999 to purchase all the Altria (MO) stock that you could get, and you made money from this exercise, you learned a bad lesson. If you applied this lesson in leveraging your portfolio to purchase high yielding Canadian energy trusts in 2007, or US Banks in 2008, you would have lost everything. Investors who today are purchasing high yielding telecom stocks such as Frontier (FTR) or mREITS such as American Capital Agency (AGNC) without understanding their risks, might find out that they have been playing with fire in a few years.
These investments would likely generate high yields for the next five years. This might even continue for a longer period of time, if our yield starved investors get particularly lucky. However, I highly doubt that these companies would maintain their dividends for the next thirty years. If investors spend all the dividend income from these high yielding investments, they would be out of luck when the dividends are cut. However, looking at the brief history of these investments, I would much rather stick to traditional dividend paying stocks yielding 3 – 4 percent on average today. If a four percent yield is not sufficient for you, then chances are that you do not have enough money to retire. You might try to purchase some time by investing in securities yielding more than that, but you increase your risk of dividend cuts. If your portfolio consists of high dividend stocks yielding 8% on average, and dividends are cut by 50%, then you will need to find a job to cover the difference. Finding a job in your 70s and 80s is not an easy task however.
A company that cuts an unsustainably high dividend is usually punished by a steep decline in its stock price. Thus, investors experience the double whammy of lower income, and a depreciation in asset base. This is a problem, because if our investors need to replace the investment with something else, they would have less money to do so. This is a particular problem for situations where the dividend is eliminated completely. American Capital Strategies (ACAS) is a great example for this scenario. In 2008 the company cut dividends, which prompted a sell-off from $10/share to less than $1/share within 2 – 3 months.
Stocks are not inherently “bad investments” simply because they have high current yields. If these companies can afford to pay the dividend, and can grow earnings over time then these could be very good investments. However, high yielding companies which cut dividends over time, pay fluctuating dividends, have unsustainable payout ratios and are in declining industries are investments that should probably not be touched with a ten foot pole by individual yield hungry investors, without fully understanding what they are getting into.
The best way to invest your money is to focus on the best opportunities out there. The more experience I get with dividend investing, the more I realize that current yield should not be the most important factor in selecting investments. It should not even be in the top five reasons to select an investment. It is number six in my list of entry criteria. Investors who salivate over the high yields without understanding whether the business can grow revenues and earnings to pay for the dividend are committing a sin against their asset base. However, I am somewhat impacted by the four percent rule, in that I do believe that a portfolio that yields anywhere between three to four percent is the optimal solution in today’s market environment. I do own stocks whose yield is 1% such as Visa (V), as well as stocks whose yield is 6% such as Omega Healthcare (OHI). I just purchased the ones that made sense at the time.
In my portfolio, I screen the lists of dividend champions and dividend achievers every week, looking for attractively valued stocks to purchase or to research. I keep an open eye for attractively valued companies with room to grow distributions out of growing cash flow and earnings. After analyzing companies, I only invest in those ones where I can see earnings and dividend growth for the next two – three decades. For example, I expect that Coca-Cola (KO) would still be a company with recognizable brands that will be selling a product that customers desire and are willing to pay for.
Other companies that will be around over the next 20 -30 years include energy infrastructure plays such as Kinder Morgan (KMP) and Enterprise Product Partners (EPD). These companies create the infrastructure to store and transmit oil and natural gas across the US.
Full Disclosure: Long V, OHI, KO, KMP, EPD
Relevant Articles:
- Dividend Champions - The Best List for Dividend Investors
- Are these high yield dividends sustainable?
- Don’t chase High Yielding Stocks Blindly
- Four Percent Rule for Dividend Investing in Retirement
- Dividend Investing Misconceptions
This link was featured in the latest Carnival of Wealth
Monday, April 15, 2013
Six Dividend Paying Stocks I Purchased for my IRA
Readers of my April fools post chuckled at my spending addiction, where I mentioned how the tax man was preventing me from investing in stocks for almost two months. I recently opened an IRA, and allocated the funds equally in the following six dividend stocks:
Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. The company has raised dividends for 25 years in a row, and has a ten year dividend growth rate of 9.60%/year. Currently, this dividend achiever trades at 9 times earnings at yields 3%. Check my analysis of Chevron.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends for 4 years in a row. Currently, the stock trades at 18.60 times earnings at yields 3.60%. Check my analysis of Philip Morris International.
Johnson & Johnson (JNJ), together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company has raised dividends for 50 years in a row, and has a ten year dividend growth rate of 11.70%/year. Currently, this dividend champion trades at 16.90 times earnings at yields 3%. Check my analysis of Johnson & Johnson.
McDonald’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company has raised dividends for 36 years in a row, and has a ten year dividend growth rate of 28.40%/year. Currently, this dividend champion trades at 19.30 times earnings at yields 3%. Check my analysis of McDonald’s .
Kinder Morgan, Inc. (KMI) owns and operates energy transportation and storage assets in the United States and Canada. The company has raised dividends ever since it went public in 2011, yields 3.80% and is projecting to grow them by over 10%/year for the foreseeable future. Check my analysis of Kinder Morgan.
Vodafone Group Plc (VOD) provides mobile telecommunication services worldwide. The company has raised dividends since 1989. Since 2002, the annual dividend in British Pounds has increased from 1.47 pence/share to 9.52 pence/share in 2012.. Currently, this international dividend achiever yields around 5%.
The reason why I purchased these companies is because they were attractively valued at the moment, provided decent entry yields and the opportunity for growth in earnings and dividends going forward.
By making this IRA contribution, I was able to reduce my tax due by more than half. The amount I put in that IRA produced an instant tax savings that was equivalent to over one third of its value in taxes. This also made me review my paychecks closer, and I noticed that I pay in taxes an amount that could easily cover 60% of my expenses. This was the tipping point that made me think about reducing tax expenses, in order to accumulate as much funds in my name, both in taxable and tax-deferred brokerage accounts. Most people do not even realize the amount of taxes they pay each year, because they are automatically withdrawn from their paychecks.
Long-term readers might have sensed the fact that I am a big fan of early retirement. According to my 2013 goals, I discussed how I would be able to retire in five – six years. As a result, I have always discussed that I keep most of my investable assets in taxable brokerage accounts. It made sense for me to only put the bare minimum in tax-deferred accounts such as 401 (k) only to get the company sponsored match. Since 2009, I have consistently ended up owing money to the government come April 15. What I realized over the past year is that the taxes I end up paying do not provide a specific benefit to myself. These taxes help pay for roads, defense, education and public services, but the payment of them was costing me a lot of money. Just looking at my paychecks I recently realized that I need to make a change. As a result, I am going to contribute the maximum I can in 401 (k) plans and IRA’s, in order to reduce my taxable income. Any tax savings from deferring my spending will be directly realizable to moi, although there are a few obstacles to that.
The first issue is that there are limited investment options for 401 (k) plans. For IRA’s however, it is possible to put individual dividend paying stocks. As a portion of my total portfolio however, I do not foresee the sum of 401 (k) and IRA accounts to exceed 15% – 20%. If I choose to retire in five years, I should be able to convert my 401 (k) into an IRA, and invest the money as I see fit. This is not an ideal situation, but any money I put into a 401 (k) would translate into immediate returns of over 1/3 the invested amount, because of tax savings. To me, investing in index funds and not in individual dividend stocks is worth generating a 33% return through the instant tax savings. Most of my current 401 (k) money is in an old 401 (k) from my last employer that I left in the prior year. I plan to roll this into an IRA, which would allow me better flexibility with my investments.
The second issue is that funds in tax-deferred accounts such as 401 (k) and IRA cannot be easily accessed at a whim. There is a 10% early withdrawal penalty on money that is withdrawn prior to ages 55 for 401 (k) and 59 ½ for IRA’s. In addition to that, investors need to pay ordinary tax rates on money that is distributed. Investors in Roth IRA’s can withdraw contributions without any penalties, but they do not get a tax break for contributing today.
So to summarize, I am better off getting tax deduction today that allows me to save an amount each year, which is lost for me when paying taxes. I am much better off to have some claims to money in the future even if accessing it is more difficult, than to simply throw it away (by giving it to the federal and state and local governments). The rate at which I will accumulate individual dividend stocks in taxable brokerage accounts would decline from 3 new purchases a month to 2 purchases every month. An interesting fact is that when I increased my 401 (k) contribution from 6% to 10%, my paycheck decreased only by % .
Throughout my early retirement, I expect that the majority of income will come in the form of dividends, distributions and some 1099 business income. This would put me in a lower tax bracket, which is why distributions from an IRA in early retirement would still be a cheap way to withdraw money if I had to, even with the 10% penalty on distributions. However, if I choose to go to Substantially Equal Periodic Payment arrangement, I might end up withdrawing dividends from that IRA, without having to pay the 10% penalty. I found two calculators behind SEPP here and here. Depending on your age at retirement, the distribution you can take without paying the 10% penalty could cover 50% - 75% of your annual dividend income earned from that particular portfolio, assuming a current yield around 3.50% - 4%.
Full Disclosure: Long CVX, PM, JNJ, MCD, VOD, KMI
Relevant Articles:
- Roth IRA’s for Dividend Investors
- Should income investors worry about higher dividend taxes
- Will higher taxes bring dividend stocks down?
- Dividend Achievers Offer Income Growth and Capital Appreciation Potential
- Dividend Champions - The Best List for Dividend Investors
Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. The company has raised dividends for 25 years in a row, and has a ten year dividend growth rate of 9.60%/year. Currently, this dividend achiever trades at 9 times earnings at yields 3%. Check my analysis of Chevron.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends for 4 years in a row. Currently, the stock trades at 18.60 times earnings at yields 3.60%. Check my analysis of Philip Morris International.
Johnson & Johnson (JNJ), together with its subsidiaries, engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company has raised dividends for 50 years in a row, and has a ten year dividend growth rate of 11.70%/year. Currently, this dividend champion trades at 16.90 times earnings at yields 3%. Check my analysis of Johnson & Johnson.
McDonald’s Corporation (MCD) franchises and operates McDonald's restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company has raised dividends for 36 years in a row, and has a ten year dividend growth rate of 28.40%/year. Currently, this dividend champion trades at 19.30 times earnings at yields 3%. Check my analysis of McDonald’s .
Kinder Morgan, Inc. (KMI) owns and operates energy transportation and storage assets in the United States and Canada. The company has raised dividends ever since it went public in 2011, yields 3.80% and is projecting to grow them by over 10%/year for the foreseeable future. Check my analysis of Kinder Morgan.
Vodafone Group Plc (VOD) provides mobile telecommunication services worldwide. The company has raised dividends since 1989. Since 2002, the annual dividend in British Pounds has increased from 1.47 pence/share to 9.52 pence/share in 2012.. Currently, this international dividend achiever yields around 5%.
The reason why I purchased these companies is because they were attractively valued at the moment, provided decent entry yields and the opportunity for growth in earnings and dividends going forward.
By making this IRA contribution, I was able to reduce my tax due by more than half. The amount I put in that IRA produced an instant tax savings that was equivalent to over one third of its value in taxes. This also made me review my paychecks closer, and I noticed that I pay in taxes an amount that could easily cover 60% of my expenses. This was the tipping point that made me think about reducing tax expenses, in order to accumulate as much funds in my name, both in taxable and tax-deferred brokerage accounts. Most people do not even realize the amount of taxes they pay each year, because they are automatically withdrawn from their paychecks.
Long-term readers might have sensed the fact that I am a big fan of early retirement. According to my 2013 goals, I discussed how I would be able to retire in five – six years. As a result, I have always discussed that I keep most of my investable assets in taxable brokerage accounts. It made sense for me to only put the bare minimum in tax-deferred accounts such as 401 (k) only to get the company sponsored match. Since 2009, I have consistently ended up owing money to the government come April 15. What I realized over the past year is that the taxes I end up paying do not provide a specific benefit to myself. These taxes help pay for roads, defense, education and public services, but the payment of them was costing me a lot of money. Just looking at my paychecks I recently realized that I need to make a change. As a result, I am going to contribute the maximum I can in 401 (k) plans and IRA’s, in order to reduce my taxable income. Any tax savings from deferring my spending will be directly realizable to moi, although there are a few obstacles to that.
The first issue is that there are limited investment options for 401 (k) plans. For IRA’s however, it is possible to put individual dividend paying stocks. As a portion of my total portfolio however, I do not foresee the sum of 401 (k) and IRA accounts to exceed 15% – 20%. If I choose to retire in five years, I should be able to convert my 401 (k) into an IRA, and invest the money as I see fit. This is not an ideal situation, but any money I put into a 401 (k) would translate into immediate returns of over 1/3 the invested amount, because of tax savings. To me, investing in index funds and not in individual dividend stocks is worth generating a 33% return through the instant tax savings. Most of my current 401 (k) money is in an old 401 (k) from my last employer that I left in the prior year. I plan to roll this into an IRA, which would allow me better flexibility with my investments.
The second issue is that funds in tax-deferred accounts such as 401 (k) and IRA cannot be easily accessed at a whim. There is a 10% early withdrawal penalty on money that is withdrawn prior to ages 55 for 401 (k) and 59 ½ for IRA’s. In addition to that, investors need to pay ordinary tax rates on money that is distributed. Investors in Roth IRA’s can withdraw contributions without any penalties, but they do not get a tax break for contributing today.
So to summarize, I am better off getting tax deduction today that allows me to save an amount each year, which is lost for me when paying taxes. I am much better off to have some claims to money in the future even if accessing it is more difficult, than to simply throw it away (by giving it to the federal and state and local governments). The rate at which I will accumulate individual dividend stocks in taxable brokerage accounts would decline from 3 new purchases a month to 2 purchases every month. An interesting fact is that when I increased my 401 (k) contribution from 6% to 10%, my paycheck decreased only by % .
Throughout my early retirement, I expect that the majority of income will come in the form of dividends, distributions and some 1099 business income. This would put me in a lower tax bracket, which is why distributions from an IRA in early retirement would still be a cheap way to withdraw money if I had to, even with the 10% penalty on distributions. However, if I choose to go to Substantially Equal Periodic Payment arrangement, I might end up withdrawing dividends from that IRA, without having to pay the 10% penalty. I found two calculators behind SEPP here and here. Depending on your age at retirement, the distribution you can take without paying the 10% penalty could cover 50% - 75% of your annual dividend income earned from that particular portfolio, assuming a current yield around 3.50% - 4%.
Full Disclosure: Long CVX, PM, JNJ, MCD, VOD, KMI
Relevant Articles:
- Roth IRA’s for Dividend Investors
- Should income investors worry about higher dividend taxes
- Will higher taxes bring dividend stocks down?
- Dividend Achievers Offer Income Growth and Capital Appreciation Potential
- Dividend Champions - The Best List for Dividend Investors
Saturday, April 13, 2013
Which stocks did I purchase over the past week edition?
I had a 401(k) plan from a previous employer at Fidelity, which I recently rolled over into an IRA. The rollover took a few hours, after which the money was available to invest the very next morning. Over the past week I purchased stock in approximately twenty individual stocks in this rollover IRA. I typically post my purchases within one day of making the transaction and post it on my twitter feed. I write a detailed article several weeks later. If you are interested in learning about my transactions in almost real-time, you can always subscribe to my feed here. My handle is Dividendgrowth.
I also recently opened an IRA in order to reduce taxes this year. I am posting an article about this on Monday.
My readers have enjoyed the following five articles for the month of March:
Thank you for reading, and have a great weekend!
I also recently opened an IRA in order to reduce taxes this year. I am posting an article about this on Monday.
My readers have enjoyed the following five articles for the month of March:
- Pure Dividend Growth Stocks I wish I owned
- Are these high yield dividends sustainable?
- Three High Yielding Dividend Machines Boosting Distributions
- Warren Buffett on Dividends: Ideas from his 2013 Letter to Shareholders
- How to invest when the market is at all time highs?
Thank you for reading, and have a great weekend!
Friday, April 12, 2013
High Yield REIT Analysis: Omega Healthcare Investors (OHI)
Omega Healthcare Investors (OHI) invests in healthcare facilities, principally long-term healthcare facilities in the United States. It provides lease or mortgage financing to qualified operators of skilled nursing facilities , as well as to assisted living facilities , independent living facilities, and rehabilitation and acute care facilities. This real estate investment trust has raised dividends for ten years in a row. Back in March, I initiated a position in Omega Healthcare Investors and Digital Realty Trust (DLR), after I sold my position in Universal Healthcare Realty Investors (UHT).
One of the reasons why I have been hesitant to look at Omega Healthcare before, was the fact that the REIT cut distributions in 2000, and eliminated them for 2001 and 2002. The risk with a company that eliminates dividends once, is that the conditions might appear again, thus causing the firm to become a repeat dividend cut offender. In this article, I will review the operating performance over the past decade, and conclude on whether the company is a good addition to an investor’s portfolio.I will evaluate this REIT using the five criteria I use as outlined in an earlier article this week.
Since 2005, FFO has grown by 150%, while the dividend has doubled in the same period.
I usually prefer a margin of safety in dividend payments. At 82%, the FFO Payout ratio is sustainable. A lower payout is always a plus, because it allows the company to absorb any short-term fluctuation in FFO, which lowers risk to dividend payments.
Future distribution growth would be driver by growth in investments that the company has been making over the past decade. Acquisitions of property have accelerated starting in 2009, with over $1.30 billion invested over the period. The REIT’s strategy is focused on pursuing selective investments in senior care facilities.
Skilled Nursing Facilities will be a growth industry for the next three – four decades, as the population ages. For example, the proportion population aged over 85 years is estimated to increase from six million in 2010 to 10 million by 2030 and 15 million by 2040.
Another positive factor is the stable occupancy of the company’s properties. Occupancy has increased from 80% in 2001 to 84% in 2011. A stable and growing occupancy percentage is a plus, and shows that management has maintained quality of new assets being acquired. The REIT will face a potential obstacle in 2018, when 19% of its leases expire.
The ten largest tenants account for 68% of revenues. Generally, I prefer that there isn’t a very high concentration of tenants, and 68.50% is in the top range of what I am willing to tolerate. All of the REIT’s properties are leased under 5 – 15 year lease terms, and are triple-net leases. The lease terms always have renewal options. Under a triple-net lease, the tenant pays net real estate taxes, building insurance and net common area maintenance, in addition for paying rent.
Omega Healthcare disclosed that a significant portion of its operators’ revenue is derived from governmentally-funded reimbursement programs, primarily Medicare and Medicaid. According to The Alliance for Quality Nursing Home Care, as of January 2013, approximately 70% of SNF residents depend upon Medicare and/or Medicaid funding for care. With the focus on cutting federal deficits, this could slow down growth in reimbursements.
Generally, debt is one item that could derail a real estate investment trust’s ability to pay distributions. With Omega Healthcare Investors, there isn’t a significant amount of debt to be paid over the next five years. In addition, the lower interest rates can afford the company to renew debt at lower rates or to utilize low current rates if it chooses to draw from its line of credit.
Currently, I find Omega Healthcare Investors to be attractively valued at 15.50 times FFO and yielding 5.70%.
Full Disclosure: Long OHI and DLR
Relevant Articles:
- Five Things to Look For in a Real Estate Investment Trust
- High Dividend Growth REITs: Digital Realty Trust (DLR)
- Realty Income (O) – The Monthly Dividend Company
- Three High Yielding Dividend Machines Boosting Distributions
One of the reasons why I have been hesitant to look at Omega Healthcare before, was the fact that the REIT cut distributions in 2000, and eliminated them for 2001 and 2002. The risk with a company that eliminates dividends once, is that the conditions might appear again, thus causing the firm to become a repeat dividend cut offender. In this article, I will review the operating performance over the past decade, and conclude on whether the company is a good addition to an investor’s portfolio.I will evaluate this REIT using the five criteria I use as outlined in an earlier article this week.
Since 2005, FFO has grown by 150%, while the dividend has doubled in the same period.
Over the past decade, dividends have grown from $0.72/share in 2004 to $1.69/share by 2012
I usually prefer a margin of safety in dividend payments. At 82%, the FFO Payout ratio is sustainable. A lower payout is always a plus, because it allows the company to absorb any short-term fluctuation in FFO, which lowers risk to dividend payments.
Future distribution growth would be driver by growth in investments that the company has been making over the past decade. Acquisitions of property have accelerated starting in 2009, with over $1.30 billion invested over the period. The REIT’s strategy is focused on pursuing selective investments in senior care facilities.
Skilled Nursing Facilities will be a growth industry for the next three – four decades, as the population ages. For example, the proportion population aged over 85 years is estimated to increase from six million in 2010 to 10 million by 2030 and 15 million by 2040.
Another positive factor is the stable occupancy of the company’s properties. Occupancy has increased from 80% in 2001 to 84% in 2011. A stable and growing occupancy percentage is a plus, and shows that management has maintained quality of new assets being acquired. The REIT will face a potential obstacle in 2018, when 19% of its leases expire.
The ten largest tenants account for 68% of revenues. Generally, I prefer that there isn’t a very high concentration of tenants, and 68.50% is in the top range of what I am willing to tolerate. All of the REIT’s properties are leased under 5 – 15 year lease terms, and are triple-net leases. The lease terms always have renewal options. Under a triple-net lease, the tenant pays net real estate taxes, building insurance and net common area maintenance, in addition for paying rent.
Generally, debt is one item that could derail a real estate investment trust’s ability to pay distributions. With Omega Healthcare Investors, there isn’t a significant amount of debt to be paid over the next five years. In addition, the lower interest rates can afford the company to renew debt at lower rates or to utilize low current rates if it chooses to draw from its line of credit.
Currently, I find Omega Healthcare Investors to be attractively valued at 15.50 times FFO and yielding 5.70%.
Full Disclosure: Long OHI and DLR
Relevant Articles:
- Five Things to Look For in a Real Estate Investment Trust
- High Dividend Growth REITs: Digital Realty Trust (DLR)
- Realty Income (O) – The Monthly Dividend Company
- Three High Yielding Dividend Machines Boosting Distributions
Wednesday, April 10, 2013
Does Fixed Income Allocation Make Sense for Dividend Investors Today?
Income portfolio diversification is important in order to maintain dependability to your dividend checks when the proverbial bad apple cuts or eliminates distributions. When a whole sector turns out to include an above average concentration of bad apples, which was the case with financials between 2007 and 2009, investors that had allocations to other sectors should have been able to maintain the level of their distributions consistent. They could have easily replaced any dividend cutters or eliminators into other promising and extremely undervalued dividend paying securities.
Diversification protects investors against certain risks. At some point however, no matter how many quality dividend growth stocks one holds in their income portfolio, they would not be properly positioned against other risks. One of the biggest risks that an economy can experience is the risk of deflation. Deflation is bad for corporate profits, and therefore is bad for dividend payments. The only assets that can maintain the level of income during a deflationary environment are Treasury Bonds.
In a previous article, I outlined the idea that dividend growth investors should have at least a 25% allocation to fixed income at the time of their retirement. I mentioned how an investor can simply use the proceeds from their income portfolio for the five years prior to retirement, in order to build this fixed income cushion. However, with interest rates near all-time lows, purchasing US Treasuries today seems like a recipe for disaster for those starting today. The most that investors in treasury bonds today can expect is a 2% - 3% annual return for the next ten, twenty, thirty years. This is barely enough to keep up with historical rates of inflation however. Some high quality stocks like McDonald's at 3.10% (MCD), Johnson & Johnson at 3% (JNJ) and Phillip Morris International at 3.70% (PM) yield much more than US treasuries today. In addition, their distributions are much more likely to increase over the next 20 - 30 years. The investor who started purchasing bonds two or three years ago however could have seen better rates in the 4% – 5% range for Treasuries and Agencies.
Risk is that we get deflation over the next decade, which can hurt corporate profitability. As governments around the world have been pumping out liquidity for almost five years now, it is difficult to forecast any other scenario than rampant inflation over the next five to ten years. However, the fears of rampant inflation have been going on over the past five years, and yet these might be over-hyped. Japan has had record low interest rates for almost 20 years, coupled with poor stock market returns. The country has been taking on debt to prop up local demand, without really resulting in anything other than deflation. Investors in Japanese bonds did much better than investors in stocks or real estate over the past twenty years.
During the Great Depression, plenty of companies cut dividends as their revenues and net incomes were hurt by the contraction in demand for their products and services. Losses in nominal dividend income ranged anywhere between 50% for the S&P 500 to 75% for the companies in the Dow Jones Industrial index. Investors in US Treasuries however managed to receive a stable stream of income.
I did my first investment in US Treasuries in 2010, but the rising prices made me sell for hefty profits. Since then, my allocation to fixed income has decreased to approximately 3%, and continues dropping as I allocate new funds exclusively to dividend stocks. I preferred to purchase individual bonds, rather than bond funds, and then ladder them by maturity. I am not a fan of corporate bonds, because I believe that I am not properly compensated for the risk of default due to a soft economy. As a result I am much better off in the company stock than the bond. I am not a big fan of bond funds, because I have no guarantee that they would be holding bonds to maturity. In a rising interest rate environment, bond funds that sell existing low yielding bonds and purchase higher yielding new bonds in order to maintain their maturities could end up losing money for investors. If I hold my bonds to maturity, at least I will get my principle back, albeit with a lower purchasing power. I also avoid municipal bonds, because they have a risk of default.
As I near the five year bond accumulation period prior to the potential financial independence point, I am not seeing much value in Treasuries today. That leaves my portfolio wildly exposed to the risk of deflation. I might end up simply laddering bonds and concentrate on US Agencies like Fannie Mae and Freddie Mac with duration that is less than 10 years. However, I highly doubt that a 25% allocation to fixed income makes sense in the current environment. The most I see putting is probably two years’ worth of expenses in short-term laddered fixed income securities with an average maturity of five years. That could work to anywhere between 6% - 8% of my total portfolio.
Full Disclosure: Long MCD, PM, JNJ
Relevant Articles:
- Fixed Income for dividend investors
- The Hyperinflation Scam
- Dividend Investing Goals for 2013
- Why dividend investing beats US Treasuries today?
Diversification protects investors against certain risks. At some point however, no matter how many quality dividend growth stocks one holds in their income portfolio, they would not be properly positioned against other risks. One of the biggest risks that an economy can experience is the risk of deflation. Deflation is bad for corporate profits, and therefore is bad for dividend payments. The only assets that can maintain the level of income during a deflationary environment are Treasury Bonds.
In a previous article, I outlined the idea that dividend growth investors should have at least a 25% allocation to fixed income at the time of their retirement. I mentioned how an investor can simply use the proceeds from their income portfolio for the five years prior to retirement, in order to build this fixed income cushion. However, with interest rates near all-time lows, purchasing US Treasuries today seems like a recipe for disaster for those starting today. The most that investors in treasury bonds today can expect is a 2% - 3% annual return for the next ten, twenty, thirty years. This is barely enough to keep up with historical rates of inflation however. Some high quality stocks like McDonald's at 3.10% (MCD), Johnson & Johnson at 3% (JNJ) and Phillip Morris International at 3.70% (PM) yield much more than US treasuries today. In addition, their distributions are much more likely to increase over the next 20 - 30 years. The investor who started purchasing bonds two or three years ago however could have seen better rates in the 4% – 5% range for Treasuries and Agencies.
Risk is that we get deflation over the next decade, which can hurt corporate profitability. As governments around the world have been pumping out liquidity for almost five years now, it is difficult to forecast any other scenario than rampant inflation over the next five to ten years. However, the fears of rampant inflation have been going on over the past five years, and yet these might be over-hyped. Japan has had record low interest rates for almost 20 years, coupled with poor stock market returns. The country has been taking on debt to prop up local demand, without really resulting in anything other than deflation. Investors in Japanese bonds did much better than investors in stocks or real estate over the past twenty years.
During the Great Depression, plenty of companies cut dividends as their revenues and net incomes were hurt by the contraction in demand for their products and services. Losses in nominal dividend income ranged anywhere between 50% for the S&P 500 to 75% for the companies in the Dow Jones Industrial index. Investors in US Treasuries however managed to receive a stable stream of income.
I did my first investment in US Treasuries in 2010, but the rising prices made me sell for hefty profits. Since then, my allocation to fixed income has decreased to approximately 3%, and continues dropping as I allocate new funds exclusively to dividend stocks. I preferred to purchase individual bonds, rather than bond funds, and then ladder them by maturity. I am not a fan of corporate bonds, because I believe that I am not properly compensated for the risk of default due to a soft economy. As a result I am much better off in the company stock than the bond. I am not a big fan of bond funds, because I have no guarantee that they would be holding bonds to maturity. In a rising interest rate environment, bond funds that sell existing low yielding bonds and purchase higher yielding new bonds in order to maintain their maturities could end up losing money for investors. If I hold my bonds to maturity, at least I will get my principle back, albeit with a lower purchasing power. I also avoid municipal bonds, because they have a risk of default.
As I near the five year bond accumulation period prior to the potential financial independence point, I am not seeing much value in Treasuries today. That leaves my portfolio wildly exposed to the risk of deflation. I might end up simply laddering bonds and concentrate on US Agencies like Fannie Mae and Freddie Mac with duration that is less than 10 years. However, I highly doubt that a 25% allocation to fixed income makes sense in the current environment. The most I see putting is probably two years’ worth of expenses in short-term laddered fixed income securities with an average maturity of five years. That could work to anywhere between 6% - 8% of my total portfolio.
Full Disclosure: Long MCD, PM, JNJ
Relevant Articles:
- Fixed Income for dividend investors
- The Hyperinflation Scam
- Dividend Investing Goals for 2013
- Why dividend investing beats US Treasuries today?
Monday, April 8, 2013
Six Things to Look For in a Real Estate Investment Trust (REIT)
Real estate investment trusts (REITS) represent a unique opportunity for dividend growth investors. They provide exposure to real estate, without the hassle of direct ownership. REITs are structured as trusts for tax reasons, and as a result, they do not pay federal income taxes at the entity level. The dividends they pay to shareholders are typically treated as ordinary income, and do not qualify for the preferential rate on qualified dividends. However, because income is taxed only at the shareholder level, there is more money for distributions to shareholders. In addition, a portion of your typical REIT distributions is non-taxable and it is treated as return of capital for tax purposes. This decreases shareholder's basis in the stock. The return of capital portion is caused by depreciation expense. By law, Real Estate Investment Trusts have to distribute at least 90% of income to shareholders, in order to maintain their preferential tax status.
There are five factors I analyze at a REIT, before putting my money to work in the sector. I used three REITs I own in this exercise - Realty Income (O), Digital Realty Trust (DLR) and Omega Healthcare Investors (OHI):
Funds from Operations (FFO)
Earnings per share are not an adequate way to look at REITs. Instead, analysts use Funds from Operations (FFO). FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. I like to look at the trends in Funds from Operations per share over the past five or ten years, in order to see if there is any fuel for dividend growth. The slow growth in FFO led me to sell my position in Universal Healthcare Realty Trust (UHT) in March.
I usually prefer to see growth in FFO/share over the past five and ten years. REITs are pass-through entities, which means they return almost all of their free cashflow to shareholders. As a result, they sell shares and bonds each year in order to fund their expansion projects. These projects usually cause an increase in total revenues and FFO, but because of the dilution to existing shareholders, I want to see growth in FFO/share. This shows me that new projects are accretive to the FFO for all the shareholders. In the table below, I have placed the trends in FFO/share for three REITs I own:
FFO Payout
For REITs, I use FFO Payout Ratio, which is calculated by dividing the dividend payment over the FFO/share. I usually prefer to see a REIT whose payout ratio is below 90%. While REIT revenues are typically stable, I want to have some margin of safety in the form of a lower FFO Payout Ratio. Ideally, it would be flat or trending down over time. An FFO ratio above 90% couple with slow growth in FFO/share could jeopardize distribution growth. In the table below, I have summarized the FFO payout trends in three REITs I own:
Occupancy and Tenant Diversification
Diversification is an important thing to have in any portfolio, as it offers some level of protection to the company when something unexpected happens. I usually scan through the list of top tenants, and make sure that they do not account for an extremely large portion of revenues. I define extremely large as somewhere above the range of 50% - 66% of revenues. In addition, I also want to see stable and hopefully growing occupancy percentages over time. The occupancy ratios vary somewhat for different REITs. For example, Realty Income has an occupancy ratio of 97%, Digital Realty Trust has an occupancy of almost 94%, whereas Omega Healthcare Investors has an occupancy rate of 84%. The top ten tenants account for 64% of Omega Healthcare Investors revenues, but 35% for Digital Realty's revenues. The top ten tenants of Realty Income account for 37% of revenues.
Plans for growth
The fuel behind future distributions growth is growth in FFO/share. The growth in FFO/share is one of the factors that will determine whether distributions grow above the rate of inflation, stay flat or even worse - get cut or eliminated. I usually like to see a company that can manage to deploy capital raised in the public markets into projects that have attractive rates of return, have signed long-term leases and have escalation clauses that would allow them to charge higher rents over time. In terms of growth, Digital Realty Trust, Omega Healthcare and Realty Income all rely on strategic acquisitions of quality properties. Realty Income went one step further in 2012, when in completed the acquisition of American Realty Capital Trust. As a result, it was able to boost monthly distributions by 19.20%.
Debt, Cost of Capital and Risks
Understanding leverage is an important part of understanding REITs and risks behind REITs. Most Real Estate Investment Trusts pay for new projects either by issuing stock or issuing debt. If they issue too much debt and the projects do not work out as expected, the interest costs might eat into the profit. If it is difficult to renew the debt, or it gets more expensive, this could eat into the profit as well. This is why it is important to review the maturity schedules for the REITs you are interested in analyzing. Currently, issuing debt is very cheap, which should bode well for various projects. When the debt has to be refinanced in ten years however, it would likely cost much more to renew it. Realty Income, Digital Realty Trust and Omega Healthcare Investors do not seem to have problem accessing capital markets, nor do they have steep amounts of debt maturing soon. Omega Healthcare sold 12 year bonds in 2012 at 5.875%, while Realty Income managed to sell $450 million notes maturing in 10 years at 3.25%. Realty Income also sold 5 year notes, which yielded 2%. Digital Realty Trust sold 12 year, 400 million British Pound notes at 4.25%. Digital Realty, also managed to sell 300 million in ten year notes at 3.625%.
Dividend Growth
The table below shows the dividend growth for Realty Income, Digital Realty Trust and Omega Healthcare Investors.
I prefer to look for consistent dividend growth over time. A long streak of dividend increases for at least ten years is important. A company that manages to maximize existing investment opportunities for the benefit of growing distributions to shareholders is the right company for my money. Although dividend cuts in the past cause a red flag, if the company has managed to build a ten year streak of dividend increases, and has FFO growth coupled with adequate levels of debt, I would take a chance on it.
Relevant Articles:
- High Dividend Growth REITs: Digital Realty Trust (DLR)
- Realty Income (O) – The Monthly Dividend Company
- Three High Yielding Dividend Machines Boosting Distributions
- Four High Yield REITs for current income
- National Retail Properties (NNN) Dividend Stock Analysis
- Spring Cleaning My Income Portfolio, Part II
Thursday, April 4, 2013
High Dividend Growth REITs: Digital Realty Trust (DLR)
Digital Realty Trust, Inc. (DLR), a real estate investment trust (REIT), through its controlling interest in Digital Realty Trust, L.P., engages in the ownership, acquisition, development, redevelopment, and management of technology-related real estate. It focuses on strategically located properties containing applications and operations critical to the day-to-day operations of technology industry tenants and corporate enterprise data center users, including the information technology departments of Fortune 1000 companies, and financial services companies. I recently initiated a position in Digital Realty Trust, after selling my position in United Healthcare Realty Trust (UHT).
Digital Realty Trust went public in 2004 and has been increasing dividends for eight consecutive years. In less than two years, the company will be able to join the list of dividend achievers.
The company’s top ten tenants account for 35% of revenues. The largest tenant is CenturyLink (CTL), at 9%. Tenant diversification is important; in order to reduce the impact on revenues if they broke the lease and the property had to be leased to a new prospective client. The REIT has an average original lease term of 13.60 years, and usually has an annual 2.50% - 3% cash rent increase on existing leases. Furthermore tenants are usually the ones responsible for power costs.
The industries that Digital Realty serves include IT and Telecom Providers, as well as Financial and Corporate Service. In addition, this real estate investment trust also derives a good amount of revenues from European and Asia-Pacific operations, which together account for 21% of rents.
Approximately 39% of gross rent is under Triple Net Leases, where the tenant spends a considerable amount of capital in data center infrastructure. This reduces the risk of breaking the lease by the customer. The beauty of triple net leases is that the tenant is the one who maintains the building.
Approximately half of the revenues are derived from modified gross leases, where the REIT makes the capital investment in infrastructure. These offer a fully commissioned, flexible data center solution with dedicated electrical and mechanical infrastructure. Given the fact that technology changes fast, the risk with this revenue stream is that the company might have to make substantial capital investment to meet the power and cooling requirements of today’s advanced data centers, or may no longer be suitable for this use.
One key metric for real estate investment trusts is their occupancy ratio. An asset that is not leased is not generating any money and is costing capital and maintenance. Generally, it is important that companies are as close to maximum occupancy as possible. Digital Realty has managed to maintain occupancy between 94 and 95% over the past five years, which is impressive because it made a large amount of property acquisitions over the period, without sacrificing quality. In addition, the company has been able to renew 82% to 90% of leases that expired in 2012.
Since 2009 however, cap rates have been declining and are reaching 7.60%, which is still not bad. If the company makes large acquisitions at decreasing cap rates however, future growth might not be as robust. However, with record low interest rates, the company has been able to tap debt markets at 3.625% to 4.25% for 10 and 12 year notes.
Digital Realty Trust has managed to increase FFO from $1.37/share in 2005 to $4.46/share by 2012.
At the same time, distributions have grown from $1/share in 2005 to $2.92 in 2012.
The company’s policy is to pay at least 100% of taxable income but no more than 90% of FFO. I find that there is adequate margin of safety in distributions, as seen through the trends in the FFO/payout ratio.
Future FFO growth would be fueled by acquisitions made at attractive cap rates, while maintaining portfolio occupancy levels. The trust tends to obtain capital mostly through common share offerings. The low interest rates could offer a cheaper way to obtain capital for further expansion, that could be more beneficial to current shareholders. Given the current conservative capital structure, I see room for increasing leverage at fixed rates.
Currently I find Digital Realty Trust to be attractively priced an 15 times FFO and yielding a very safe 4.70%.
Full Disclosure: Long DLR
Relevant Articles:
- Spring Cleaning My Income Portfolio, Part II
- Margin of Safety in Dividends
- Four High Yield REITs for current income
- National Retail Properties (NNN) Dividend Stock Analysis
- Dividend Achievers Offer Income Growth and Capital Appreciation Potential
Digital Realty Trust went public in 2004 and has been increasing dividends for eight consecutive years. In less than two years, the company will be able to join the list of dividend achievers.
The company’s top ten tenants account for 35% of revenues. The largest tenant is CenturyLink (CTL), at 9%. Tenant diversification is important; in order to reduce the impact on revenues if they broke the lease and the property had to be leased to a new prospective client. The REIT has an average original lease term of 13.60 years, and usually has an annual 2.50% - 3% cash rent increase on existing leases. Furthermore tenants are usually the ones responsible for power costs.
The industries that Digital Realty serves include IT and Telecom Providers, as well as Financial and Corporate Service. In addition, this real estate investment trust also derives a good amount of revenues from European and Asia-Pacific operations, which together account for 21% of rents.
Approximately 39% of gross rent is under Triple Net Leases, where the tenant spends a considerable amount of capital in data center infrastructure. This reduces the risk of breaking the lease by the customer. The beauty of triple net leases is that the tenant is the one who maintains the building.
Approximately half of the revenues are derived from modified gross leases, where the REIT makes the capital investment in infrastructure. These offer a fully commissioned, flexible data center solution with dedicated electrical and mechanical infrastructure. Given the fact that technology changes fast, the risk with this revenue stream is that the company might have to make substantial capital investment to meet the power and cooling requirements of today’s advanced data centers, or may no longer be suitable for this use.
One key metric for real estate investment trusts is their occupancy ratio. An asset that is not leased is not generating any money and is costing capital and maintenance. Generally, it is important that companies are as close to maximum occupancy as possible. Digital Realty has managed to maintain occupancy between 94 and 95% over the past five years, which is impressive because it made a large amount of property acquisitions over the period, without sacrificing quality. In addition, the company has been able to renew 82% to 90% of leases that expired in 2012.
Since 2009 however, cap rates have been declining and are reaching 7.60%, which is still not bad. If the company makes large acquisitions at decreasing cap rates however, future growth might not be as robust. However, with record low interest rates, the company has been able to tap debt markets at 3.625% to 4.25% for 10 and 12 year notes.
Digital Realty Trust has managed to increase FFO from $1.37/share in 2005 to $4.46/share by 2012.
At the same time, distributions have grown from $1/share in 2005 to $2.92 in 2012.
The company’s policy is to pay at least 100% of taxable income but no more than 90% of FFO. I find that there is adequate margin of safety in distributions, as seen through the trends in the FFO/payout ratio.
Future FFO growth would be fueled by acquisitions made at attractive cap rates, while maintaining portfolio occupancy levels. The trust tends to obtain capital mostly through common share offerings. The low interest rates could offer a cheaper way to obtain capital for further expansion, that could be more beneficial to current shareholders. Given the current conservative capital structure, I see room for increasing leverage at fixed rates.
Currently I find Digital Realty Trust to be attractively priced an 15 times FFO and yielding a very safe 4.70%.
Full Disclosure: Long DLR
Relevant Articles:
- Spring Cleaning My Income Portfolio, Part II
- Margin of Safety in Dividends
- Four High Yield REITs for current income
- National Retail Properties (NNN) Dividend Stock Analysis
- Dividend Achievers Offer Income Growth and Capital Appreciation Potential
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