Back in early 2008, I was getting started building my dividend portfolio. At this time, I made a prediction about the next bubble in the making. Now, I seldom make predictions, as I believe that noone can predict the future accurately with any consistency. Rather, this was more of a post in wishful thinking. In this article, I had described how the need for a growing stream of income, will likely cause investors to focus on dividend paying stocks. This is because a lot of retirees need income in their golden years, that also increases over time to protect the purchasing power of their dollars.
It also makes a lot more sense to focus on the income you need to pay for your retirement needs, rather than focus on a total dollar amount of assets. This is because by focusing on income, you are getting something to pay for your retirement, and gaining capital gains as an afterthought. Using the traditional approaches to retirement, you are focusing your energies on creating a huge pile of cash first, and then worrying how to use it to pay for your retirement later. The second process just seems so inefficient and backwards as a retirement planning tool. It also exposes the success of your retirement on fluctuations in stock prices, which are often irrationally set by Mr. Market.
I have no way of predicting what the next five, ten or thirty years would look like. However, I know for sure that at some point, there will be a difficult time for dividend investors. From the limited knowledge I have in 2013, I can predict that taxes on dividend income could be increased even for ordinary people earning more than say $43,000/year. I would also not be surprised if we get a few severe bear markets, where quoted prices of dividend paying stocks drop by 30 – 40% or so, and remain there for a relatively long period of time. In addition, if interest rates increase dramatically from here, and you have a situation where 10 year US treasuries yield 8 – 10%, prices of many dividend paying stocks are going to reflect that. For example, there was a time in the 1970s and early 1980s, where some consumer staple companies had managed to increase earnings, and raise dividends, yet their stock prices were either low or declining for a few years. While dividend incomes were increasing above the rates of inflation, investors were dumping their relatively lower yielding shares for Treasuries yielding 12 – 15%. Today it would sound stupid to sell Procter & Gamble (PG) or Coca-Cola (KO) that yield 4% - 6%, but in a double digit risk free interest rates environment, it wouldn't be unheard of for some investors.
That being said, I wouldn't be surprised if the next five years are not as good as the last five years for share prices of dividend stocks. It is likely that stock prices on many overextended dividend stocks would stop increasing, and would be relatively flat over the next five years. The pundits who are in the anti-dividend camp would probably be exhilarated. As a long term dividend investor in the accumulation stage, I am actually hoping that dividend stocks become hated by everyone. This would mean that I would be able to buy future dividend income at bargain prices. Therefore my investment dollars would provide me with a higher benefit.
The goal of this exercise is not to scare you, and make you think that dividend investing is a flawed strategy. In reality, no single investment strategy works ALL the TIME! Even shares of Buffett’s Berkshire Hathaway had difficult times in the early 1970s and again in the late 1990’s. However, what truly matters is to stick to your strategy through thick and thin, and not abandon ship at the worst time possible.
The goal is to also get you thinking about probabilities, and how you can protect your golden goose, so that it keeps laying its golden eggs every 90 days for you on average. You need to be able to mitigate your risks somehow. Otherwise, if you panic, you might undo the positive compounding effects on your portfolio from previous years. By understanding potential risks and devising a plan to mitigate them, you should be able to do well next time you hear about the end of dividend investing. You will also be prepared to be calm next time stock prices fall by 40% - 50%. If you also manage to buy shares at depressed prices, when it seems like the world is coming to an end, that would be a tough but ultimately rewarding action to take.
For example, if you are already fully invested, and just live off the dividends generated by your portfolio, you should understand that stock market fluctuations are not hurting you at all. As long as the business fundamentals of the companies you own are sound, they will be able to pay and raise dividends for you, even if their stock prices are down by 40 – 50%. This is because stock prices for most quality companies that generate solid earnings always come back up, helped by bargain hunters who identify the value of dividends and earnings.
In a second example, if interest rates increase dramatically to say over 6%, and your portfolio is yielding say only 4%, there is no room for concern as long as the business fundamentals of your holdings are still sound on aggregate. You should not be worried, because your portfolio will generate a growing stream of income to compensate you for the faster increase in inflation. Therefore, if your portfolio is worth $500,000 and generates $20,000 in annual dividend income to cover all of your expenses, rising interest rates should not mean anything to you. It is true that you can sell your dividend stocks, and earn $30,000 in annual interest income. However, this stream of income will be certain to lose purchasing power in the inflationary world that produces yields of 6%. In addition, if rates increase further to say 8%, your bonds yielding 6% would surely lose value and you would still only earn 6% on your cost. However, if you didn't do anything in the first place other than hold on to your sound businesses, your dividend portfolio would have likely delivered the growing stream of income that would have ensured purchasing power even as interest rates kept increasing.
A third way to mitigate certain risks is through diversification. Diversification gets a lot of bad rep, but it could protect your assets in the case things take an unexpected turn of events. Let’s face it, no one can predict the future. Therefore, even if you know everything there is about a company, you can still lose money on this investment if an unexpected turn of events occurs. If you hold less than 10 - 15 individual dividend paying stocks in your portfolio, you are likely asking for trouble. This is because just a bad apple or two could seriously derail your dividend earning potential for a few years, thus potentially causing you to dip into principal. You should also try not to concentrate your portfolio in companies that are in similar industries. If you owned ten oil and gas companies, and five pipeline MLPs, you are not diversified adequately. Many investors have been betting heavily on major energy companies in 2013, but they might be ignoring the fact that they have no pricing power. If commodity prices drop, those earnings could cause dividend freezes across the board. In addition, having a slight 20-25% allocation of US Government bonds could help you avoid losing sleep in case deflation happens. Unfortunately, since 2010 it has been difficult to get decent returns with Treasuries and Agencies in terms of yields.
During any of the scenarios above, and probably others that I cannot even conceivably forecast today, you would likely get a pretty negative sentiment towards dividend investing. This is actually fine, because as a true contrarian investor, you should be happy when everyone hates your strategy. This is because when the fans of your investment style are few, security prices are usually lower as there is less competition from others. So, anytime you hear about the death of dividend investing, rejoice a little. This is because lower entry prices for the quality companies we discuss on this site would translate into better entry yields for you. This could potentially help you reach your financial goals much sooner.
In conclusion, dividend investors can expect some temporary short-term discomfort when holding dividend paying stocks, due to some of the reasons above. However if the dividend investor did their homework in stock selection and bought shares at reasonable prices, they can afford to simply sit down and watch their capital compound over time. This is because on aggregate, their portfolio of quality businesses will keep earning more, and showering him or her with more cash each year. This rising stream of dividend payments coming to his bank or brokerage account will provide this investor with the strength to keep holding, even during the most turbulent times.
Full Disclosure: Long PG and KO
Relevant Articles:
- Complete List of Articles on Dividend Growth Investor
- The Four Percent Rule is Dependent on Dividend Yields
- Four Percent Rule for Dividend Investing in Retirement
- Living off dividends in retirement
- Dividend Investing Works in All Markets
Tuesday, December 31, 2013
Monday, December 30, 2013
Dividends Offer an Instant Rebate on Your Purchase Price
Imagine that you had the foresight to put $25,000 to work in Realty Income (O) in December 2004, after it became a dividend achiever. Over the next decade, the company keeps expanding, and grows the monthly dividend payments to its loyal shareholders from $0.109375/share to $0.1821667/share. As a result, you collect $15,000 in dividends over the next ten years. You have a few choices to deal with that cash:
A. Reinvest it back into Realty Income Stock
B. Reinvest it into another income generating stock
C. Save it in the bank for a rainy day
D. Spend it
Now, if Realty Income went bankrupt tomorrow (absolute worst case scenario), you would still have something of value, if you chose options B and C. Under all scenarios however, the dividends you received from the asset covered a large portion of the price you paid. This shows that a company that pays you a growing dividend over time, fueled by the improving business fundamentals, and purchased at attractive valuation, can pay for itself in less than a couple of decades.
In essence, the dividend checks you receive every month or quarter or year, act as a sort of rebate, that essentially reduces the amount you have invested and have put at risk. Therefore, if you bought Realty Income at a split-adjusted $25/share in December 2004, and you manage to collect $25 in dividends over the next 10 – 15 years, you have essentially recovered your whole total investment. However, in the case of a Realty Income investment in 2004, you would still own your stock and you would have a higher claim on dividend checks, simply because the future is more than ten years long. Even if Realty Income never pays more than $2/share for the next 40 years, you would make several times your initial investment amount. Therefore, your risk was only $25, and was limited. But your reward was unlimited.
It is also important to not forget that a $1 today is worth more than a $1 from 2033, due to the eroding power of inflation. However, if that dividend at least keeps up with inflation or is reinvested in other income producing assets, chances are that each dollar would multiply exponentially over time.
For example, if you purchased shares of Eastman Kodak in 1983 for $1000, and you used the dividend checks to put in the bank or invest in other companies, you would be ahead of the game. This is because you would have collected dividends for 25 years in a row, and would have been able to put this money to work for you. The stock traded at a split-adjusted $33.83/share in 1983, but paid a total of $37.28 in dividends for every share through 2008. In addition, you received shares in Eastman Chemical (EMN) in 1994, due to a spin-off from Kodak.
The important thing to take away from this exercise is that you should not merely focus on stock prices themselves, as they do not show the whole picture of your investment returns. Even if the stock you hold drops by 50% after purchase and stays there, or even if the stock price fluctuates manically each year, you should not care, as long as you keep collecting those dividend checks.
I usually accumulate all my dividend checks in cash, and add them to the contributions I make to my dividend portfolio. After that, I allocate the cash in the best valued quality dividend stocks I could find at the moment. So far I have always been able to find something to put my money in, but if I was short of ideas, I would simply keep the money in cash.
Full Disclosure: Long O
Relevant Articles:
- Realty Income (O) – The Monthly Dividend Company
- Realty Income (O) Raises Dividends by a Record 19.20%
- Five Free Dividend Stocks
- Why would I not sell dividend stocks even after a 1000% gain?
- Reinvest Dividends Selectively
A. Reinvest it back into Realty Income Stock
B. Reinvest it into another income generating stock
C. Save it in the bank for a rainy day
D. Spend it
Now, if Realty Income went bankrupt tomorrow (absolute worst case scenario), you would still have something of value, if you chose options B and C. Under all scenarios however, the dividends you received from the asset covered a large portion of the price you paid. This shows that a company that pays you a growing dividend over time, fueled by the improving business fundamentals, and purchased at attractive valuation, can pay for itself in less than a couple of decades.
In essence, the dividend checks you receive every month or quarter or year, act as a sort of rebate, that essentially reduces the amount you have invested and have put at risk. Therefore, if you bought Realty Income at a split-adjusted $25/share in December 2004, and you manage to collect $25 in dividends over the next 10 – 15 years, you have essentially recovered your whole total investment. However, in the case of a Realty Income investment in 2004, you would still own your stock and you would have a higher claim on dividend checks, simply because the future is more than ten years long. Even if Realty Income never pays more than $2/share for the next 40 years, you would make several times your initial investment amount. Therefore, your risk was only $25, and was limited. But your reward was unlimited.
It is also important to not forget that a $1 today is worth more than a $1 from 2033, due to the eroding power of inflation. However, if that dividend at least keeps up with inflation or is reinvested in other income producing assets, chances are that each dollar would multiply exponentially over time.
For example, if you purchased shares of Eastman Kodak in 1983 for $1000, and you used the dividend checks to put in the bank or invest in other companies, you would be ahead of the game. This is because you would have collected dividends for 25 years in a row, and would have been able to put this money to work for you. The stock traded at a split-adjusted $33.83/share in 1983, but paid a total of $37.28 in dividends for every share through 2008. In addition, you received shares in Eastman Chemical (EMN) in 1994, due to a spin-off from Kodak.
The important thing to take away from this exercise is that you should not merely focus on stock prices themselves, as they do not show the whole picture of your investment returns. Even if the stock you hold drops by 50% after purchase and stays there, or even if the stock price fluctuates manically each year, you should not care, as long as you keep collecting those dividend checks.
I usually accumulate all my dividend checks in cash, and add them to the contributions I make to my dividend portfolio. After that, I allocate the cash in the best valued quality dividend stocks I could find at the moment. So far I have always been able to find something to put my money in, but if I was short of ideas, I would simply keep the money in cash.
Full Disclosure: Long O
Relevant Articles:
- Realty Income (O) – The Monthly Dividend Company
- Realty Income (O) Raises Dividends by a Record 19.20%
- Five Free Dividend Stocks
- Why would I not sell dividend stocks even after a 1000% gain?
- Reinvest Dividends Selectively
Friday, December 27, 2013
Kimberly Clark (KMB) Dividend Stock Analysis
Kimberly-Clark Corporation, together with its subsidiaries, manufactures and markets personal care, consumer tissue, and health care products worldwide. The company operates in four segments: Personal Care, Consumer Tissue, K-C Professional, and Health Care. This dividend champion has paid dividends since 1935 and has increased them for 41 years in a row.
The company’s last dividend increase was in February 2013 when the Board of Directors approved a 9.50% increase in the quarterly annual dividend to 81 cents /share. The company’s peer group includes Procter & Gamble (PG), Colgate-Palmolive (CL), and Clorox (CLX).
Over the past decade this dividend growth stock has delivered an annualized total return of 11.20% to its shareholders.
The company has managed to deliver a 3.20% average increase in annual EPS over the past decade. Kimberly-Clark is expected to earn $5.72 per share in 2013 and $6.10 per share in 2014. In comparison, the company earned $4.42/share in 2012.
The company has maintained a very consistent stock buyback program over the past year. Between 2003 and 2013, the number of shares decreased from 509 million to 386 million.
Kimberly-Clark has focused on increasing market share through product innovation and increased marketing. The company has worked closely in streamlining operations in the sluggish North American market, eliminating positions and closing several facilities under its FORCE plan. Kimberly-Clark plans on realizing $400 – 500 million in annual cost savings through 2013 with its FORCE plan to streamline operations and focus on best practices.
Commodity prices could be detrimental to total costs at the company, as is the competitive nature of developed markets in which Kimberly-Clark does business. As with other consumer products companies, the growth is likely to come from developing and emerging markets, rather than developed markets. Developed markets could benefit from cost cutting and efficiency profits, which would decrease the total price of doing business. Under the company’s global business plan, announced in 2003, it is looking for annual sales growth in the 3%-5% range, EPS growth in the mid to high single digits and dividend increases in line with earnings growth. For more on the global business plan, check this document.
The company recently announced its intention to spin-off its healthcare business. Existing Kimberly-Clark shareholders will receive shares in the K-C Healthcare unit through a tax-free distribution. The K-C healthcare unit had $1.6 billion in annual sales in 2012, and $229 million in operating income. It accounted for approximately 8.50% of Kimberly-Clark’s operating income in 2013. If approved by the board, this transaction could close by the third quarter of 2014.
Kimberly-Clark has maintained a high level of returns on equity over the past decade. The indicator never fell below 25% during our study period. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 9.50% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 9% growth in distributions translates into the dividend payment doubling every eight years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the mid-single digits.
The dividend payout ratio has increased from 41% in 2003 to almost 67% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 57%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Kimberly-Clark is attractively valued at 18.40 times estimated 2013 earnings, yields 3% and has a sustainable distribution. However, if you manage to find a company with low P/E, and/or higher expected growth, you might want to purchase the shares of the other company. This assumes comparable yields, and dividend sustainability. I almost bought some Kimberly-Clark for my Roth IRA in early October at 16 times forward earnings, but unfortunately the shares took off before I had the cash to invest. While the company's business is pretty consistent, I would look for lower entry valuations before adding to my position there.
Full Disclosure: Long KMB, PG, CLX, CL
Relevant Articles:
- Dividends versus Share Buybacks/Stock repurchases
- S&P Dividend Aristocrats Index – An Incomplete List for Dividend Investors
- Three stages of dividend growth
- Not all P/E ratios are created equal
- Six Exciting Dividend Increases for Long-Term Income Investors
The company’s last dividend increase was in February 2013 when the Board of Directors approved a 9.50% increase in the quarterly annual dividend to 81 cents /share. The company’s peer group includes Procter & Gamble (PG), Colgate-Palmolive (CL), and Clorox (CLX).
Over the past decade this dividend growth stock has delivered an annualized total return of 11.20% to its shareholders.
The company has managed to deliver a 3.20% average increase in annual EPS over the past decade. Kimberly-Clark is expected to earn $5.72 per share in 2013 and $6.10 per share in 2014. In comparison, the company earned $4.42/share in 2012.
The company has maintained a very consistent stock buyback program over the past year. Between 2003 and 2013, the number of shares decreased from 509 million to 386 million.
Kimberly-Clark has focused on increasing market share through product innovation and increased marketing. The company has worked closely in streamlining operations in the sluggish North American market, eliminating positions and closing several facilities under its FORCE plan. Kimberly-Clark plans on realizing $400 – 500 million in annual cost savings through 2013 with its FORCE plan to streamline operations and focus on best practices.
Commodity prices could be detrimental to total costs at the company, as is the competitive nature of developed markets in which Kimberly-Clark does business. As with other consumer products companies, the growth is likely to come from developing and emerging markets, rather than developed markets. Developed markets could benefit from cost cutting and efficiency profits, which would decrease the total price of doing business. Under the company’s global business plan, announced in 2003, it is looking for annual sales growth in the 3%-5% range, EPS growth in the mid to high single digits and dividend increases in line with earnings growth. For more on the global business plan, check this document.
The company recently announced its intention to spin-off its healthcare business. Existing Kimberly-Clark shareholders will receive shares in the K-C Healthcare unit through a tax-free distribution. The K-C healthcare unit had $1.6 billion in annual sales in 2012, and $229 million in operating income. It accounted for approximately 8.50% of Kimberly-Clark’s operating income in 2013. If approved by the board, this transaction could close by the third quarter of 2014.
Kimberly-Clark has maintained a high level of returns on equity over the past decade. The indicator never fell below 25% during our study period. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 9.50% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 9% growth in distributions translates into the dividend payment doubling every eight years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the mid-single digits.
The dividend payout ratio has increased from 41% in 2003 to almost 67% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 57%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Kimberly-Clark is attractively valued at 18.40 times estimated 2013 earnings, yields 3% and has a sustainable distribution. However, if you manage to find a company with low P/E, and/or higher expected growth, you might want to purchase the shares of the other company. This assumes comparable yields, and dividend sustainability. I almost bought some Kimberly-Clark for my Roth IRA in early October at 16 times forward earnings, but unfortunately the shares took off before I had the cash to invest. While the company's business is pretty consistent, I would look for lower entry valuations before adding to my position there.
Full Disclosure: Long KMB, PG, CLX, CL
Relevant Articles:
- Dividends versus Share Buybacks/Stock repurchases
- S&P Dividend Aristocrats Index – An Incomplete List for Dividend Investors
- Three stages of dividend growth
- Not all P/E ratios are created equal
- Six Exciting Dividend Increases for Long-Term Income Investors
Monday, December 23, 2013
Seven dividend companies bringing holiday joy to shareholders
The goal of every dividend investor is to generate a rising stream of sustainable dividend income. The growth in dividends protects the purchasing power of the income, and further turbochargers the compounding process in the accumulation phase. Not all dividend increases are created equal however, as they vary depending on size and sustainability. It is important to focus on growing income, but it is also important to focus on those companies that can sustainably pay distributions out of their growing earnings. Without growth in earnings, future dividend growth would eventually hit a ceiling. In addition, dividend investors should also refuse to purchase the rights to the future stream of dividends at any price.
If the investor manages to purchase quality dividend growth companies at fair prices after analyzing them individually, and puts them in a diversified income portfolio that is monitored regularly, they would greatly increase their odds of achieving their goals. Dividend stocks would therefore be the gift that keeps on giving for this investor, showering him with cash for years to come.
Over the past week, several dividend payers approved higher distributions for shareholders:
AT&T Inc. (T) provides telecommunications services to consumers, businesses, and other providers in the United States and internationally. The company raised dividends by 2.20% to 46 cents/share. This marked the 30th consecutive dividend increase for this dividend champion. Over the past decade, AT&T has raised dividends by 5.20%/year. Currently the stock trades at 13.90 times expected 2013 earnings and yields 5.40%. Given the deceleration of the dividend growth rate, and the increasing competition in the telecom markets, I am going to stay away from this one. This is not different than my stance on the company for the past five years. Check my analysis of AT&T.
Archer-Daniels-Midland Company (ADM) manufactures and sells protein meal, vegetable oil, corn sweeteners, flour, biodiesel, ethanol, and other value-added food and feed ingredients; and processes oilseeds, corn, wheat, cocoa, and other agricultural commodities. The company raised dividends by 26.30% to 24 cents/share. This marked the 39th consecutive dividend increase for this dividend champion. Over the past decade, Archer-Daniels-Midland has raised dividends by 9.10%/year. Currently the stock trades at 19.40 times earnings and yields 2.30%. I like the company, and would like to add to my position on dips below $38.50/share. Check my analysis of ADM.
3M Company (MMM) operates as a diversified technology company worldwide. The company raised dividends by 34.60% to 85.50 cents/share. This marked the 56th consecutive dividend increase for this dividend king. Over the past decade, 3M has raised dividends by 6.60%/year. Currently the stock trades at 20 times estimated 2013 earnings and yields 2.50%. It is nice to see another company that becomes a better dividend value in this otherwise overheated environment. Check my analysis of 3M.
Realty Income Corporation (O) is a publicly traded real estate investment trust that invests in commercial real estate markets of the United States. The company raised dividends to 18.217 cents/share. This dividend achiever has raised distributions since 1994. Over the past decade, the REIT has raised dividends by 4.20%/year. Currently the stock trades at 15.70 times FFO and yields 5.50%. The increase in interest rates in a few years might lead to further declines in stock prices for REITs. As a long-term investor, I see some growth in distributions from Realty Income in the future fueled by acquisitions and rent increases. This makes this REIT a buy in my book. I recently sold some January 2015 at-the-money puts on the stock. Check my analysis of Realty Income.
CVS Caremark Corporation (CVS), together with its subsidiaries, provides integrated pharmacy health care services in the United States. The company raised dividends by 22.20% to 27.50 cents/share. This marked the 11th consecutive dividend increase for this dividend achiever. Over the past decade, CVS has raised dividends by 18.80%/year. Currently the stock trades at 17.70 times estimated 2013 earnings and yields 1.60%. While the stock is below my minimum entry yield requirement, I would continue monitoring future developments at CVS.
General Electric Company (GE) operates as an infrastructure and financial services company worldwide.
The company raised dividends by 15.80% to 22 cents/share. This marked the 4th consecutive annual dividend increase for General Electric. The new dividend is still below the levels of 31 cents/share for shareholders, that was last seen in early 2009. Currently the stock trades at 16.70 times estimated 2013 earnings and yields 3.30%. I plan on reviewing GE in more detail in the coming weeks, in order to determine if it is worthy of my investment dollars.
Urstadt Biddle Properties, Inc. (UBA), a real estate investment trust (REIT), engages in the acquisition, ownership, and management of commercial real estate properties in the United States.
The company raised dividends by 1% to 25.25 cents/share. This marked the 20th consecutive dividend increase for this dividend achiever. Over the past decade, Urstadt Biddle Properties has raised dividends by 2%/year. Currently the REIT trades at 20 times FFO and yields 5.50%. I am generally not a fan of dividend growth companies that raise dividends simply to maintain a streak, but the nominal raises are below the rate of inflation. Despite the high current yield, I do not find the company worthy of further research.
Full Disclosure: Long O, MMM and ADM
Relevant Articles:
- Check the Complete Article Archive
- The Dividend Kings List Keeps Expanding
- My Dividend Retirement Plan
- Dividend Investing Goals for 2013
- Margin of Safety in Dividends
If the investor manages to purchase quality dividend growth companies at fair prices after analyzing them individually, and puts them in a diversified income portfolio that is monitored regularly, they would greatly increase their odds of achieving their goals. Dividend stocks would therefore be the gift that keeps on giving for this investor, showering him with cash for years to come.
Over the past week, several dividend payers approved higher distributions for shareholders:
AT&T Inc. (T) provides telecommunications services to consumers, businesses, and other providers in the United States and internationally. The company raised dividends by 2.20% to 46 cents/share. This marked the 30th consecutive dividend increase for this dividend champion. Over the past decade, AT&T has raised dividends by 5.20%/year. Currently the stock trades at 13.90 times expected 2013 earnings and yields 5.40%. Given the deceleration of the dividend growth rate, and the increasing competition in the telecom markets, I am going to stay away from this one. This is not different than my stance on the company for the past five years. Check my analysis of AT&T.
Archer-Daniels-Midland Company (ADM) manufactures and sells protein meal, vegetable oil, corn sweeteners, flour, biodiesel, ethanol, and other value-added food and feed ingredients; and processes oilseeds, corn, wheat, cocoa, and other agricultural commodities. The company raised dividends by 26.30% to 24 cents/share. This marked the 39th consecutive dividend increase for this dividend champion. Over the past decade, Archer-Daniels-Midland has raised dividends by 9.10%/year. Currently the stock trades at 19.40 times earnings and yields 2.30%. I like the company, and would like to add to my position on dips below $38.50/share. Check my analysis of ADM.
3M Company (MMM) operates as a diversified technology company worldwide. The company raised dividends by 34.60% to 85.50 cents/share. This marked the 56th consecutive dividend increase for this dividend king. Over the past decade, 3M has raised dividends by 6.60%/year. Currently the stock trades at 20 times estimated 2013 earnings and yields 2.50%. It is nice to see another company that becomes a better dividend value in this otherwise overheated environment. Check my analysis of 3M.
Realty Income Corporation (O) is a publicly traded real estate investment trust that invests in commercial real estate markets of the United States. The company raised dividends to 18.217 cents/share. This dividend achiever has raised distributions since 1994. Over the past decade, the REIT has raised dividends by 4.20%/year. Currently the stock trades at 15.70 times FFO and yields 5.50%. The increase in interest rates in a few years might lead to further declines in stock prices for REITs. As a long-term investor, I see some growth in distributions from Realty Income in the future fueled by acquisitions and rent increases. This makes this REIT a buy in my book. I recently sold some January 2015 at-the-money puts on the stock. Check my analysis of Realty Income.
CVS Caremark Corporation (CVS), together with its subsidiaries, provides integrated pharmacy health care services in the United States. The company raised dividends by 22.20% to 27.50 cents/share. This marked the 11th consecutive dividend increase for this dividend achiever. Over the past decade, CVS has raised dividends by 18.80%/year. Currently the stock trades at 17.70 times estimated 2013 earnings and yields 1.60%. While the stock is below my minimum entry yield requirement, I would continue monitoring future developments at CVS.
General Electric Company (GE) operates as an infrastructure and financial services company worldwide.
The company raised dividends by 15.80% to 22 cents/share. This marked the 4th consecutive annual dividend increase for General Electric. The new dividend is still below the levels of 31 cents/share for shareholders, that was last seen in early 2009. Currently the stock trades at 16.70 times estimated 2013 earnings and yields 3.30%. I plan on reviewing GE in more detail in the coming weeks, in order to determine if it is worthy of my investment dollars.
Urstadt Biddle Properties, Inc. (UBA), a real estate investment trust (REIT), engages in the acquisition, ownership, and management of commercial real estate properties in the United States.
The company raised dividends by 1% to 25.25 cents/share. This marked the 20th consecutive dividend increase for this dividend achiever. Over the past decade, Urstadt Biddle Properties has raised dividends by 2%/year. Currently the REIT trades at 20 times FFO and yields 5.50%. I am generally not a fan of dividend growth companies that raise dividends simply to maintain a streak, but the nominal raises are below the rate of inflation. Despite the high current yield, I do not find the company worthy of further research.
Full Disclosure: Long O, MMM and ADM
Relevant Articles:
- Check the Complete Article Archive
- The Dividend Kings List Keeps Expanding
- My Dividend Retirement Plan
- Dividend Investing Goals for 2013
- Margin of Safety in Dividends
Friday, December 20, 2013
Republic Services (RSG) Dividend Stock Analysis 2013
Republic Services, Inc. (RSG), together with its subsidiaries, provides non-hazardous solid waste collection, transfer, and recycling and disposal services for commercial, industrial, municipal, and residential customers in the United States and Puerto Rico. The company has paid dividends since 2003 and has increased them for ten years in a row.
The company’s last dividend increase was in July 2013 when the Board of Directors approved a 10.60% increase in the quarterly annual dividend to 26 cents /share. The company’s peer group includes Waste Management (WM), Waste Connections (WCN), and Veolia (VE).
Over the past decade this dividend growth stock has delivered an annualized total return of 9.90% to its shareholders. The largest shareholder with an approximate 25% stake is Bill Gates, through his holding vehicle Cascade Investment LLC.
The company has managed to deliver a 6.40% average increase in annual EPS between 2003 and 2012. The company is expected to earn $1.87 per share in 2013 and $2.01 per share in 2014. In comparison, the company earned $1.55/share in 2012.
The company is the second largest provider of waste management services in the US, after acquiring Allied Waste in 2008.
I like the economics of the waste management business, and believe that Republic Services has a few ways to grow revenues over time.
First, the nature of its business is to provide an essential service that is relatively recession resistant. Over time, I would expect that the amount of trash volumes to only increase, as a factor of increasing population and level of industrial and societal output.
Second, the company benefits from economies of scale, as of 12/31/2012 it owned 191 landfills, 195 transfer stations and 71 recycling centers. Trash collection services generate over three quarters of revenues ( 35% municipal and residential, 40% commercial & 25% industrial), while transfer services and landfill generate about one-sixth. Recycling services generate the majority of any remainders. Landfills are difficult to set up and operate, and require companies to go through a lot of government red tape to obtain proper permits/licenses. In addition, landfills require high costs in setting up, monitoring etc. Thus landfill ownership could be viewed as a competitive advantage.
Third, the company can grow through acquisitions, especially those that complement its geographic presence in a certain part of the country. Currently Republic Services and Waste Management (WM) generate approximately 60% of revenues in the industry combined. Through acquisitions, the company can leverage its economies of scale, and generate synergies such as reductions in capital requirements and in personnel. If you have relatively fixed costs in terms of landfills, transfer stations and truck fleet, any marginal increases in volumes can result in much higher increases in earnings. In addition, the company seeks to achieve a high rate of internalization by controlling waste streams from the point of collection through processing or disposal.
Fourth, a large portion of the company’s contracts also include price hikes tied to inflation. In addition, it could contain costs by standardizing the truck fleet it operates, and switching it from diesel to natural gas. The company operates under one – five years contracts with municipal, commercial and industrial customers.
Fifth, the company can also increase earnings per share through regular share repurchases. Between 2003 and 2008, shares outstanding decreased from 240 to 192 million. After the acquisition of Allied Waste in 2008, the number of shares outstanding has decreased from 381 million in 2009 to 363 million in 2013.
The company can also leverage its existing position to generate new revenue streams. Examples include recycling centers as well as using trash to generate energy. These are existing operations, which could potentially generate extra money for shareholders. Currently, 35% of trash is recycled, and this percentage is expected to increase.
Risks
While to compete with Republic Services requires a lot of capital, and there is limited pricing power. Contracts are due for renegotiation every few years or so, and subject to competitive bidding. If a competitor wants to gain market share, they can potentially lower prices to gain key contracts. Given the scale and vertical integration of Republic’s operations the chances of that are low, since it can probably outbid most of the smaller rivals in the industry. The company is also number one or two provider in 90% of the markets it operates in.
The second risk involves potential for environmental liabilities. The company needs to be really good at managing environmental issues, particularly as it relates to its landfills. After a landfill is filled up with trash, the company has to monitor it for at least 30 years.
If management does not do a very good job of continuously monitoring risks related to an environmental contamination on a systematic basis, the results could be terrible for communities affected and shareholders. Again, the possibility of this actually happening is likely low, but it is something to think about.
The third item is that I do not expect future growth in earnings per share might not exceed 5-6%/year over say the next 5 – 10 years. Therefore, the opportunity cost of owning Republic Services is missing out on a stock that yields 3% but grows distributions by more than 6%/year.
Republic Services increased Returns on Equity from 5.70% in 2003 to over 21% by 2007. There was a big drop during the financial crisis, and currently the ROE is standing at 7.40%. Based on forward earnings, I expect this ratio to increase above 10%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 12.80% per year over the past five years, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 12% growth in distributions translates into the dividend payment doubling almost every six years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the high single digits.
The dividend payout ratio has increased from 9% in 2003 to almost 59% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 56%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Republic Services is attractively valued at 18.50 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been a little slow in the past five years. If earnings per share grow by 2 – 3%/year based on organic growth (such as growth in population) and acquisitions, and 2-3%/year due to share repurchases, this could translate to total growth of 4 – 6%/year. Given the high dividend payout ratio, I am not sure if long-term dividend growth would be higher than 6%/year over the next 5 - 10 years. This is not too bad of course, given a starting yield of 3%. However, if I find a stock that yields 3% and expect it to grow distributions above 6%/year, I would likely buy that stock, rather than Republic Services.
Full Disclosure: None
Relevant Articles:
- Check the Complete Article Archive
- Waste Management (WM) Dividend Stock Analysis
- Dividend Paying Stocks for Retirement Income
- Dividends versus Share Buybacks/Stock repurchases
- Reinvest Dividends Selectively
The company’s last dividend increase was in July 2013 when the Board of Directors approved a 10.60% increase in the quarterly annual dividend to 26 cents /share. The company’s peer group includes Waste Management (WM), Waste Connections (WCN), and Veolia (VE).
Over the past decade this dividend growth stock has delivered an annualized total return of 9.90% to its shareholders. The largest shareholder with an approximate 25% stake is Bill Gates, through his holding vehicle Cascade Investment LLC.
The company has managed to deliver a 6.40% average increase in annual EPS between 2003 and 2012. The company is expected to earn $1.87 per share in 2013 and $2.01 per share in 2014. In comparison, the company earned $1.55/share in 2012.
The company is the second largest provider of waste management services in the US, after acquiring Allied Waste in 2008.
I like the economics of the waste management business, and believe that Republic Services has a few ways to grow revenues over time.
First, the nature of its business is to provide an essential service that is relatively recession resistant. Over time, I would expect that the amount of trash volumes to only increase, as a factor of increasing population and level of industrial and societal output.
Second, the company benefits from economies of scale, as of 12/31/2012 it owned 191 landfills, 195 transfer stations and 71 recycling centers. Trash collection services generate over three quarters of revenues ( 35% municipal and residential, 40% commercial & 25% industrial), while transfer services and landfill generate about one-sixth. Recycling services generate the majority of any remainders. Landfills are difficult to set up and operate, and require companies to go through a lot of government red tape to obtain proper permits/licenses. In addition, landfills require high costs in setting up, monitoring etc. Thus landfill ownership could be viewed as a competitive advantage.
Third, the company can grow through acquisitions, especially those that complement its geographic presence in a certain part of the country. Currently Republic Services and Waste Management (WM) generate approximately 60% of revenues in the industry combined. Through acquisitions, the company can leverage its economies of scale, and generate synergies such as reductions in capital requirements and in personnel. If you have relatively fixed costs in terms of landfills, transfer stations and truck fleet, any marginal increases in volumes can result in much higher increases in earnings. In addition, the company seeks to achieve a high rate of internalization by controlling waste streams from the point of collection through processing or disposal.
Fourth, a large portion of the company’s contracts also include price hikes tied to inflation. In addition, it could contain costs by standardizing the truck fleet it operates, and switching it from diesel to natural gas. The company operates under one – five years contracts with municipal, commercial and industrial customers.
Fifth, the company can also increase earnings per share through regular share repurchases. Between 2003 and 2008, shares outstanding decreased from 240 to 192 million. After the acquisition of Allied Waste in 2008, the number of shares outstanding has decreased from 381 million in 2009 to 363 million in 2013.
The company can also leverage its existing position to generate new revenue streams. Examples include recycling centers as well as using trash to generate energy. These are existing operations, which could potentially generate extra money for shareholders. Currently, 35% of trash is recycled, and this percentage is expected to increase.
Risks
While to compete with Republic Services requires a lot of capital, and there is limited pricing power. Contracts are due for renegotiation every few years or so, and subject to competitive bidding. If a competitor wants to gain market share, they can potentially lower prices to gain key contracts. Given the scale and vertical integration of Republic’s operations the chances of that are low, since it can probably outbid most of the smaller rivals in the industry. The company is also number one or two provider in 90% of the markets it operates in.
The second risk involves potential for environmental liabilities. The company needs to be really good at managing environmental issues, particularly as it relates to its landfills. After a landfill is filled up with trash, the company has to monitor it for at least 30 years.
If management does not do a very good job of continuously monitoring risks related to an environmental contamination on a systematic basis, the results could be terrible for communities affected and shareholders. Again, the possibility of this actually happening is likely low, but it is something to think about.
The third item is that I do not expect future growth in earnings per share might not exceed 5-6%/year over say the next 5 – 10 years. Therefore, the opportunity cost of owning Republic Services is missing out on a stock that yields 3% but grows distributions by more than 6%/year.
Republic Services increased Returns on Equity from 5.70% in 2003 to over 21% by 2007. There was a big drop during the financial crisis, and currently the ROE is standing at 7.40%. Based on forward earnings, I expect this ratio to increase above 10%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 12.80% per year over the past five years, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 12% growth in distributions translates into the dividend payment doubling almost every six years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the high single digits.
The dividend payout ratio has increased from 9% in 2003 to almost 59% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 56%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Republic Services is attractively valued at 18.50 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been a little slow in the past five years. If earnings per share grow by 2 – 3%/year based on organic growth (such as growth in population) and acquisitions, and 2-3%/year due to share repurchases, this could translate to total growth of 4 – 6%/year. Given the high dividend payout ratio, I am not sure if long-term dividend growth would be higher than 6%/year over the next 5 - 10 years. This is not too bad of course, given a starting yield of 3%. However, if I find a stock that yields 3% and expect it to grow distributions above 6%/year, I would likely buy that stock, rather than Republic Services.
Full Disclosure: None
Relevant Articles:
- Check the Complete Article Archive
- Waste Management (WM) Dividend Stock Analysis
- Dividend Paying Stocks for Retirement Income
- Dividends versus Share Buybacks/Stock repurchases
- Reinvest Dividends Selectively
Wednesday, December 18, 2013
Leveraged dividend growth investing
One of the assets that a typical middle class person owns is their house. Houses are purchased with approximately 20% down or less. People usually get a mortgage for the remainder, and they pay the credit off for 30 years. The house provides shelter to the family that purchased it, and hopefully its price keeps up with inflation. Houses however cost a lot of time and money, including renovations, property taxes etc.
With stocks however, regular investors rarely go into debt to purchase partial ownerships of companies. This could be attributed to several factors such as lack of desire to invest in stocks in the first place, the lack of understanding of margin and the higher interest rates paid on stocks with borrowed money. Dividend stocks on the other hand pay you money and you can offset interest expense against dividend income.
Stocks are usually valued mark to market in a brokerage account. If they fall in value the broker would require more money as collateral. This is the dreaded margin call where we either need to add more money or the broker would sell your position. Stock prices fluctuate daily, and as a result if one were to invest $1000 in shares of Procter & Gamble (PG), and bought $1000 more on margin they could end up with nothing if the stock price fell by 50%. If your house value fell by 50%, the mortgage company wouldn't require more money as collateral. They would not repossess your house, unless you are really late on your payment.
Another reason why investing with borrowed money is not popular is because interest rates on margin loans are usually very high. Many brokers charge over 6% presently, which is very high in the current interest rate environment. Only a few brokers, such as Interactive Brokers have margin rates at around 1%. In addition, margin interest rates are also not fixed, but variable. While interest rates are expected to remain low until 2014 - 2015, an increase in the benchmark rate would likely increase the cost of interest rates on margin loans. This could reduce investor returns as a result.
By using borrowed money to purchase dividend stocks, investors can magnify their dividend income significantly. For example, an investor with $100,000 in dividend paying stocks yielding 3% will generate $3,000 in annual dividend income. If they were to buy $100,000 in dividend stocks on margin, they would end up paying around 1.67%/year to a broker like Interactive Brokers, and increase dividend income to $4,330/year. This strategy can work for investors in the accumulation phase, as it could speed up the accumulation of dividend paying shares and compounding of dividend income.
In order to minimize risks mentioned above, an investor should use an adequate margin of safety with leveraged dividend investing. This would means that they should not borrow more than 25% – 30% from their account for margin investments. This would protect the investor from margin calls even if stock prices fell by 50%.
In addition, investors in the accumulation phase should have a plan to pay off their margin loans from their expected monthly contributions to their portfolio within 4- 5 years.
For example let’s assume that our investor with the $100,000 portfolio plans on adding $12,000/year for the next five years. This means that if they purchased $25,000 on margin, they could pay it off within 2 years simply by sticking to their regular investment schedule. However, by using a low cost margin loan, they would be accelerating their dividend compounding process.
In my personal portfolio, I sometimes purchase shares on margin when I see good values in the market. For example, if my portfolio was worth $100,000, and my lot size was $1,000, I might spend $2,000 - $3,000 on 2 – 3 stocks that looked attractive. I would then pay off the margin in a few weeks. I always pay my margin within a couple weeks however, as I use it to scoop up shares that are temporarily beaten down, while waiting for my paycheck to get deposited.
In the past month, I purchased shares of Target (TGT) and Becton Dickinson (BDX) on margin. However, as of this time, the margin has been repaid.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has rewarded shareholders with higher dividends for 46 years in a row. Over the past decade, Target has managed to raise dividends by 18.60%/year. Currently, the stock is attractively valued at 16 times earnings and yields 2.60%. Check my analysis of Target for more details.
Becton, Dickinson and Company (BDX), a medical technology company, develops, manufactures, and sells medical devices, instrument systems, and reagents worldwide. This dividend champion has rewarded shareholders with higher dividends for 42 years in a row. Over the past decade, Target has managed to raise dividends by 16.80%/year. Currently, the stock is attractively valued at 16.70 times earnings and yields 2%. Check my analysis of Becton Dickinson for more details.
I am also playing around with Loyal3, which lets you buy shares with a credit card, commission free. If you time your monthly purchases there, you can essentially get an interest free loan for almost 6 - 8 weeks, while also earning credit card rewards points. In addition, Loyal3 allows investors to buy shares with as little as $10 per each investment.
Full Disclosure: Long TGT, BDX, PG,
Relevant Articles:
- Dividend Investors are Getting Paid for Holding Dividend Paying Stocks
- Reinvesting Dividends Pays Off
- What to do about those rising stock prices?
- How to buy dividend stocks with as little as $10
- Check the Complete Article Archive
With stocks however, regular investors rarely go into debt to purchase partial ownerships of companies. This could be attributed to several factors such as lack of desire to invest in stocks in the first place, the lack of understanding of margin and the higher interest rates paid on stocks with borrowed money. Dividend stocks on the other hand pay you money and you can offset interest expense against dividend income.
Stocks are usually valued mark to market in a brokerage account. If they fall in value the broker would require more money as collateral. This is the dreaded margin call where we either need to add more money or the broker would sell your position. Stock prices fluctuate daily, and as a result if one were to invest $1000 in shares of Procter & Gamble (PG), and bought $1000 more on margin they could end up with nothing if the stock price fell by 50%. If your house value fell by 50%, the mortgage company wouldn't require more money as collateral. They would not repossess your house, unless you are really late on your payment.
Another reason why investing with borrowed money is not popular is because interest rates on margin loans are usually very high. Many brokers charge over 6% presently, which is very high in the current interest rate environment. Only a few brokers, such as Interactive Brokers have margin rates at around 1%. In addition, margin interest rates are also not fixed, but variable. While interest rates are expected to remain low until 2014 - 2015, an increase in the benchmark rate would likely increase the cost of interest rates on margin loans. This could reduce investor returns as a result.
By using borrowed money to purchase dividend stocks, investors can magnify their dividend income significantly. For example, an investor with $100,000 in dividend paying stocks yielding 3% will generate $3,000 in annual dividend income. If they were to buy $100,000 in dividend stocks on margin, they would end up paying around 1.67%/year to a broker like Interactive Brokers, and increase dividend income to $4,330/year. This strategy can work for investors in the accumulation phase, as it could speed up the accumulation of dividend paying shares and compounding of dividend income.
In order to minimize risks mentioned above, an investor should use an adequate margin of safety with leveraged dividend investing. This would means that they should not borrow more than 25% – 30% from their account for margin investments. This would protect the investor from margin calls even if stock prices fell by 50%.
In addition, investors in the accumulation phase should have a plan to pay off their margin loans from their expected monthly contributions to their portfolio within 4- 5 years.
For example let’s assume that our investor with the $100,000 portfolio plans on adding $12,000/year for the next five years. This means that if they purchased $25,000 on margin, they could pay it off within 2 years simply by sticking to their regular investment schedule. However, by using a low cost margin loan, they would be accelerating their dividend compounding process.
In my personal portfolio, I sometimes purchase shares on margin when I see good values in the market. For example, if my portfolio was worth $100,000, and my lot size was $1,000, I might spend $2,000 - $3,000 on 2 – 3 stocks that looked attractive. I would then pay off the margin in a few weeks. I always pay my margin within a couple weeks however, as I use it to scoop up shares that are temporarily beaten down, while waiting for my paycheck to get deposited.
In the past month, I purchased shares of Target (TGT) and Becton Dickinson (BDX) on margin. However, as of this time, the margin has been repaid.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has rewarded shareholders with higher dividends for 46 years in a row. Over the past decade, Target has managed to raise dividends by 18.60%/year. Currently, the stock is attractively valued at 16 times earnings and yields 2.60%. Check my analysis of Target for more details.
Becton, Dickinson and Company (BDX), a medical technology company, develops, manufactures, and sells medical devices, instrument systems, and reagents worldwide. This dividend champion has rewarded shareholders with higher dividends for 42 years in a row. Over the past decade, Target has managed to raise dividends by 16.80%/year. Currently, the stock is attractively valued at 16.70 times earnings and yields 2%. Check my analysis of Becton Dickinson for more details.
I am also playing around with Loyal3, which lets you buy shares with a credit card, commission free. If you time your monthly purchases there, you can essentially get an interest free loan for almost 6 - 8 weeks, while also earning credit card rewards points. In addition, Loyal3 allows investors to buy shares with as little as $10 per each investment.
Full Disclosure: Long TGT, BDX, PG,
Relevant Articles:
- Dividend Investors are Getting Paid for Holding Dividend Paying Stocks
- Reinvesting Dividends Pays Off
- What to do about those rising stock prices?
- How to buy dividend stocks with as little as $10
- Check the Complete Article Archive
Monday, December 16, 2013
Five Dividend Payers to Consider for 2014 and beyond
Many investors find it difficult to put more money in the stock market nowadays, given the rapid rise in stock prices this year. As stock indexes are hitting all-time-highs several times in 2013, it is very difficult to commit when you have talks of ending the stimulus, which could potentially cripple the already fragile economic recovery.
As a dividend investor, I do not pay attention to these items. Despite all of those negative factors, there are attractively valued companies in almost any market environment. The current one is no exception. I focus my attention on picking individual securities in businesses I understand, rather than the overall macroeconomic factors. I try to uncover companies which have strong competitive advantages, trade at fair valuations, and have catalysts for long term growth. I then buy them, and plan on holding them forever.
The goal of dividend investing is to generate a rising stream of income in order to pay monthly expenses. Dividend income is always positive and is more stable than capital gains, which makes it a preferred way to live off your portfolio. With dividend investing, your retirement income is not reliant on the wild swings of stock prices, unlike traditional asset depleting strategies like the four percent rule.
In other words, with dividend paying stocks you earn a positive return on your money no matter if the stock price goes up or down. The beauty of dividend growth stocks is that by regularly growing dividends, they provide investors with more cash over time, which also makes the stock more valuable to investors at the same time. As a result, a company that yields 3% today but grows dividends by 10%/year, would yield 6% on cost in 7 years and 12% on cost in 14 years.
I am finding value in the following companies, which have strong recognizable brands, sell at fair valuations and could increase earnings over the next 15 – 20 years. I believe that each one of these companies would be a very good addition to a diversified dividend portfolio. As mentioned above, these companies would be great long term holdings to hold “forever”. They are selling at good prices to acquire today, and are good candidates for holding in 2014 and for a long time after that.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has raised dividends for 46 years in a row. Over the past decade, Target has managed to boost dividends by 18.60%/year. Currently, the stock trades at 17 times earnings and yields 2.70%. Check my analysis of Target for more information about the company.
General Mills, Inc. (GIS) produces and markets branded consumer foods in the United States and internationally. This dividend achiever has raised dividends for 10 years in a row. Over the past decade, General Mills has managed to boost dividends by 8.70%/year. Currently, the stock trades at 17.70 times forward earnings and yields 2.90%. Check my analysis of General Mills for more information about the company.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend champion has raised dividends for 46 years in a row. Since the spin-off from parent Altria Group in 2008, Philip Morris International has managed to boost dividends by 15%/year. Currently, the stock trades at 16.30 times earnings and yields 4.40%. Check my analysis of PMI for more information about the company.
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. This dividend champion has raised dividends for 38 years in a row. Over the past decade, McDonald’s has managed to boost dividends by 28.40%/year. Currently, the stock trades at 17.30 times earnings and yields 3.30%. Check my analysis of McDonald’s for more information about the company.
Realty Income Corporation (O) is a publicly traded real estate investment trust. This dividend achiever has raised dividends for 19 years in a row. Over the past decade, Realty Income has managed to boost dividends by 4.20%/year. Currently, the stock trades at 15.60 times Funds from Operations (FFO) and yields 5.90%. Check my analysis of Realty Income for more information about the company.
Full Disclosure: I have a position in all the companies listed above
Relevant Articles:
- Check the Complete Article Archive
- What to do about those rising stock prices?
- How to invest when the market is at all time highs?
- The right time to sell dividend stocks
- Why would I not sell dividend stocks even after a 1000% gain?
As a dividend investor, I do not pay attention to these items. Despite all of those negative factors, there are attractively valued companies in almost any market environment. The current one is no exception. I focus my attention on picking individual securities in businesses I understand, rather than the overall macroeconomic factors. I try to uncover companies which have strong competitive advantages, trade at fair valuations, and have catalysts for long term growth. I then buy them, and plan on holding them forever.
The goal of dividend investing is to generate a rising stream of income in order to pay monthly expenses. Dividend income is always positive and is more stable than capital gains, which makes it a preferred way to live off your portfolio. With dividend investing, your retirement income is not reliant on the wild swings of stock prices, unlike traditional asset depleting strategies like the four percent rule.
In other words, with dividend paying stocks you earn a positive return on your money no matter if the stock price goes up or down. The beauty of dividend growth stocks is that by regularly growing dividends, they provide investors with more cash over time, which also makes the stock more valuable to investors at the same time. As a result, a company that yields 3% today but grows dividends by 10%/year, would yield 6% on cost in 7 years and 12% on cost in 14 years.
I am finding value in the following companies, which have strong recognizable brands, sell at fair valuations and could increase earnings over the next 15 – 20 years. I believe that each one of these companies would be a very good addition to a diversified dividend portfolio. As mentioned above, these companies would be great long term holdings to hold “forever”. They are selling at good prices to acquire today, and are good candidates for holding in 2014 and for a long time after that.
Target Corporation (TGT) operates general merchandise stores in the United States. This dividend champion has raised dividends for 46 years in a row. Over the past decade, Target has managed to boost dividends by 18.60%/year. Currently, the stock trades at 17 times earnings and yields 2.70%. Check my analysis of Target for more information about the company.
General Mills, Inc. (GIS) produces and markets branded consumer foods in the United States and internationally. This dividend achiever has raised dividends for 10 years in a row. Over the past decade, General Mills has managed to boost dividends by 8.70%/year. Currently, the stock trades at 17.70 times forward earnings and yields 2.90%. Check my analysis of General Mills for more information about the company.
Philip Morris International Inc. (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. This dividend champion has raised dividends for 46 years in a row. Since the spin-off from parent Altria Group in 2008, Philip Morris International has managed to boost dividends by 15%/year. Currently, the stock trades at 16.30 times earnings and yields 4.40%. Check my analysis of PMI for more information about the company.
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. This dividend champion has raised dividends for 38 years in a row. Over the past decade, McDonald’s has managed to boost dividends by 28.40%/year. Currently, the stock trades at 17.30 times earnings and yields 3.30%. Check my analysis of McDonald’s for more information about the company.
Realty Income Corporation (O) is a publicly traded real estate investment trust. This dividend achiever has raised dividends for 19 years in a row. Over the past decade, Realty Income has managed to boost dividends by 4.20%/year. Currently, the stock trades at 15.60 times Funds from Operations (FFO) and yields 5.90%. Check my analysis of Realty Income for more information about the company.
Full Disclosure: I have a position in all the companies listed above
Relevant Articles:
- Check the Complete Article Archive
- What to do about those rising stock prices?
- How to invest when the market is at all time highs?
- The right time to sell dividend stocks
- Why would I not sell dividend stocks even after a 1000% gain?
Friday, December 13, 2013
Kellogg Company (K) Dividend Stock Analysis
Kellogg Company (K), together with its subsidiaries, manufactures and markets ready-to-eat cereal and convenience food products primarily in North America, Europe, Latin America, and the Asia Pacific. The company has paid dividends since 1925 and has increased them for nine years in a row. Between 1960 and 2001, the company had raised annual dividends every year. However it kept dividends unchanged between 2002 and 2004, this ending the long streak of consecutive dividend increases.
The company’s last dividend increase was in April 2013 when the Board of Directors approved a 4.50 % increase in the quarterly annual dividend to 46 cents /share. The company’s peer group includes Nestle Group (NSRGY), General Mills (GIS), Campbell Soup (CPB) and Hershey (HSY).
Over the past decade this dividend growth stock has delivered an annualized total return of 8.40% to its shareholders.
The company has managed to deliver a 3.70% average increase in annual EPS between 2003 and 2012. The company is expected to earn $3.77 per share in 2013 and $4.06 per share in 2014. In comparison, the company earned $2.67/share in 2012. The low earnings were the result of a one-time accounting hit of 85 cents/share, related to a change in accounting for pensions.
The board of directors authorized a $1 billion stock repurchase program in April 2013, which expires in April 2014. At current prices, it can result in the retirement of as much as 4% of shares outstanding.
An interesting fact about Kellogg is that the Kellogg WK Foundation Trust owns approximately 20.60% of shares outstanding. This is a great example of a trust fund, which has been “living off dividends” for several decades. In fact, the trust is projected to earn over $136 million in annual dividend income from their ownership of Kellogg shares.
I also found another hidden dividend millionaire after researching Kellogg. Agnes Plumb inherited Kellogg stock from her father, who was one of the early investors in the company. When she died in 1996,she left almost $100 million worth of Kellogg stock to charity.
The company has strong brand names like Special K, Frosted Flakes, Corn Flakes, Pop-Tarts, Pringles etc, and it continuously invests to strengthen them. Another source of growth could include product innovation. The firm has invested approximately 2% of sales on R&D over the past two years.
Kellogg can increase earnings through new acquisitions, such as the purchase of Pringles from Procter & Gamble (PG) in 2012 for almost $2.7 billion in cash. This purchase could be a strong platform for international growth that Kellogg’s snack business can definitely benefit from. Other historical acquisitions include Kashi in 2000.
The US accounts for 2/3rds of sales in 2012. A potential opportunity for growth could materialize in emrging markets, where the company is lagging behind competitors right now. In 2012, Kellogg also announced a joint venture with Wilmar International, which would make snack foods in China. Wilmar will contribute infrastructure, supply chain scale, an extensive sales and distribution network in China, as well as local China market expertise to the joint venture. Kellogg will contribute a portfolio of globally recognized brands and products such as Kellogg and Pringles, along with deep cereal and snacks category expertise.
Kellogg has a very high return on equity at 46%. Over the past decade, the returns on equity have stayed between 43% and 67%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 5.60% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 6% growth in distributions translates into the dividend payment doubling almost every 12 years on average. If we look at historical data, going as far back as 1959, one would notice that the company has managed to double distributions every eight years on average.
The dividend payout ratio has increased from 52% in 2003 to almost 65% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 49%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Kellogg is attractively valued at 16.10 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been rather slow in the past decade. I am planning to add to the stock in the next year, subject to availability of funds. However, if a faster growth company like General Mills is available at comparable valuations at the time I have available funds, I would choose General Mills instead.
Full Disclosure: Long K, GIS, NSRGY
Relevant Articles:
- Check the Complete Article Archive
- Nestle (NSRGY): A Global Dividend Powerhouse
- General Mills (GIS) Dividend Stock Analysis
- Dividend income is more stable than capital gains
- What is Dividend Growth Investing?
The company’s last dividend increase was in April 2013 when the Board of Directors approved a 4.50 % increase in the quarterly annual dividend to 46 cents /share. The company’s peer group includes Nestle Group (NSRGY), General Mills (GIS), Campbell Soup (CPB) and Hershey (HSY).
Over the past decade this dividend growth stock has delivered an annualized total return of 8.40% to its shareholders.
The company has managed to deliver a 3.70% average increase in annual EPS between 2003 and 2012. The company is expected to earn $3.77 per share in 2013 and $4.06 per share in 2014. In comparison, the company earned $2.67/share in 2012. The low earnings were the result of a one-time accounting hit of 85 cents/share, related to a change in accounting for pensions.
The board of directors authorized a $1 billion stock repurchase program in April 2013, which expires in April 2014. At current prices, it can result in the retirement of as much as 4% of shares outstanding.
An interesting fact about Kellogg is that the Kellogg WK Foundation Trust owns approximately 20.60% of shares outstanding. This is a great example of a trust fund, which has been “living off dividends” for several decades. In fact, the trust is projected to earn over $136 million in annual dividend income from their ownership of Kellogg shares.
I also found another hidden dividend millionaire after researching Kellogg. Agnes Plumb inherited Kellogg stock from her father, who was one of the early investors in the company. When she died in 1996,she left almost $100 million worth of Kellogg stock to charity.
The company has strong brand names like Special K, Frosted Flakes, Corn Flakes, Pop-Tarts, Pringles etc, and it continuously invests to strengthen them. Another source of growth could include product innovation. The firm has invested approximately 2% of sales on R&D over the past two years.
Kellogg can increase earnings through new acquisitions, such as the purchase of Pringles from Procter & Gamble (PG) in 2012 for almost $2.7 billion in cash. This purchase could be a strong platform for international growth that Kellogg’s snack business can definitely benefit from. Other historical acquisitions include Kashi in 2000.
The US accounts for 2/3rds of sales in 2012. A potential opportunity for growth could materialize in emrging markets, where the company is lagging behind competitors right now. In 2012, Kellogg also announced a joint venture with Wilmar International, which would make snack foods in China. Wilmar will contribute infrastructure, supply chain scale, an extensive sales and distribution network in China, as well as local China market expertise to the joint venture. Kellogg will contribute a portfolio of globally recognized brands and products such as Kellogg and Pringles, along with deep cereal and snacks category expertise.
Kellogg has a very high return on equity at 46%. Over the past decade, the returns on equity have stayed between 43% and 67%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 5.60% per year over the past decade, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 6% growth in distributions translates into the dividend payment doubling almost every 12 years on average. If we look at historical data, going as far back as 1959, one would notice that the company has managed to double distributions every eight years on average.
The dividend payout ratio has increased from 52% in 2003 to almost 65% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 49%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Kellogg is attractively valued at 16.10 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been rather slow in the past decade. I am planning to add to the stock in the next year, subject to availability of funds. However, if a faster growth company like General Mills is available at comparable valuations at the time I have available funds, I would choose General Mills instead.
Full Disclosure: Long K, GIS, NSRGY
Relevant Articles:
- Check the Complete Article Archive
- Nestle (NSRGY): A Global Dividend Powerhouse
- General Mills (GIS) Dividend Stock Analysis
- Dividend income is more stable than capital gains
- What is Dividend Growth Investing?
Wednesday, December 11, 2013
Dividends Provide a Tax-Efficient Form of Income
A famous saying goes that there are two things certain in this world: death and taxes. While I am pretty sure I can’t escape death, I know that I can try to legally minimize taxes as much as possible. I hate paying more taxes than I have to. In a previous series of articles I discussed how I am maxing out tax-deferred accounts today, in order to minimize my tax liabilities as much as possible. In addition, I am trying to get a deduction today, and then roll these amounts into Roth and try to pay as close to zero percent on the conversion as possible. The amounts in tax-deferred accounts will be the tip of the iceberg, or the “safety net” in case my main strategy experiences turbulence. In effect, these tax-deferred accounts are equivalent to an emergency fund for my retirement.
However, I think I didn't stress enough the fact that most of my income in retirement would be coming from qualified dividends. This will be my bread and butter, because dividends provide the best tax-efficient method of income in the US.
Did you know that if you were single, and your taxable income does not exceed $36,250 in 2013, you would owe zero dollars in Federal taxes on your qualified dividend income? If you were married, filing jointly, you won’t owe a dime in taxes on qualified dividends at the Federal level as long as your taxable income does not exceed $72,500.
This means that if you are single, living on your own, and only claiming yourself as a dependent, you can essentially make $46,250 in annual qualified dividend income, and pay zero taxes on that. This includes the Standard Deduction of $6,100 and the Personal Exemption of $3,900. This calculation also assumes you have no other sources of income and no other deductions for the sake of simplicity and to illustrate the point. In order for you to generate so much in income, your portfolio would likely be worth anywhere between $1.321 million and $1.542 million at yields between 3% – 3.50%. If you made your selections wisely, your dividend income should at least keep up with inflation over time. With most dividend growth stocks, I expect a 6% annual dividend increase in the long run, ahead of the annual inflation rate of 3%.
This net dividend income for the single individual above is equivalent to $58,900 in salary earnings. In other words, if you are single, it would take you to earn $58,900 from a day job in order to end up with the same amount of net income that the same individual can achieve with “only” $46,250 in qualified dividend income. And you were wondering why Warren Buffett’s secretary is so vocal about her bosses taxes.
Let’s see how this translates for a married couple, filing jointly, without any kids, mortgages and student loans. They could essentially earn $92,500 in annual qualified dividend income, before owing a single cent to the Federal government in 2013. This includes two standard deductions and two personal exemptions in the tax return. In order for this couple to generate so much in income, their dividend growth portfolio would likely be worth anywhere between $2.643 million and $3.083 million at yields between 3% – 3.50%.
This net dividend income for the married individuals above is equivalent to $117,800 in salary earnings. In other words, if you are married with no children, it would take the couple to earn $117,800 from a day job in order to end up with the same amount of net income they can achieve with “only” $92,500 in qualified dividend income.
For the sake of simplicity, and to illustrate a point about the tax efficiency of dividends, I have compared salary only income versus dividend only income. The tax code is so complicated, that it would probably take me years and hundreds of pages before I can explain every single possible scenario affecting those sample single and married individuals.
I claim that the dividend income is the most efficient form of income in the US, because it can increase over time to compensate for inflation. With municipal bonds, you do not pay any income tax, no matter how much you make. However, since your income is fixed, your “real” purchasing power is decreasing over time. As a result, you are worse off than with dividend stocks over extended periods of time.
I should also mention that ordinary dividend income is taxed like ordinary income. Luckily, this type of dividends are not taxed at the FICA level. Examples of ordinary dividend income includes the income sent your way by Real Estate Investment trusts, net of any depreciation for example. Each REIT has a different tax picture, which also varies every year. I didn’t include these into my scenario above, because I didn’t want to overly complicate something that was already complicated. But feel free to play it out safely at home. If you do not believe me, you can check the website of National Retail Properties (NNN) at this link.
I purposefully also avoided included MLP distributions, because these are even hairier at tax time. These distributions might not even be taxable to you as long as your cost basis is above zero.
Foreign dividends are another type of income which is taxed usually as qualified dividends. The twist is that some governments withhold the tax at the source, which entitles you to a credit. Therefore, if you paid $15 in dividend taxes to Canada on your $100 dividend check from Canadian National Railway (CNI), you don’t also have to pay Uncle Sam $15 additional dollars in dividend income. You can essentially get a credit for this. If you are single earning under $46,250 in dividend income, you might even get a check in the mail for $15.
Full Disclosure: I am not a tax advisor, and this article should not be considered as individual tax advice. Please discuss your individual tax situation with a licensed CPA. I have no position in the companies listed above.
Relevant Articles:
- Best International Dividend Stocks
- My Retirement Strategy for Tax-Free Income
- How to Retire Early With Tax-Advantaged Accounts
- Six Dividend Paying Stocks I Purchased for my IRA
- Should income investors worry about higher dividend taxes?
However, I think I didn't stress enough the fact that most of my income in retirement would be coming from qualified dividends. This will be my bread and butter, because dividends provide the best tax-efficient method of income in the US.
Did you know that if you were single, and your taxable income does not exceed $36,250 in 2013, you would owe zero dollars in Federal taxes on your qualified dividend income? If you were married, filing jointly, you won’t owe a dime in taxes on qualified dividends at the Federal level as long as your taxable income does not exceed $72,500.
This means that if you are single, living on your own, and only claiming yourself as a dependent, you can essentially make $46,250 in annual qualified dividend income, and pay zero taxes on that. This includes the Standard Deduction of $6,100 and the Personal Exemption of $3,900. This calculation also assumes you have no other sources of income and no other deductions for the sake of simplicity and to illustrate the point. In order for you to generate so much in income, your portfolio would likely be worth anywhere between $1.321 million and $1.542 million at yields between 3% – 3.50%. If you made your selections wisely, your dividend income should at least keep up with inflation over time. With most dividend growth stocks, I expect a 6% annual dividend increase in the long run, ahead of the annual inflation rate of 3%.
This net dividend income for the single individual above is equivalent to $58,900 in salary earnings. In other words, if you are single, it would take you to earn $58,900 from a day job in order to end up with the same amount of net income that the same individual can achieve with “only” $46,250 in qualified dividend income. And you were wondering why Warren Buffett’s secretary is so vocal about her bosses taxes.
Let’s see how this translates for a married couple, filing jointly, without any kids, mortgages and student loans. They could essentially earn $92,500 in annual qualified dividend income, before owing a single cent to the Federal government in 2013. This includes two standard deductions and two personal exemptions in the tax return. In order for this couple to generate so much in income, their dividend growth portfolio would likely be worth anywhere between $2.643 million and $3.083 million at yields between 3% – 3.50%.
This net dividend income for the married individuals above is equivalent to $117,800 in salary earnings. In other words, if you are married with no children, it would take the couple to earn $117,800 from a day job in order to end up with the same amount of net income they can achieve with “only” $92,500 in qualified dividend income.
I claim that the dividend income is the most efficient form of income in the US, because it can increase over time to compensate for inflation. With municipal bonds, you do not pay any income tax, no matter how much you make. However, since your income is fixed, your “real” purchasing power is decreasing over time. As a result, you are worse off than with dividend stocks over extended periods of time.
I should also mention that ordinary dividend income is taxed like ordinary income. Luckily, this type of dividends are not taxed at the FICA level. Examples of ordinary dividend income includes the income sent your way by Real Estate Investment trusts, net of any depreciation for example. Each REIT has a different tax picture, which also varies every year. I didn’t include these into my scenario above, because I didn’t want to overly complicate something that was already complicated. But feel free to play it out safely at home. If you do not believe me, you can check the website of National Retail Properties (NNN) at this link.
I purposefully also avoided included MLP distributions, because these are even hairier at tax time. These distributions might not even be taxable to you as long as your cost basis is above zero.
Foreign dividends are another type of income which is taxed usually as qualified dividends. The twist is that some governments withhold the tax at the source, which entitles you to a credit. Therefore, if you paid $15 in dividend taxes to Canada on your $100 dividend check from Canadian National Railway (CNI), you don’t also have to pay Uncle Sam $15 additional dollars in dividend income. You can essentially get a credit for this. If you are single earning under $46,250 in dividend income, you might even get a check in the mail for $15.
Full Disclosure: I am not a tax advisor, and this article should not be considered as individual tax advice. Please discuss your individual tax situation with a licensed CPA. I have no position in the companies listed above.
Relevant Articles:
- Best International Dividend Stocks
- My Retirement Strategy for Tax-Free Income
- How to Retire Early With Tax-Advantaged Accounts
- Six Dividend Paying Stocks I Purchased for my IRA
- Should income investors worry about higher dividend taxes?
Tuesday, December 10, 2013
These three ideas can jeopardize your investing success
I have been writing about dividend investing on my website since 2008. This was a very tumultuous period for investors, which included sharp drops in prices through 2009, followed by a relentless recovery in stock prices ever since. As someone who gets a lot of interaction with regular investors through my website, I get to develop an understanding of popular investor sentiment almost at all times.
As a long term investor, I find overall investor sentiment to be counterproductive for me, because it removes my focus on what really matters for my investing strategy. In my strategy, I try to acquire tiny pieces of ownership at attractive valuations, in large established dividend growing companies . These companies usually have a product or service that is unique and which customers purchase repeatedly. Many of these products are essentials that people use on an everyday basis, and are therefore relatively immune to recessions. The goal is also to purchase businesses that I can understand, and that would still be there in 20 years, while maintaining a strong competitive position. I also try to determine whether there are any catalysts that would bring more earnings per share and hopefully more dividends in 10 – 20 years. I expect to hold on to these companies for decades, or until something material changes that would make me want to sell. As such, I do not try forecast the direction of the stock market. In order to make my living. I simply have to find enough quality businesses selling at fair prices, and put my capital there.
My success as an investor will depend on the overall level of success of the collection of businesses I partially own in my portfolio. For example, if Colgate Palmolive (CL) manages to sell more toothpaste in 20 – 30 years, it would likely earn more and pay higher dividends to me. In addition, if the rising number of babies in the US and China translates into the need for more diapers every year, Procter & Gamble (PG) would be able to sell more to new mothers. This is the type of things you should focus on as a long-term investor. In contrast, a lot of investors try to forecast interest rates, economic growth, quarterly earnings and so forth. This might be helpful for anyone who actively trades the markets, but is pretty useless for me as an investor in businesses.
Ever since the end of 2009, the common sentiment I have heard from investors is that stocks are too high. I have been hearing that at least several times per year since then. There is always “a reason” why stocks as a whole should not go up. So far in 2013, I have been hearing that non-stop. Two indicators that many investors seems to be using as a reason to avoid stocks these days are the market capitalization to GDP ratio, and the Schiller CAPE Ratio. The last item I will discuss are perma-bears, and the dangers they pose for long-term investors.
The market capitalization to GDP indicator is calculated by dividing the total US market capitalization to the level of GDP. Extremely high levels are supposed to have predicted the 1929 stock market collapse. However, I do not subscribe to this black magic for a few reasons. The first is that the increase in this ratio might not mean anything, especially as we have an increased financialization of assets. Estimated wealth in the US is approximately 3- 4 times the level of GDP or Market capitalization. If all the office buildings or rental units are no longer owned by private landlords, but are owned by publicly traded companies listed on NYSE, this would increase the Market Cap to GDP ratio. Therefore, all the increase in Market Cap to GDP ratio would show is that most of the wealth is now listed on a stock exchange. The second reason I believe that the Market cap to GDP is not useful these days, is because a large portion of US company profits are generated outside the US. For example, the ten largest components of S&P 500 derive almost half of sales from outside the US. In reality, I am not sure why any change in the market capitalization to GDP would mean anything of value to the dividend investor. A dividend investor should look at individual companies, and how their business is doing, and not make a macro bet on things.
I also don’t follow Shillers Cyclically Adjusted P/E Ratio (CAPE), because it gives value to earnings which happened 10 years ago. For example, if a stock earned $50/share starting in 2004 for 5 years, but for past 5 years earns $100/share and EPS is relatively sustainable, should the stock be valued at 15 times times $75 (average of EPS over the past decade) or 15 times $100? This indicator has had stocks overvalued for several years since 2009, and currently is close to 25. In reality, S&P 500 has a P/E ratio of 18 or 19 times earnings, which got a little overstretched in 2013. Based on forward estimate however, the P/E ratio on stocks in general looks fair. However, as an individual investor, my goal is to pick individual stocks, not have opinions on everything that is publicly traded on a stock exchange.
To put it in layman terms, in my previous job, new hires started at $48,000/year. Approximately 10 years before, the starting salary was $36,000/year. During recruiting, the potential new hires never asked the recruiter what the salary was five or ten years ago. All they cared about is the income they will make this year.
I do agree that starting valuations have an impact on the returns an investor will generate. For example, if you paid 30 or 40 times this or next year’s earnings even for a blue chip stock like Coca-Cola (KO) or Wal-Mart Stores (WMT), you would not do very well. This is because your initial dividend yield will be ridiculously low, and the price you paid would have all the growth for the next decade already baked into it. In the case of Coca-Cola and Wal-Mart investors, who overpaid in 1999 – 2000, earned low returns over the subsequent decade. This was despite the fact that the underlying businesses produced stellar operating results during the same time period. In addition, one should focus on the current and future ability of the business to generate profits, and not focus on profits that were generated 5 or 10 years ago.
That being said, I can find fewer good candidates to buy today than a year ago. However, there are few alternatives to stocks today, especially when fixed income securities won’t cover even a minimal increase in inflation.
Another item I always choose to ignore are opinions from Perma-Bears. Perma-Bears are those highly intelligent analysts, who unfortunately always forecast doom and gloom. You can always find a perma-bear that would give you the reasons why stocks are going to crash by 50-80% - just pick a number. Now it is entirely possible that stock prices collapse and this triggers an economic contraction. However, the US economy is resilient and diversified, and US policy makers have managed to step up to the plate in difficult conditions to help out. Therefore, if we are lucky enough to get a stock market crash, this would be a short term opportunity for long-term investors to load up on quality companies at depressed prices. I believe that the future will bring in more people, more innovations, and a higher standard of living for humans. I see billions of people that are going to be lifted out of poverty over the 21st century. These people are very motivated to work hard and achieve their dreams, and lift themselves out of the poverty that previous generations lived under.
Every morning, several billion people wake-up, and ask themselves how to live better lives for themselves, their families and their communities. If you believe that social order as we know it will collapse, and you are stocking up on guns, ammunition and gold, then chances are you will never be wealthy. Even at the super unlikely event that this happens, you will not do well, because the guns and gold can and would be taken away from you by a stronger opponent. Even for those milder forecasts of a mere depression coupled with stock market crashes, these occur only a few times per century. Are you willing to be wrong for 30 years in a row and miss out on a few thousand percent of gains, for the ability to predict a mere 50% crash? If you look at a long-term chart of Dow Jones Industrial's over the past century, you would see the 1929 – 1932 crash as a mere blip on that chart.
Don’t be perma bull either. Be realist, and put money in opportunities where you stand to have a chance to make more than what you put in. Even in 1999-2000, there were pockets of opportunity for enterprising dividend investors. While difficult than a year ago, one can still find pockets of opportunity today also. You just have to look harder, and be able to capitalize on the rare selloffs.
There are some investors who have been patiently waiting for a 40-50% crash FOR FIVE YEARS, and thus have ended up missing out on the recovery. Even if stocks did crash by 40% tomorrow, their performance would still lag a buy and hold of an index fund. There are a few perma-bears, who supposedly forecasted the 1987 stock market crash. Over the past 26 years however, I think they have continued being bearish. I don’t think you should be bearish on America if you are a long term investor. I also do not understand how someone can afford to lose money for a quarter century, and still be quoted in mainstream media.
As I discussed in my article from yesterday, investors should be very careful about taking other's opinions at face value. You need to weigh in the credibility of this opinion, against relevant facts, before making a decision of whether it needs to be taken seriously or not.
Full Disclosure: Long CL, PG, KO, WMT
Relevant Articles:
- Check the Complete Article Archive
-Living off dividends in retirement
- Dividends and The Great Depression
- Dividend Cuts - the worst nightmare for dividend investors
- Six things I learned from the financial crisis
As a long term investor, I find overall investor sentiment to be counterproductive for me, because it removes my focus on what really matters for my investing strategy. In my strategy, I try to acquire tiny pieces of ownership at attractive valuations, in large established dividend growing companies . These companies usually have a product or service that is unique and which customers purchase repeatedly. Many of these products are essentials that people use on an everyday basis, and are therefore relatively immune to recessions. The goal is also to purchase businesses that I can understand, and that would still be there in 20 years, while maintaining a strong competitive position. I also try to determine whether there are any catalysts that would bring more earnings per share and hopefully more dividends in 10 – 20 years. I expect to hold on to these companies for decades, or until something material changes that would make me want to sell. As such, I do not try forecast the direction of the stock market. In order to make my living. I simply have to find enough quality businesses selling at fair prices, and put my capital there.
My success as an investor will depend on the overall level of success of the collection of businesses I partially own in my portfolio. For example, if Colgate Palmolive (CL) manages to sell more toothpaste in 20 – 30 years, it would likely earn more and pay higher dividends to me. In addition, if the rising number of babies in the US and China translates into the need for more diapers every year, Procter & Gamble (PG) would be able to sell more to new mothers. This is the type of things you should focus on as a long-term investor. In contrast, a lot of investors try to forecast interest rates, economic growth, quarterly earnings and so forth. This might be helpful for anyone who actively trades the markets, but is pretty useless for me as an investor in businesses.
Ever since the end of 2009, the common sentiment I have heard from investors is that stocks are too high. I have been hearing that at least several times per year since then. There is always “a reason” why stocks as a whole should not go up. So far in 2013, I have been hearing that non-stop. Two indicators that many investors seems to be using as a reason to avoid stocks these days are the market capitalization to GDP ratio, and the Schiller CAPE Ratio. The last item I will discuss are perma-bears, and the dangers they pose for long-term investors.
The market capitalization to GDP indicator is calculated by dividing the total US market capitalization to the level of GDP. Extremely high levels are supposed to have predicted the 1929 stock market collapse. However, I do not subscribe to this black magic for a few reasons. The first is that the increase in this ratio might not mean anything, especially as we have an increased financialization of assets. Estimated wealth in the US is approximately 3- 4 times the level of GDP or Market capitalization. If all the office buildings or rental units are no longer owned by private landlords, but are owned by publicly traded companies listed on NYSE, this would increase the Market Cap to GDP ratio. Therefore, all the increase in Market Cap to GDP ratio would show is that most of the wealth is now listed on a stock exchange. The second reason I believe that the Market cap to GDP is not useful these days, is because a large portion of US company profits are generated outside the US. For example, the ten largest components of S&P 500 derive almost half of sales from outside the US. In reality, I am not sure why any change in the market capitalization to GDP would mean anything of value to the dividend investor. A dividend investor should look at individual companies, and how their business is doing, and not make a macro bet on things.
Source: Barry Ritholz
Source: Multipl
To put it in layman terms, in my previous job, new hires started at $48,000/year. Approximately 10 years before, the starting salary was $36,000/year. During recruiting, the potential new hires never asked the recruiter what the salary was five or ten years ago. All they cared about is the income they will make this year.
I do agree that starting valuations have an impact on the returns an investor will generate. For example, if you paid 30 or 40 times this or next year’s earnings even for a blue chip stock like Coca-Cola (KO) or Wal-Mart Stores (WMT), you would not do very well. This is because your initial dividend yield will be ridiculously low, and the price you paid would have all the growth for the next decade already baked into it. In the case of Coca-Cola and Wal-Mart investors, who overpaid in 1999 – 2000, earned low returns over the subsequent decade. This was despite the fact that the underlying businesses produced stellar operating results during the same time period. In addition, one should focus on the current and future ability of the business to generate profits, and not focus on profits that were generated 5 or 10 years ago.
That being said, I can find fewer good candidates to buy today than a year ago. However, there are few alternatives to stocks today, especially when fixed income securities won’t cover even a minimal increase in inflation.
Another item I always choose to ignore are opinions from Perma-Bears. Perma-Bears are those highly intelligent analysts, who unfortunately always forecast doom and gloom. You can always find a perma-bear that would give you the reasons why stocks are going to crash by 50-80% - just pick a number. Now it is entirely possible that stock prices collapse and this triggers an economic contraction. However, the US economy is resilient and diversified, and US policy makers have managed to step up to the plate in difficult conditions to help out. Therefore, if we are lucky enough to get a stock market crash, this would be a short term opportunity for long-term investors to load up on quality companies at depressed prices. I believe that the future will bring in more people, more innovations, and a higher standard of living for humans. I see billions of people that are going to be lifted out of poverty over the 21st century. These people are very motivated to work hard and achieve their dreams, and lift themselves out of the poverty that previous generations lived under.
Every morning, several billion people wake-up, and ask themselves how to live better lives for themselves, their families and their communities. If you believe that social order as we know it will collapse, and you are stocking up on guns, ammunition and gold, then chances are you will never be wealthy. Even at the super unlikely event that this happens, you will not do well, because the guns and gold can and would be taken away from you by a stronger opponent. Even for those milder forecasts of a mere depression coupled with stock market crashes, these occur only a few times per century. Are you willing to be wrong for 30 years in a row and miss out on a few thousand percent of gains, for the ability to predict a mere 50% crash? If you look at a long-term chart of Dow Jones Industrial's over the past century, you would see the 1929 – 1932 crash as a mere blip on that chart.
Don’t be perma bull either. Be realist, and put money in opportunities where you stand to have a chance to make more than what you put in. Even in 1999-2000, there were pockets of opportunity for enterprising dividend investors. While difficult than a year ago, one can still find pockets of opportunity today also. You just have to look harder, and be able to capitalize on the rare selloffs.
There are some investors who have been patiently waiting for a 40-50% crash FOR FIVE YEARS, and thus have ended up missing out on the recovery. Even if stocks did crash by 40% tomorrow, their performance would still lag a buy and hold of an index fund. There are a few perma-bears, who supposedly forecasted the 1987 stock market crash. Over the past 26 years however, I think they have continued being bearish. I don’t think you should be bearish on America if you are a long term investor. I also do not understand how someone can afford to lose money for a quarter century, and still be quoted in mainstream media.
As I discussed in my article from yesterday, investors should be very careful about taking other's opinions at face value. You need to weigh in the credibility of this opinion, against relevant facts, before making a decision of whether it needs to be taken seriously or not.
Full Disclosure: Long CL, PG, KO, WMT
Relevant Articles:
- Check the Complete Article Archive
-Living off dividends in retirement
- Dividends and The Great Depression
- Dividend Cuts - the worst nightmare for dividend investors
- Six things I learned from the financial crisis
Monday, December 9, 2013
The work required to have an opinion
The stock market is a very interesting place, because for every transaction you have a buyer and a seller who both think are smarter than the other person. Unfortunately, only one of them ends up making money. As a dividend investor, I am exposed to opinions all the time.
I usually choose to ignore other’s opinions. I suggest you also implement a filter on who to listen to. I will explain why in this article.
My strategy is based on purchasing shares in undervalued dividend stocks, that have a history of growing distributions. I make these purchases after analyzing these companies one at a time, and find a catalyst that would help each company to potentially earn more in the future. This could include the ability to increase prices ahead of costs, cut costs through increasing efficiencies, expand in new markets etc. The rising profits at the company level could then fuel future dividend growth. I spend my free time reading about companies I own, and reading about companies I want to own, while waiting for prices to get down to a reasonable level before I invest. I also spend time thinking about my investments, monitoring them, and asking myself if the companies will still be relevant 20 years from now.
My financial well-being in retirement is based on my own efforts to do the work and choose stocks wisely. This is why I am more prone to be overly conservative, because I would rather be safe than sorry. However, this provides me the incentive to not only avoid losing principal at all costs, but also avoid getting into dogs that use my capital but fail to shower me with a growing pile of cash every year. I have confidence in my work as a result of the process I have, following the stocks I follow and monitoring my investments. I know that I won’t win every single time, and I know I would probably do many stupid things along the way. That is ok, as long as I learn from them and on the aggregate I am ahead.
I view others opinions as merely obstacles that prevent me from executing my own strategy. There are many negatives associated with taking someone’s opinions to heart:
- If you get conflicting arguments against a stock you strongly believe in, you might get hesitant and fail to pull the trigger. Any time I buy a stock there is always a reason not to buy it and someone to point that reason in my face. As an investor however, my goal is not to be right but to make money. Very often these “reasons” not to invest are merely useless pieces of random information that won’t affect the profits of the company you are investing in. For example, tobacco has been known for its harmful effects on health, yet companies like Altria (MO) have delivered some of the best returns to investors over the past 20 – 30 - 50 years. The thing that mattered is that hiking cigarette prices and cutting costs outweighed decreasing number of smokers. Actually some of the best times to buy a security is when everyone hates investing in it. Back in 2008 – 2009 everyone was expecting the world as we know it to end, and for a while it did seem that way. Yet in hindsight, this was the time to put every dollar you could get your hands on quality dividend growth stocks selling at ridiculously cheap valuations. I did buy a lot of stocks back in 2008 – 2009, but in hindsight I should have bought more.
- The person who is criticizing you might not know what they are talking about. Very frequently I get in touch with someone who is biased based on limited amount of homework they have done. Quite often, these individuals might have overheard something, and might have decided for themselves that it is the truth, and would not hesitate to present their opinion. For example, since 2009, people have been scared of hyperinflation because the Fed had pumped billions of dollars into the economy. As I had explained earlier, the government simply stepped into the economy, to substitute the private sector that was afraid to do much. Yet, a reader told me that they won’t read my site anymore, because I was wrong. I wish them well, but I can’t let what my readers might or might not think influence my investing strategy.
- The person who is giving you their opinion might be out there to sell you something. Any time I talk about dividend investing, someone always tells me that it is a bad strategy because they think so. One financial adviser routinely bashes dividend investing (link to my rebuttal), but I assume he does that because he feels threatened that self-directed investors would not need someone to hold their hands in exchange for a percentage of their assets every year.
- The person who is criticizing you might be focusing on minutiae (missing the forest for the trees). For example, I often hear things that illustrate that the person I discuss investments with is focused on recent events that they might have heard on the radio, TV, newspapers etc. These items might be great for selling newspapers, but that might not make them relevant to an investor. Back in early 2008, everyone was convinced that Oil was going to $200/barrel, that the US dollar was toast and therefore companies should have international exposure. After Lehman failed, the rest of the world was not doing well relative to the US dollar, and therefore international exposure was bad. For any serious long-term investor, currency fluctuations in the global operations of multinationals like Phillip Morris International (PM) are mostly a wash. Do not let them influence your decision to buy or sell a stock. In addition, companies that fail to meet or exceed Wall Street estimates by a penny and sell-off, provide another example of minutiae or irrelevant facts that you should mostly ignore in your decision making. If you hold Coca-Cola (KO) for the next 20 years, would it matter if it had one bad quarter in 2014 where it missed Wall Street consensus by 1 penny?
- There are always two sides to an argument – For example, some investors want to concentrate their portfolios in less than 10 stocks, others want to hold as many stocks as possible, while a third group might fall somewhere in the middle. For example, I fall closer to the group that espouses owning as many companies that are of good quality, if they are purchased at fair prices and offer the possibility for long term dividend wealth creation. I am totally fine with the fact that investors would disagree with me on holding positions in 50 – 60 securities. This is because what I do is meant to accomplish my goals, and not what Joe thinks of my strategy. As an investor, you should do what you are comfortable with, as long as you have a good reason and have done the homework on the topic. If you built your portfolio of 40 stocks over the past decade, but none of them are buys today, it might make perfect sense to purchase 10 - 20 additional quality companies that are available at reasonable prices. Otherwise, you might find yourself with too much cash on hand, which could cause pressure that you are missing out, especially if prices start rising.
- The persons you are talking with, might not understand your strategy or have a different strategy. For example, when I purchased shares of IBM after it fell in October, a reader posted an analysis of the company from another source. The other source mentioned that the stock should not be acquired. I replied to the reader that I do not care about this other analysis, because I was following my strategy. One should not never others opinions influence their decisions, particularly if they have done the work needed to have their initial conviction in the first place.
If you have done the work, someone who doesn't agree with you should not have an impact on your decision. In fact, some of my best bets have been at a time when the majority of investors disagreed with me. Actually, since 2009, it seemed that almost everyone disagreed with me on buying stocks.
However, if I found out new and material information about my investment, I should evaluate whether it impacts my analysis or not. But if you let random people's opinions influence your decisions, then you are doing yourself a disservice.
- They might be bad investors. The thing is that I do not take others opinions into consideration, because I never know if the person has done their homework, what their level of experience is, and whether they are using facts, or whether they are simply biased against something for whatever reason. However, I do review these opinions especially if they come from someone who I regard as knowledgeable. Those are not only the Warren Buffett, Charlie Munger, and Peter Lynch of the world however. It could be an ordinary investor, who can also provide some you with a nice dose of common sense when you most need it. These investors are rare, but once you find them, hold on to them for their opinion. If I learn a fact that I have not come across during my analysis of a stock, I would seriously consider it, and determine how it impacts the probabilistic outcome of my investment, if it came from a reputable source. I do not subscribe to conspiracy theories on investment matters however. For anyone else who is untested, you would do well for yourself if you ignore them, after applying your BS filter.
The truth however is that sometimes, investors make mistakes. I make my fair share of mistakes on a monthly basis. Input from other smart investors can catch any blind spots in my research. However, if I had done a good job in analyzing securities, any “opinions” I receive should not bring anything new to the table. If they do bring something new and material, then I should definitely evaluate them. For example, when I was first starting out as a dividend investor in 2007-2008, I analyzed Realty Income (O) and determined that it was a terrible investment. This was because I was doing the mistake of looking at earnings per share, and hadn't even heard about Funds From Operations (FFO). After I learned about my mistake, I did some work researching this new theory on valuing REITs and determining for myself whether it made sense. I realized I was wrong, and in a subsequent analysis decided it was an attractive investment. As you gain experience in investing, you would notice certain recurring opinion themes you need to ignore at all times, such as conspiracy theories or constant doom and gloom. However, you should also be able to distinguish opinion that are well grounded in facts, which require further investigation on your part.
Another example includes my attitude towards taxation and investing. For as long as possible, my attitude has been that my goal is to earn money first, and only then worry about taxes. However, after reviewing my tax situation for several years I realized I was wrong to ignore taxation issues. If I have to sell a stock, I sell it regardless if it would produce long or short-term gain, since I don't want to turn gains into losses. However, I am trying to max out 401 (k) and IRA accounts today, in order to gain the most in tax benefits. My goal is to then convert those amounts slowly into a Roth IRA after I retire. I was inspired by blogger J Money on gaining the most in tax deductions today. However, I think I came up with the idea to perform a Roth IRA rollover and pay low taxes on it myself. I think.
Another example includes my recent monitoring of Procter & Gamble (PG). I have been accumulating the stock of this dividend king for several years. However, while it has been able to increase dividends every year for over 5 decades, it has been unable to increase earnings per share since earning $4.26/share in 2009. This means that dividend growth has been running on fumes over the past four years, while I have been patiently hoping for earnings growth to materialize. This means that I should not be buying more shares in this company for the time being. I would still be holding on to my shares, as the risk of dividend cut looks remote. At this point it looks as if future dividend growth would likely exceed inflation only slightly. As a long-term investor, you sometimes have to be able to change your mind, when presented with facts that might run contrary to your opinions too. I think that Procter & Gamble is a core holding for any dividend investor, but if the company cannot grow earnings per share over the next decade, I would not add any money there and would use the dividend checks elsewhere. If they cut the dividend, I would close my position one minute after the announcement.
This is why investing is more of an art than science – you can probably ignore the opinions of the people that haven’t done any homework, but you should be aware of differing opinions that bring a material fact you haven’t previously considered. By practicing the art of stock picking for a long time, you would likely be able to distinguish which one deserves your attention, and which group doesn't.
Full Disclosure: Long PG, O, IBM
Relevant Articles:
- Check the Complete Article Archive
- Dividend Investing is not a black or white process
- Dividend Investing – Science versus Intuition
- Dividend Investing Goals for 2013
- My Dividend Retirement Plan
I usually choose to ignore other’s opinions. I suggest you also implement a filter on who to listen to. I will explain why in this article.
My strategy is based on purchasing shares in undervalued dividend stocks, that have a history of growing distributions. I make these purchases after analyzing these companies one at a time, and find a catalyst that would help each company to potentially earn more in the future. This could include the ability to increase prices ahead of costs, cut costs through increasing efficiencies, expand in new markets etc. The rising profits at the company level could then fuel future dividend growth. I spend my free time reading about companies I own, and reading about companies I want to own, while waiting for prices to get down to a reasonable level before I invest. I also spend time thinking about my investments, monitoring them, and asking myself if the companies will still be relevant 20 years from now.
My financial well-being in retirement is based on my own efforts to do the work and choose stocks wisely. This is why I am more prone to be overly conservative, because I would rather be safe than sorry. However, this provides me the incentive to not only avoid losing principal at all costs, but also avoid getting into dogs that use my capital but fail to shower me with a growing pile of cash every year. I have confidence in my work as a result of the process I have, following the stocks I follow and monitoring my investments. I know that I won’t win every single time, and I know I would probably do many stupid things along the way. That is ok, as long as I learn from them and on the aggregate I am ahead.
I view others opinions as merely obstacles that prevent me from executing my own strategy. There are many negatives associated with taking someone’s opinions to heart:
- If you get conflicting arguments against a stock you strongly believe in, you might get hesitant and fail to pull the trigger. Any time I buy a stock there is always a reason not to buy it and someone to point that reason in my face. As an investor however, my goal is not to be right but to make money. Very often these “reasons” not to invest are merely useless pieces of random information that won’t affect the profits of the company you are investing in. For example, tobacco has been known for its harmful effects on health, yet companies like Altria (MO) have delivered some of the best returns to investors over the past 20 – 30 - 50 years. The thing that mattered is that hiking cigarette prices and cutting costs outweighed decreasing number of smokers. Actually some of the best times to buy a security is when everyone hates investing in it. Back in 2008 – 2009 everyone was expecting the world as we know it to end, and for a while it did seem that way. Yet in hindsight, this was the time to put every dollar you could get your hands on quality dividend growth stocks selling at ridiculously cheap valuations. I did buy a lot of stocks back in 2008 – 2009, but in hindsight I should have bought more.
- The person who is criticizing you might not know what they are talking about. Very frequently I get in touch with someone who is biased based on limited amount of homework they have done. Quite often, these individuals might have overheard something, and might have decided for themselves that it is the truth, and would not hesitate to present their opinion. For example, since 2009, people have been scared of hyperinflation because the Fed had pumped billions of dollars into the economy. As I had explained earlier, the government simply stepped into the economy, to substitute the private sector that was afraid to do much. Yet, a reader told me that they won’t read my site anymore, because I was wrong. I wish them well, but I can’t let what my readers might or might not think influence my investing strategy.
- The person who is giving you their opinion might be out there to sell you something. Any time I talk about dividend investing, someone always tells me that it is a bad strategy because they think so. One financial adviser routinely bashes dividend investing (link to my rebuttal), but I assume he does that because he feels threatened that self-directed investors would not need someone to hold their hands in exchange for a percentage of their assets every year.
- The person who is criticizing you might be focusing on minutiae (missing the forest for the trees). For example, I often hear things that illustrate that the person I discuss investments with is focused on recent events that they might have heard on the radio, TV, newspapers etc. These items might be great for selling newspapers, but that might not make them relevant to an investor. Back in early 2008, everyone was convinced that Oil was going to $200/barrel, that the US dollar was toast and therefore companies should have international exposure. After Lehman failed, the rest of the world was not doing well relative to the US dollar, and therefore international exposure was bad. For any serious long-term investor, currency fluctuations in the global operations of multinationals like Phillip Morris International (PM) are mostly a wash. Do not let them influence your decision to buy or sell a stock. In addition, companies that fail to meet or exceed Wall Street estimates by a penny and sell-off, provide another example of minutiae or irrelevant facts that you should mostly ignore in your decision making. If you hold Coca-Cola (KO) for the next 20 years, would it matter if it had one bad quarter in 2014 where it missed Wall Street consensus by 1 penny?
- There are always two sides to an argument – For example, some investors want to concentrate their portfolios in less than 10 stocks, others want to hold as many stocks as possible, while a third group might fall somewhere in the middle. For example, I fall closer to the group that espouses owning as many companies that are of good quality, if they are purchased at fair prices and offer the possibility for long term dividend wealth creation. I am totally fine with the fact that investors would disagree with me on holding positions in 50 – 60 securities. This is because what I do is meant to accomplish my goals, and not what Joe thinks of my strategy. As an investor, you should do what you are comfortable with, as long as you have a good reason and have done the homework on the topic. If you built your portfolio of 40 stocks over the past decade, but none of them are buys today, it might make perfect sense to purchase 10 - 20 additional quality companies that are available at reasonable prices. Otherwise, you might find yourself with too much cash on hand, which could cause pressure that you are missing out, especially if prices start rising.
- The persons you are talking with, might not understand your strategy or have a different strategy. For example, when I purchased shares of IBM after it fell in October, a reader posted an analysis of the company from another source. The other source mentioned that the stock should not be acquired. I replied to the reader that I do not care about this other analysis, because I was following my strategy. One should not never others opinions influence their decisions, particularly if they have done the work needed to have their initial conviction in the first place.
If you have done the work, someone who doesn't agree with you should not have an impact on your decision. In fact, some of my best bets have been at a time when the majority of investors disagreed with me. Actually, since 2009, it seemed that almost everyone disagreed with me on buying stocks.
However, if I found out new and material information about my investment, I should evaluate whether it impacts my analysis or not. But if you let random people's opinions influence your decisions, then you are doing yourself a disservice.
- They might be bad investors. The thing is that I do not take others opinions into consideration, because I never know if the person has done their homework, what their level of experience is, and whether they are using facts, or whether they are simply biased against something for whatever reason. However, I do review these opinions especially if they come from someone who I regard as knowledgeable. Those are not only the Warren Buffett, Charlie Munger, and Peter Lynch of the world however. It could be an ordinary investor, who can also provide some you with a nice dose of common sense when you most need it. These investors are rare, but once you find them, hold on to them for their opinion. If I learn a fact that I have not come across during my analysis of a stock, I would seriously consider it, and determine how it impacts the probabilistic outcome of my investment, if it came from a reputable source. I do not subscribe to conspiracy theories on investment matters however. For anyone else who is untested, you would do well for yourself if you ignore them, after applying your BS filter.
The truth however is that sometimes, investors make mistakes. I make my fair share of mistakes on a monthly basis. Input from other smart investors can catch any blind spots in my research. However, if I had done a good job in analyzing securities, any “opinions” I receive should not bring anything new to the table. If they do bring something new and material, then I should definitely evaluate them. For example, when I was first starting out as a dividend investor in 2007-2008, I analyzed Realty Income (O) and determined that it was a terrible investment. This was because I was doing the mistake of looking at earnings per share, and hadn't even heard about Funds From Operations (FFO). After I learned about my mistake, I did some work researching this new theory on valuing REITs and determining for myself whether it made sense. I realized I was wrong, and in a subsequent analysis decided it was an attractive investment. As you gain experience in investing, you would notice certain recurring opinion themes you need to ignore at all times, such as conspiracy theories or constant doom and gloom. However, you should also be able to distinguish opinion that are well grounded in facts, which require further investigation on your part.
Another example includes my attitude towards taxation and investing. For as long as possible, my attitude has been that my goal is to earn money first, and only then worry about taxes. However, after reviewing my tax situation for several years I realized I was wrong to ignore taxation issues. If I have to sell a stock, I sell it regardless if it would produce long or short-term gain, since I don't want to turn gains into losses. However, I am trying to max out 401 (k) and IRA accounts today, in order to gain the most in tax benefits. My goal is to then convert those amounts slowly into a Roth IRA after I retire. I was inspired by blogger J Money on gaining the most in tax deductions today. However, I think I came up with the idea to perform a Roth IRA rollover and pay low taxes on it myself. I think.
Another example includes my recent monitoring of Procter & Gamble (PG). I have been accumulating the stock of this dividend king for several years. However, while it has been able to increase dividends every year for over 5 decades, it has been unable to increase earnings per share since earning $4.26/share in 2009. This means that dividend growth has been running on fumes over the past four years, while I have been patiently hoping for earnings growth to materialize. This means that I should not be buying more shares in this company for the time being. I would still be holding on to my shares, as the risk of dividend cut looks remote. At this point it looks as if future dividend growth would likely exceed inflation only slightly. As a long-term investor, you sometimes have to be able to change your mind, when presented with facts that might run contrary to your opinions too. I think that Procter & Gamble is a core holding for any dividend investor, but if the company cannot grow earnings per share over the next decade, I would not add any money there and would use the dividend checks elsewhere. If they cut the dividend, I would close my position one minute after the announcement.
This is why investing is more of an art than science – you can probably ignore the opinions of the people that haven’t done any homework, but you should be aware of differing opinions that bring a material fact you haven’t previously considered. By practicing the art of stock picking for a long time, you would likely be able to distinguish which one deserves your attention, and which group doesn't.
Full Disclosure: Long PG, O, IBM
Relevant Articles:
- Check the Complete Article Archive
- Dividend Investing is not a black or white process
- Dividend Investing – Science versus Intuition
- Dividend Investing Goals for 2013
- My Dividend Retirement Plan
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