Many investors who are looking for an income stream in retirement choose the relative safety of US Treasury bonds. While the coupon payments lose their purchasing power each year due to inflation, they are fixed and guaranteed by the US government. This makes budgeting expenses somewhat easier. With dividend stocks on the other hand, distributions are not guaranteed which is probably why pundits advise retirees to increase their asset location in fixed income instruments. This is despite the fact that for most US companies which pay dividends, distributions do not fluctuate.
Most companies try to get a following from long-term investors by enticing them with a stable or growing distribution over time. That way there is a greater chance that those investors would not sell even under the best or worst of circumstances. If dividend growers have a stable business model which allows them to pass on cost of increases to their customers while still earning a respectable return on capital, they could afford to raise distributions to their stockholders. Stocks that pay rising distributions could essentially provide investors with a real inflation adjusted stream of income, which is something that most fixed income securities do not provide. This makes it easier for investors to budget for their expenses, since their revenues would now be keeping up pace with inflation. One issue with these payers however is that they offer yields ranging from 3% to 5%, which is not enough for some investors.
Not all dividend stocks pay a stable distribution however. Some high yielding but speculative stocks which investors hold pay dividends which fluctuate from quarter to quarter. Companies which pay all of their operating earnings are typically the ones which pay fluctuating dividends. Examples include Canadian royalty trusts such as Pengrowth (PGH), PennWest (PWE) and shipping companies such as Nordic American Tanker (NAT). These stocks spot high yields most of the times, which might not truly reflect the yield on cost of original holders. Pengrowth Energy (PGH) for example yielded 15.30% at the end of 2007 while paying out a distribution of 22.70 cents monthly. Two years later it paid out a distribution of 6.70 cents/share, while yielding 8.40%. Obviously investors who purchased the stock in 2007 are not earning as much on their invested capital as they had originally planned to do- their yield on cost was 4.50% by the end of 2009.
Another example of this situation is Nordic American Tanker which has paid a quarterly distribution ranging from a low of 30 cents/share to a high of $1.88/share. Investors who relied on the high dividends which NAT paid must have been terribly surprised when the company announced a quarterly distribution of just 10 cents. Having limited to no visibility as to what the distribution might be next quarter could impose a strain on an already thin retirement budget.
The stocks which investors should concentrate on are the ones which pay a stable and growing distribution, which are adequately covered by earnings. That way investors’ portfolios would not be exposed to temporary fluctuations in earnings, which would affect the amount of dividend payouts. Companies, which pay consistent dividends, pay out up to a certain sustainable amount of their earnings to shareholders as dividends. They reinvest the rest in the business, which could bring in a solid foundation from which further growth in earnings and distributions is achieved. While there is always a risk that a company could slash or eliminate its distribution, few regular dividend growers do that unless they face unforeseen circumstances.
An example of such stock is Abbott Labs (ABT) has increased dividends for 37 consecutive years. Abbott Laboratories manufactures and sells health care products worldwide Check my analysis of the company.
Full Disclosure: Long ABT
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Realty Income Corporation engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company leases its retail properties primarily to regional and national retail chain store operators. Realty Income is widely known among its investors as the monthly dividend company. The company is a dividend achiever, which has increased its dividend for 15 years in a row by raising its monthly distributions several times per year. The company is one my best dividend stocks for 2010 list.
Over the past decade the stock has delivered a total return of 18% per annum to its shareholders.
Realty Income owned 2348 retail properties at the end of 2008. The company’s properties which are leased by 119 retail chains in 30 industries are located in 49 states. Most new properties acquired are under long term leases (15-20 years) with tenants from a variety of industries and geographic location. The average remaining lease life was 11.9 years in 2008. Tenants are typically responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, occupants are also responsible for future rent increases based on increases in the consumer price index, fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level. Due to the stability of company's revenue streams and above average yield, the company might be a good pick for investors who are seeking current retirement income.
As a Real Estate Investment trust, the company has to distribute almost all of its net income to shareholders. An important metric for evaluating REITs is Funds from operations (FFO), which stood at $1.83/share in 2008. Realty Income distributed $1.66 /share in 2008. FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. The company doesn’t have any debt maturing until 2013 and also has an unused credit facility worth $355 million.
Over the past decade FFO has increased by 4.5% on average.
Over the past decade distributions have increased by 5.3% per annum. A 5% annual gowth in distributions translates into dividends doubling every 14 years. In 2009 the company has raised distributions by 1.10%.
The FFO payout ratio has increased to 90.80% in 2008, which is higher than the 86.60% to 81.50% average range over the past decade.
The main risk for the company is if occupancy rate decreases. About 3% - 4% of the company’s properties face lease expirations each year, which is why it has to be able to find new tenants. The company could try to sell properties which are not occupied currently however, which might be problematic in the current market for real estate. Another negative for the company is the fact that it typically expands its operations through additional sales of its common stock, which dilutes the stakes of existing stockholders.
While Realty Income acquired 108 new properties in 2008, so far in 2009 it has only acquired 3 new properties. Without new acquisitions, the company might not be able to increase distributions above the rate of inflation in the future.
The company owns and actively manages a diverse mix of properties, which provide a stable and dependable income stream for the company’s shareholders. Realty Income currently yields and has raised distributions and FFO’s for over 15 years in a row. I believe that Realty Income is a good addition to any dividend growth portfolio, since it provides growing income and also provides diversification into commercial real estate.
Full disclosure: Long O
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Most of the companies which leave the dividend achievers or the dividend aristocrat indexes do so because of three reasons. Firtst, they might stop raising dividends because they needed cash for acquisitions. Another reason is that companies cut distributions because of poor economic conditions or need for cash in acquisition. The third reason why companies are booted out of these elite dividend indexes is because they are being acquired or have merged with another company.
Some of the best dividend stocks have raised distributions for many years in a row. This could only be achieved if they had a solid business model, and a durable competitive advantage which prevents barriers to entry and allows the company to maintain a loyal customer base. Dividend stocks could be found in many industries including pharmaceuticals, telecommunications, utilities, financial services and consumer staples to name a few.
While some investors believe that a company should plow back all of its earnings into the business, some of the most successful companies which incidentally boast a long record of dividend raises have proven otherwise. Companies such as Wal-Mart Stores (WMT) or Automatic Data Processing (ADP) have managed to not only grow their business successfully for many decades but also to reward long-term stockholders with a regularly rising payout. Maintaining a proper balance between overexpansion and rewarding shareholders is an important component of sound corporate policy, which takes into account the interests of a variety of stakeholders. Paying a dividend instills a discipline to managers, and thus makes them more careful about accepting projects which might not contribute to the bottom line.
The problem with many dividend stocks is that they could be attractive buyout targets by larger rivals or by companies which are looking to diversify into a new line of business. Shareholders usually receive a big premium which ensures that almost everyone makes a profit in the process. This doesn’t take into consideration the fact that a growing company might deliver much higher total returns if it stayed independent.
Two recent examples of solid dividend stocks which are in the process of being acquired are Cadbury (CBY) and Alcon (ACL). Both stocks are members of the elite international dividend achievers index.
Alcon (ACL) is one of the biggest players in the global market for eye-care products, specializing in surgical equipment and devices, contacts lens solutions and other consumer eye-care products. The company has raised dividends for 6 consecutive years. Swiss food giant Nestle purchased the company in 1977 for $280 million. So far Nestle is going to make about $40 billion in total from selling its whole stake to Novartis (NVS). The extra cash that Nestle would receive would be used for share repurchases or it could be used to bid for Cadbury (CBY).
Cadbury plc, (CBY) together with its subsidiaries, engages in the confectionery business worldwide. It has raised dividends for 12 consecutive years. The company's board has approved Kraft Food’s (KFT) acquisition of Cadbury. There were rumors that Hershey (HSY) and Nestle would likely team up to bid against Kraft for the maker of chocolate and gum.
Other notable dividend achievers which were acquired include Gillette, which was purchased by Procter & Gamble (PG) in 2005, Quaker Oats acquired by PepsiCo (PEP) in 2001 and Geico, which was acquired by Berkshire Hathaway (BRK.A) in 1996.
It is interesting to note that the companies which have been acquired have continued to deliver strong revenues and earnings for the companies which acquired them in the first place. In the event that a dividend achiever or aristocrat is being acquired by another dividend achiever or aristocrat in stock, it might be beneficial to keep the stock of the acquirer. The key factor is for the acquirer to keep raising distributions.
Full disclosure: Long ADP, PEP, PG and WMT
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Few investors these days seem to grasp the idea that stocks represent fractional ownership of real businesses. This is especially difficult to understand as electronic trading has become widespread, and it is now possible to buy and sell stocks and derivatives on these equities within seconds from the comfort of your home. While as a dividend investor I typically look for stocks with a consistent stream of earnings, which translates into a long history of dividend growth, I am always on the lookout to learn something new as well.
While earnings power is essential, it is also important to understand that a business or its assets do have some value, whether as a whole or as a sum of its parts. Most of the times when there is a merger or an acquisition of a company, investors get a price for their holdings from the acquirer. Thus they are able to monetize their partial ownership rights, and their stocks rise in value in the process. Other times the market undervalues companies which hold on for too long to liquid assets, because of the fear that excess cash in the hands of management might not lead to improved financial condition over the long term.
One such company was Magic Software Enterprises Ltd. (MGIC). Magic Software Enterprises Ltd. is an Israeli company which develops, markets, and supports software development and deployment technology and applications. Back in December the company announced that its board of directors has declared a cash dividend in the amount of US$0.50 per share and in the aggregate amount of approximately US$16.0 million. The stock increased in value from $1.87 to $2.23/share after the announcement. The stock is already trading ex-dividend however, which means that investors who purchase the stock today would not be able to receive the special distribution.
At the end of the third quarter of 2009, Magic Software held cash and cash equivalents worth $36.85 million and had total liabilities worth $14.21 million. This was worth approximately 55 cents/share, and that’s without including any of the company’s receivables, fixed assets, intangible assets and the company’s ability to generate future earnings. In addition to that the company has been profitable in 2007 and 2008 and is on schedule to earn money in 2009. What might have triggered the need for special dividend was the sale of the company’s office building for $5.20 million in cash in early December 2009.
At the end of the day it is important to understand that stocks represent fractional ownership of real tangible businesses. An important component of success in investing is also finding the best opportunities at bargain prices as well in addition to diversification and dividend reinvestment. Thus I believe that even if we have another lost decade, there would be plenty of opportunities for investors to make money and for companies to unlock their intrinsic value through dividend raises or special dividends.
Some of the companies which have been able to create consistent value for shareholders over the past few decades include Automatic Data Processing (ADP) and Emerson Electric (EMR). Both stocks currently trade at attractive levels and have well-covered dividends.
Automatic Data Processing, Inc. (ADP) provides technology-based outsourcing solutions to employers, and vehicle retailers and manufacturers. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. This dividend aristocrat has raised dividends for 35 years in a row. The stock is trading at 16 times earnings and yields a comfortable 3.20%. The company has a ten year average dividend growth rate of 14.50% per year. Last year ADP raised distributions by only 3%. When the business recovers however, the company would be able to grow distributions in the low double digits. The book value of the assets is $11.23/share.(analysis)
Emerson Electric Co., (EMR) a diversified global technology company, engages in designing and supplying product technology, as well as delivering engineering services and solutions to various industrial, commercial, and consumer markets worldwide. This dividend aristocrat has boosted distributions for 53 consecutive years. The stock is trading at 19 times earnings and yields 3.10%. The company has a ten year average dividend growth rate of 6.50% per year. When the world economy recovers, the company’s diversified business operations should be able to support a dividend growth in the high single digits. The books value of the assets is $11.33/share.(analysis)
Full Disclosure: Long ADP and EMR
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Warren Buffett is the most successful investor of our time. The student of legendary value investor Ben Graham took on value investing to a whole new level by transforming the small textile mill Berkshire Hathaway (BRK.A) into a diversified conglomerate with interests in insurance, utilities, jewelry sales, newspaper publishing and many others.
Buffett is a closet dividend investor. One aspect of Buffett’s value strategy that many investors seem to miss is the fact that the Oracle of Omaha is a fan of companies which distribute a portion of their excess earnings back to Berkshire. This allows Buffett to re-invest the proceeds into new companies, which lets him further compound his invested capital.
Most of the companies which Berkshire has invested have been characterized by having wide moats, or durable competitive advantages. This is also the foundation behind some of the best dividend stocks out there. Only a company with a strong competitive advantage could afford to raise prices to consumers, which translates into higher earnings and ultimately into long-term dividend growth. Not having a large need of capital infusions is another important aspect of strong dividend growers.
Looking at the current portfolio holdings of Berkshire Hathaway, there companies. Of them seven are dividend aristocrats, one is an international dividend achiever and almost all of the rest pay a dividend except for six companies. Even some of Buffett’s core holdings such as GEICO and General RE, which he has acquired, were members of the elite dividend achievers index.
Berkshire Hathaway is expected to make about $1.3 billion in dividends from its publicly traded holdings. In addition to that Berkshire is expected to earn fat dividends from its investments in preferred stocks in General Electric (GE) and Goldman Sachs (GS) as well.
Name Ticker Shares Annual Dividend Notes
January is typically a busy month for dividend increases. The past week has most probably accounted for the majority of the increases for the month already. Increasing a company’s dividend for another consecutive year reflects management’s strong financial position and their confidence in the long-term growth opportunity of the company. I have summarized the increases by several types – dividend aristocrats and achievers, Berkshire Hathaway Holdings and potential dividend achievers.
Dividend Aristocrats and Achievers
The dividend aristocrats list includes companies which have increased dividends for over 25 years in a row. It is equally weighted and re-balanced once a year. To become a dividend achiever a company must have increased its annual regular dividend payments for the last ten or more consecutive years.
Consolidated Edison, Inc. (ED), which provides electric, gas, and steam utility services in the United States, increased its quarterly dividend by 0.85% to 59.50 cents per share. Consolidated Edison, Inc. is a dividend aristocrat, which has increased its quarterly dividend for thirty-six consecutive years. The stock currently yields 5.10%. (analysis)
McGraw-Hill Companies (MHP), which provides information services and products to the financial services, education, and business information markets worldwide, increased its quarterly dividend by 4.40% to 23.50 cents per share. This is the 37th consecutive annual dividend increase for this dividend aristocrat. McGraw-Hill also announced that it will buy back over time the 17.1 million shares remaining in its share repurchase program approved by the Board in 2007. The stock currently yields 2.70%. (analysis)
Family Dollar Stores, Inc. (FDO), which operates a chain of self-service retail discount stores for low to lower-middle income consumers in the United States, increased its quarterly dividend by 14.80% to 15.50 cents per share. Family Dollar Stores, Inc. is a dividend aristocrat, which has increased its quarterly dividend in each of the past thirty-four consecutive years. The stock currently yields 2.00%. (analysis)
Polaris Industries Inc. (PII), which designs, engineers, and manufactures off-road vehicles, raised its quarterly dividend by 3% to 40 cents per share. This represents the 15th consecutive year of Polaris increasing its dividend. This dividend achiever currently yields 3.50%.
Berkshire Hathaway Holdings
These companies are owned by Berkshire Hathaway (BRK.A)
Wesco Financial Corporation (WSC), which engages in insurance, furniture rental, and steel service center businesses in the United States, increased its quarterly dividend by 2.40% to 42 cents per share. This is the thirty-seventh annual dividend increase for this dividend champion. The largest shareholder in the company is Buffett’s Berkshire Hathaway (BRK.A). The stock currently yields only 0.40%.
Washington Post Company (WPO), which operates as a diversified education and media company in the United States and internationally, increased its quarterly dividend by 4.60% to $2.25 per share. Washington Post Company also announced plans to buy back up to 750,000 shares. One of the company’s largest shareholders is Warren Buffett. Despite the fact that the company hasn’t raised dividends each year, it has been able to boost distributions every other year. However the stock currently yields 1.90%, and the dividend is not well covered.
Potential Dividend Achievers
These are the companies which could become members of the dividend achievers index if the keep raising annual distributions for the next few years.
Omega Healthcare Investors, Inc. (OHI), a self-administered real estate investment trust (REIT), which invests primarily in long-term healthcare facilities in the United States, increased its quarterly dividend by 6.70% to 32 cents per share. This is the first increase for the company since 2008. Omega Healthcare Investors, Inc. has increased its quarterly dividend in each of the past six years. The company had previously eliminated distributions for 2001 and 2002. The stock currently yields 6.00%.
Enterprise Bancorp, Inc. (EBTC), which operates as the holding company for Enterprise Bank and Trust Company that provides various banking products and services, increased its quarterly dividend by 5.30% to 10 cents per share. Enterprise Bancorp, Inc. has increased its dividends for 15 years in a row. However the company has been publicly traded only since 2005. The stock currently yields 3.70%.
ONEOK, Inc. (OKE), which engages in the purchase, transportation, storage, and distribution of natural gas in the United States and Canada, increased its quarterly dividend by 4.80% to 44 cents per share. ONEOK, Inc. is a general partner of ONEOK Partners L.P. (OKS) and has raised dividends for 8 consecutive years. The stock currently yields 3.70%.
ONEOK Partners, L.P. (OKS), which engages in the ownership and management of natural gas gathering, processing, storage, and interstate and intrastate pipeline assets, as well as natural gas liquids (NGLs) gathering and distribution pipelines, increased its quarterly distribution $1.10 per unit. This master limited partnership has increased its quarterly distributions in each of the past five consecutive years. The units currently yield 6.80%.
Spectra Energy Partners, LP (SEP), which engages in the transportation of natural gas through interstate pipeline systems, and the storage of natural gas in underground facilities in the United States, increased its quarterly dividend from 40 to 41 cents per unit. This is the ninth consecutive quarterly distribution increase for Spectra Energy Partners, LP since it went public in 2007. This master limited partnership currently yields 5.30%.
Tiffany & Co. (TIF), which engages in the design, manufacture, and retail of fine jewelry., increased its quarterly dividend by 18% to 20 cents per share. In addition to that the company announced that it would be resuming its stock buyback plan. Tiffany & Co. has increased its annual dividend in each of the past eight years. The stock currently yields 1.50%.
Pall Corporation (PLL), which manufactures and markets filtration, purification, and separation products and integrated systems solutions worldwide, increased its quarterly dividend by 10.30% to 16 cents per share. This is the sixth consecutive dividend increase for Pall Corporation since the company cut dividends in 2002. The stock currently yields 1.50%.
Finish Line, Inc. (FINL), which operates as a mall-based specialty retailer in the United States, increased its quarterly dividend by 33% to 4 cents per share. This is only the second dividend increase from the company since 2007. The stock also currently yields only 1.40%, which coupled with the short history of dividend raises makes it a pass for now.
I like Con Edison (ED) as a stock better suited for current income. McGraw-Hill Companies (MHP) looks like an interesting position to add on dips below $31.30. Polaris Industries Inc. (PII) also looks like an interesting company that I would add to my list for further research.
Full Disclosure: Long FDO, ED and MHP
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The Stanley Works manufactures tools and engineered security solutions worldwide. The company, which has raised dividends for 42 consecutive years, is a member of the S&P Dividend Aristocrats index.
Since 1999 this dividend stock has delivered an average total return of 8.10% annually.
The company has managed to deliver a 6% average annual increase in its EPS between 1999 and 2008. Analysts expect Stanley Works to earn $2.42 share next year, followed by an increase to $3.06/share in the year after that. Back in November 2009, Stanley Works announced its intent to acquire Black & Decker (BDK) in an all stock deal subject to regulatory and shareholder approvals. The combined companies could realize significant synergies and enjoy a wider product base with little overlap between the two businesses. In addition to that the company is in the process of eliminating 10% of its staff, which could help offset weaker sales this year.
Return on Equity has fluctuated widely between 9% and 21% over the past decade. This indicator has spend of the time in the high teen’s however. Rather than focus on absolute values for this indicator, I generally want to see at least a stable return on equity over time.
Annual dividends have increased by an average of 4.20% annually since 1999, which is much slower than the growth in EPS. A 4 % growth in dividends translates into the dividend payment doubling every eighteen years. If we look at historical data, going as far back as 1968, Stanley Works has actually managed to double its dividend payment every ten years on average.
The dividend payout ratio has consistently remained below 50% over the past five years. 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 the Stanley Works is overvalued at 22 times earnings, yields 2.70% and has an adequately covered distribution payment. Although the Black & Decker acquisition could be accretive to EPS, it could jeopardize the already weakened growth in distributions for Stanley Works such that the company freezes its payment for a few years. If it keeps raising distributions however I would look to enter a small position in Stanley Works (SWK) on dips below $44.
Full Disclosure: None
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Build your own inflation proof source of income in retirement with dividend stocks
Investors who are worried about inflation but want to protect their principal are often told to invest in Treasury Inflation Protected Securities, which are indexed for inflation. In other words, investors yield and principal are indexed to the CPI and adjusted as the CPI rises over time. This sounds like the perfect deal of a lifetime, except for two caveats.
First, the yields on short and medium term and even longer term TIPs (TIP) have been very low as of recently, indicating that any income growth would be derived solely from inflation. Second, some investors are afraid that the CPI number does not account for the actual inflation. Even a small difference of 1% annually compounded over a long period of time would make a difference in your retirement budget. There is also the factor that the basket of goods and services, which are used to calculate it, is different than the basket of goods and services that an individual investor uses.
So how can investors create an inflation proof source of income in retirement?
A very good solution is to create a diversified portfolio of at least 30 stocks, purchased over time. Try not to overpay for them, and make sure that they are in a market where earnings growth could be achieved. Without earnings growth, dividend growth is impossible to achieve for any sustainable period.
An investor whose main expense items are utilities, fast food, groceries, cigarettes and liquor as well as personal care items could build their own inflation proof source of income in retirement with the following dividend stocks:
Consolidated Edison, Inc.(ED), through its subsidiaries, provides electric, gas, and steam utility services in the United States. For example lets look at an investor whose monthly electric expense is about $100/month. They could purchase $20,000 worth of a basket of utilities stocks with long history of consistent dividend increases that yield 6%, in order to generate enough dividend income to never have to worry about this particular bill again. Con Edison is just one stock that could fit the characteristic. (analysis)
AT&T Inc. (T) operates as a communications holding company. Its subsidiaries and affiliates provide the AT&T brand services in the United States and internationally. What's better than having your landline or cellphone bill paid directly from your telecom company? If you spend $40/month on telecom services, you would need to invest approximately $8,000 in AT&T (T) stock. (analysis)
McDonald's Corporation (MCD), together with its subsidiaries, franchises and operates McDonald's restaurants in the food service industry worldwide. A $10,000 investment in McDonald's could provide enough income to purchase to purchase at least one big mac meal every week. (analysis)
Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. By purchasing enough Wal-Mart stock, dividend investors could receive sufficient income to pay at least a portion of their grocery expenses. (analysis)
Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in the United States and internationally. By investing in Altria, investors could essentially pay for their tobacco expenses. (analysis)
Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. Exposure to real estate would help investors hedge their rent expense. (analysis)
If you would like to have your consumer products "for free" you could invest in consumer prodcuts giants Johnson & Johnson (JNJ) and Procter & Gamble (PG). Johnson & Johnson engages in the research and development, manufacture, and sale of various products in the health care field worldwide. Check my analysis of this dividend aristocrat. The Procter & Gamble Company on the other hand engages in the manufacture and sale of consumer goods worldwide. The company has raised dividends every year for over half a century. (analysis)
In order to generate enough to pay for your gas expenses, a dividend investor might consider investing in one of the oil majors such as Exxon Mobil (XOM) or Chevron Texaco (CVX). Thus this investor would have the dividends received from these companies essentially pay for his or her annual gas expenses.
This article should really get you thinking not only about generating sufficient inflation adjusted income stream in retirement, but also about cutting unnecessary costs to the bone. Most novice dividend investors believe that simply purchasing the highest yielding stocks would do the trick of generating a sufficient dividend income stream for the next 3-4 decades. If a company is already paying most of its earnings out as dividends, chances are its ability to reinvest in the growth of the business are extremely strained. Because of the low growth expectations the market could assign a high current yield to this stock. Thus, an investor relying on this dividend stock might realize that it has failed to keep up with inflation and that he would have to downgrade his lifestyle.
Full Disclosure: I have positions in all stocks mentioned above
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The market is efficient enough sometimes to discount events and experience moves even before important pieces of information are distributed to all market participants. How many times have we seen a large increase in prices on above average volume for companies on virtually no news, only to find out that the company is going to be acquired at a hefty premium several days later?
At the end of the day, dividend growth investors expect that a company that regularly increases dividends would also lead to a higher stock price. This would leave current yields little changed for many years.
When the market goes up, 80%-90% of all stocks follow its moves. When it goes down 70% of companies go lower in tandem with it. While dividend investors do care mostly about stability and growth of their dividend income, capital gains are important as well.
While dividends have produced about 40% of average annual returns each year over the past 8 decades, capital gains are important as well. If investors believe that the company’s performance over time would improve, they would bid up the stock price. While the dividend payment would have increased roughly at the same rate as the growth in stock prices, the current yield could be unchanged. This would leave many novice investors wondering why anyone would waste their time and effort purchasing a stock which yields 2% - 4%, when other companies offer much higher current dividend yields. What they fail to notice is that the yield on cost on the original investment several years ago is much higher than the current yield.
If markets believed that the dividend growth is sustainable, the stock price would correct itself and bring the yield to about market level. This brings in some capital gains, which further compounds the wealth of the dividend investor. If investors as a group do not expect that the company’s dividend growth is sustainable, they would simply leave the price unchanged or lower over a period of time.
Mr market might be telling you something about a company that successfully increases its dividends while the stock price is down or flat. Let’s look at Pfizer (PFE). The company used to boast a record of 41 consecutive annual dividend increases. The pharmaceuticals giant cut its dividend in 2009, ending this streak. Investors might have expected that Pfizer’s long term position of a dividend growth stock is in jeopardy, as the stock price dropped from 50 to 13, pushing the yield to 10%. At the end of the day investors not only suffered from the reduced dividend income after the cut, but also from capital losses over the past decade.
A similar situation occurred with General Electric (GE), which also had a long streak of dividend increases, until it also cut its distributions in February 2009. The company’s stock price has had a rough decade, falling from 60 to 6 before partially recovering to 16. In the meantime the company’s current yield increased several times to over 10%, until the company cut its distributions by more than 60%. It definitely pays to listen to the collective wisdom of stock prices most of the times, although not at all times.
Procter & Gamble (PG) in the 1970s tells us a completely different story. The company had already established itself as a solid dividend achiever and kept rewarding shareholders with annual raises, while the stock price appeared uninterested in the general improvement of the company’s finances.
At the end of the day it is important to purchase the best dividend stocks that would throw off a rising dividend income stream. It is also important however to not completely ignore capital gains as well.
Full Disclosure: Long PG [more]
The dividend aristocrats list includes companies which have increased dividends for over 25 years in a row. It is equally weighted and re-balanced once an year. Over the past 3,5 and 7 years the index of elite dividend stocks has managed to outperform the S&P 500 by 5%, 3.7% and 4.40% respectively.
The companies which were added to the index for 2010 include:
Brown-Forman Corporation (BF.B ) engages in the manufacture, bottling, import, export, and marketing of alcoholic beverage brands. [more]
With the expectations that the financial crisis appears to be over, investors have bid up stocks to the highest levels in over a year. There’s a lot of optimism in the news, including major banks repaying TARP money, unemployment stabilizing, and major economies rebounding. If economies rebound, then consumers would be able to start spending more on everyday items, trading up from generic brands to brand name products.
The companies which could benefit from this include Johnson & Johnson (JNJ), Procter & Gamble (PG), McDonald’s (MCD), Wal-Mart (WMT) and Coca Cola (KO). They all have durable competitive advantages, which has allowed each company to become a member of the elite dividend aristocrats index after raising distributions for over a quarter of a century.
The Coca-Cola Company (KO) manufactures, distributes, and markets nonalcoholic beverage concentrates and syrups worldwide. It principally offers sparkling and still beverages. The company has increased distributions for 47 consecutive years. I would be a buyer of KO below $54.66. Check my analysis of the stock.
Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The world’s largest retailer has a 35 year record of annual dividend raises. I would be a buyer of WMT on dips. Check my analysis of the stock.
McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants in the food service industry worldwide. Its restaurants offer various food items, soft drinks, and coffee and other beverages. The golden arches has raised dividends for 33 years. I would be a buyer of MCD as long as it trades below $73. Check my analysis of the stock.
Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company has boosted distributions to shareholders for 47 years in a row. I would be a buyer of JNJ below $65.33. Check my analysis of the stock.
The Procter & Gamble Company (PG) engages in the manufacture and sale of consumer goods worldwide. The company operates in three global business units (GBUs): Beauty, Health and Well-Being, and Household Care. The company has rewarded stockholders with dividend increases for 53 consecutive years. I would be a buyer of PG below $58.67. Check my analysis of the stock.
Even if the recovery is characterized by lower consumer participation, these stocks should benefit, particularly because their revenue streams are stable and globally diversified. A decline in the stock market would present a great opportunity to initiate or add to positions in the global powerhouses.
Full Disclosure: I have positions in every company listed above
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Back in late 2008 I was invited to participate in a stock picking competition, where the goal was to pick the best stocks for 2009. The picks that I selected were Kinder Morgan (O), Realty Income (O), Con Edison (ED) and Philip Morris International (PM).
The reason for the selection of these stocks is that each of them paid an above average yield and was trading at attractive valuations. Another reason was that the dividend was well covered from cash flows for all stocks. The most important reason was that two of them, Kinder Morgan (KMP) and Con Edison (ED) were natural monopolies, which had a toll booth type business model with stable cash flows. Philip Morris International’s (PM) business model is characterized by having a globally recognizable brand product, which is addictive and for which consumers are willing to pay higher prices each year. Realty Income (O) also has a rather stable revenue source, since it typically provides long-term leases to its tenants. I do like the companies enough, that I also have a position in them. Including a company on a stock list without having a position there, shows what the real opinion of the author on the stock really is.
The time has come to reveal how the stocks fared in 2009, and also pick the best stocks for 2010. As a long term dividend investor my holding period is forever. Thus I would select the same picks mentioned above as my top picks for 2010. I would explain the reasons behind each selection below:
Realty Income (O) has consistently increased dividends several times per year since it was listed on the NYSE in 1994. This dividend achiever owns 2348 retail properties, which are under long term leases (15-20 years) with tenants from a variety of industries and geographic location. Tenants are typically responsible for monthly rent and property operating expenses including property taxes, insurance and maintenance. In addition, tenants are typically responsible for future rent increases based on increases in the consumer price index (typically subject to ceilings), fixed increases or, to a lesser degree, additional rent calculated as a percentage of the tenants’ gross sales above a specified level. As a Real Estate Investment trust, the company has to distribute almost all of its net income to shareholders. An important metric for evaluating REITs is Funds from operations (FFO), which stood at $1.83/share in 2008. Realty Income distributed $1.66 /share in 2008. FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. The company doesn’t have any debt maturing until 2013 and also has an unused credit facility worth $355 million. Realty Income currently yields 6.50% .Check my analysis of the stock.
Kinder Morgan (KMP) operates a toll-road-like network of diversified and primarily fee-based assets generated a tremendous amount of stable cash flow. This dividend achiever is largely immune to fluctuations in commodity prices and has enough in distributable cash flows per unit to cover distributions, which are expected to increase to $4.40/unit in 2010 up from $4.20 in 2009. Future growth in one of the largest MLPs in the US will be fueled by projects such as the Midcontinent Express Pipeline, Rockies Express-East and Kinder Morgan Louisiana Pipeline. Distributable cash flow includes each period’s earnings before all non-cash depreciation, depletion and amortization expenses, including amortization of excess cost of equity investments, to be an important measure of our success in maximizing returns to our partners. Kinder Morgan’s partnership agreement requires it to distribute 100% of net cash (cash receipts minus cash disbursements less changes in reserves) to unitholders on a quarterly basis. Check my analysis of the partnership.
Consolidated Edison (ED) is a regulated utility which provides electric service to 3.3 million customers and gas service to 1.1 million clients in New York city and Westchester County. The company is a natural monopoly in its geographic area, and thus is able to generate strong and steady revenue streams and enjoy a healthy balance sheet. Do not let the high payout ratio of 70% scare you from the stock – this utility has been able to maintain this high payout of 70% on average over the past decade, while still affording to grow the distributions by about 1% each year. This dividend aristocrat has been able to increase dividends in each of the past 34 years. Check my analysis of the stock.
Philip Morris International (PM) was spun out of cigarette maker Altria Group (MO) in 2008, in order to separate potential US legal liabilities from the international tobacco operations. The company is the largest cigarette manufacturer in the world, with a 15.6% market share worldwide. The company’s strategy includes organic growth and growth through acquisitions. Philip Morris International (PM) is in the middle of expanding its sales to China, which represents about one-third of the global tobacco market. The company has announced its intent to repurchase up to $13 billion of its shares over the next two years. In addition to that it has raised distributions twice since it became a separate public company in 2008. Check my analysis of the stock.
The four stocks generated a total return of 26.48% in 2009. The picks from the other bloggers participating in the contest, as well as their performance could be found below:
Intelligent Speculator: 81.55%
Where does all my money go: 56.14%
The Financial blogger: 44.62%
Four Pillars: 35.26%
Dividend Growth Investor: 26.48%
Million Dollar Journey: 20.27%
My Traders Journal: 0.18%
Zach Stocks: -8.80%
It is important to understand that while these four stocks have the necessary characteristics to grow their distributions over time, they are simply chosen for illustrative purposes only. A real portfolio should include at least 30 different companies from a variety of sectors, sizes and continents. For a list of the best dividend companies for the long run, check here.
Full disclosure: Long KMR, O, PM, MO and ED
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