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truthisntstupid (94.09)

This Game Is Rigged

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July 26, 2011 – Comments (1)

My last blog was about a pitch I had written for DRI, an outstanding company with great numbers. I doubt if any regulars on this site missed it, but if you did, this was it

http://caps.fool.com/Pitch/DRI/5390118/i-made-dri-a-caps-pick-on-dec1.aspx

 

I suppose you may have read the title of this blog and now you could very well be thinking, now what?

 

Relax.  I'm not talking about this game this time.  I'm wanting to take a couple minutes to talk about ...my game.  My game is rigged.

I have gravitated towards higher-yields for awhile, because my goal is current income.  This pick, though (DRI) is very tantalizing.  And in explaining why, I can illustrate very, very, well what makes dividend growth investors tick.

This company's last dividend increase, as I pointed out in my pitch for it, was 34%, with an average dividend growth rate of 27.33% for the last 5 years. The last quarterly payment was $0.43, up from $0.32 previously.

Of course, there's now way we could expect that every year.  But the dividend payout ratio still remains only 38%.

So consider this.  Just suppose over the next 5 years, the dividend growth slows to only...10%.

So in 5 years, the annual dividend grows from $1.72 to $2.77.  

In my pitch, I obviously expressed a very high opinion of DRI.  Suppose, in 5 years, it's still being very well run....it's still in posession of all the financial strength, profitability, and competitive advantages I feel it has now, which have allowed it to thrive all through this downturn save for one year (2007).

With that kind of financial strength and security backing its ability to pay that dividend, the market most likely wouldn't allow it to be priced such that that $2.77 annual dividend represented an outrageous yield.  If DRI's financial strength, competitive position, and profitability were still as it is now, the risk just isn't there to cause it to be priced to yield 5 or 6%.  

It would be more likely to be priced to yield 3 or 4%.  The price couldn't fall much lower than that without dividend investors going nuts over it.  

So - assuming dividend growth of only 10% annually over the next 5 years - which is pretty conservative, in light of the last 5 years - if priced so that $2.77 represents a 4% dividend yield, the price would be around $70.

If it was priced so that $2.77 represented a 3% dividend yield, the price would be around $90.

It's priced right at $50 now - close to a 52-week high.  

What are the chances of a company with such a low-risk, easily covered dividend yielding 5.57% - which is what my yield on cost would be had I actually bought it on Dec 17, 2010 at an actual original start price of $49.70?

Do you see what I'm getting at here?

The odds in my favor are enormous.

And remember, I played it conservatively with the dividend growth assumption.

And that, my friends, is why I am a dividend investor. 

 

1 Comments – Post Your Own

#1) On July 28, 2011 at 1:15 PM, truthisntstupid (94.09) wrote:

So many people see nothing but a "little 3.25% dividend." 

But in 4 or 5 years. when that dividend is approaching $3 (if the dividend growth rate slows to less than half what it's been), the chances of this still being a $50 stock are just about nonexistent. 

Dividend investors will look at DRI's continuing financial strength, profitability, payout ratio, etc. 

Dividend investors are the market for DRI and other companies with decent yields, dividend growth characteristics, and the financial strength and consistency in performance to keep paying and increasing their dividend.

My start price in real life in late 2009 for Altria was $18.46, and the dividend at the time was $1.36.

Now the dividend is $1.52, and the next dividend will reflect yet another increase.  If MO's price fell back below $19, MO would be yielding 8%.  

Fat chance, as long as dividend investors can look at MO's financials and still see a dividend they view as secure as they perceive it to be now (at least for the time being).

While this isn't the greatest example because more and more people are getting increasingly nervous about Altria's declining industry, there are no such worries about many other great dividend-paying companies.

I had both cars need some major repairs during the winter, and sold my Altria stock after holding it past the Dec 23 ex-dividend date.  I paid $18.46/share for it, collected $1.80/share in dividends while I held it, and got a little more than $26/share when I sold.

Most dividend investments aren't going to be as terrific as Altria was at $18.46 in November or December of 2009 (don't remember which) but the same principle will drive their price up over time and, meanwhile, they throw off those quarterly dividend checks.

If I do my homework, the odds of a dividend investment turning out well (if not very well!) are enormously in my favor.

My game is rigged.  And I like it that way.

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