With longer lifespans due to nutrition and health care advances, many in the Baby Boom generation today are facing the problem of caring for our aging parents in the sunset years of their lives. One problem we felt in our case was the lack of diversification in the income stream. This is how we handled it.
Grandma moved in with us a year ago. She is an 80-something woman. At the time, she was living alone about 1,000 miles away and the care-taking was left to the nearest daughter an hour's drive from her. Needless to say, it was difficult keeping track of her for everyone involved. It was during this time we came to realize that she needed better supervision. Luckily, we had room to spare and plenty of family around here to help out.
She was a child of the Great Depression. Many of those who went through that period had no trust in the stock market and not much more in banks. Despite this, my in-laws had built up sufficient savings and real estate to live comfortably on their pensions and Social Security.
Once she moved in, my wife went about organizing her mother's records, updating her will, healthcare proxy and getting the necessary Powers of Attorney so that we can help keep track of her finances. As we settled into our new routine, we found that even after taking care of her monthly expenses, there was a little more money that month left and that was added to the savings account. We did this for the last year until my wife realized her mother was being shortchanged by the low interest rates being offered by the banks. Every month, the statement would arrive with only pennies in interest being deposited.
For the last five years I've been building my wife's IRA; this was about the same time I found Seeking Alpha and learning about dividend growth investing. She's been impressed with not only the portfolio value but also the dividend income stream I've constructed so far. Because of this, she thought it only natural that she take some of her mother's savings and have me invest it in some dividend paying stocks to boost her income.
I was a bit hesitant at first. I knew she had no interest in investing her hard-earned money in a "gambling scheme". I also was fully aware that she is in the beginning stages of dementia and going forward some of that cash may be needed for more personalized care for her. However, inflation and the passage of time is only eroding what cash she has left. So, after discussing it, we decided we'd take $5,500 from her savings as an initial investment.
Once the decision was made, our next goal was defining where we were going to invest this money. Taking cues from David Van Knapp and Bob Wells, popular SA authors and outspoken proponents of a business plan for your portfolio, I laid down some guiding principles for grandma's fledgling portfolio.
- The focus is on current income. Therefore, we'll look for large, stable companies that provide dividends at the higher range of acceptable risk. In my opinion, that's in the 3% to 6% range. At grandma's age, she doesn't have time for fast growth or compounding to have much effect.
- Since the income is not needed at this time, dividends will be reinvested in the respective payer. Cash sitting in the account will not provide any further return than if we kept it in her own local savings account.
- Steer away from securities that provide a K-1. We want to keep her annual tax return simple and understandable. She's not relying on the portfolio for income so invest simply and conservatively.
- Despite shopping at the higher end of acceptable yields, we still want to keep up with inflation if not beat it by a little amount. Because of this, careful consideration will be given to companies on David Fish's CCC list first. If we aren't satisfied with our choices, we can then expand our universe. My conservative assumption uses 4.0% as a reasonable number for the expected inflation rate.
- Because this is the first time she has ever invested in common stocks, we want to hold companies whose names either are familiar or can be physically shown to be large, solid companies whose products or services are plainly visible. This is an "ease of mind" criteria for when she inevitably asks about her money.
- Spread the investments across industry groups to diversify across sectors. This won't prevent a portfolio meltdown should another drop as in the 2008-2010 time frame but will maintain some portfolio stability as the economy continues recovering and different sectors become popular.
- We will consider selling any stock which cuts or eliminates its dividend, freezes it for an extended period of time or suffers a business disruption that could seriously affect earnings or the dividend.
- If the time comes that the money will be needed for grandma's care, we'll liquidate the account and place it back in savings to cover her expenses going forward. This will only be considered after her cash reserves have been depleted to the point where we feel action needs to be taken.
- When grandma passes, any holdings left will be liquidated and the cash returned to her estate for distribution in accordance with her will.
Obviously, this leaves us a lot of wiggle room but this is not going to be a long-term portfolio with someone's life savings. The point is to narrow down our choices and then pick and choose from the resulting list. We admit we were biased going into the selection. We were hoping some of our own holdings would be natural fits to minimize the additional monitoring. Still, we went through the steps to see what Mr. Market was offering us.
Because we're looking for a higher income stream, we started our search with David Fish's Champions, Contenders and Challengers ((CCC)) spreadsheet available here. Mr. Fish updates this monthly and it is a valuable resource to have on hand. We'll be using this resource below. I've included the column labels for the fields we use to narrow our choices.
First we sorted the entire CCC list (the 4th tab at the bottom labeled "All CCC") by yield (column I) and eliminated everything above 6.25% and below 2.75%. We didn't want to eliminate a promising prospect because the yield has changed slightly with the latest market volatility. We also eliminated any MLPs on the first cut to avoid the K-1 issues.
Next we sorted by the payout ratio (column S) and deleted everything above 90%. Before we removed them, we checked the FCF payout ratio (column T) to make sure we weren't eliminating promising companies with high depreciation and amortization costs such as utilities and telecommunications companies. We used a maximum payout of 80% for free cash flow as our cutoff.
We wanted to make sure there was some growth going forward so the Board of Directors has something to justify increasing the dividend. We sorted the resulting list by Estimated 5 Year Growth (column AG) and removed anything under 3%. This left us with a list of 107 companies.
One of our criteria was it had to be something mom could relate to by their products or services. Going through the list, we picked out companies we felt she would be comfortable with and had a yield over 3%. That narrowed our list down to 20 making it a little easier to research.
Next we took our list of ticker symbols and pasted them into the Finviz screener. This way we could create a portfolio and compare the latest statistics before narrowing down our choices. This is our final selection list.
EPS growth next 5 years
Integrated Oil & Gas
Packaged Food & Meats
Toys & Games
NOTE: PM & LO show 3 yr dividend growth rates, the longest available
Using our guiding principles above, we selected 5 stocks from the resultant list for our beginning investments. This allocates about $1,100 per position to keep the commission charges at about 1% for each holding and no continuing fees going forward. We ended up with the following proposed portfolio.
EPS growth next 5 years
Integrated Oil & Gas
Packaged Food & Meats
Reviews and descriptions of our finalists are found here on Seeking Alpha and elsewhere so I won't repeat what others have been saying. Below are my thoughts on why I selected these five.
In May 2012, COP spun off Phillips66 (PSX), COP's refining & marketing divisions, to focus on exploration and production of energy products. COP has also spent the past year shedding less productive assets and re-aligning its capital investments in what it feels will produce the most value for shareholders. COP last increased its cash dividend over a year ago and has yet to declare an increase in 2013. However, I feel that once they've completed the restructuring of their core business, shareholders will again enjoy an ample and increasing dividend stream. Grandma had a Conoco gas station just down the road a piece back when she was living by herself.
General Mills (GIS)
We felt that we needed a consumer staple stock in the portfolio for balance. Everyone needs to go to the grocery store on a frequent basis. With brands in almost every aisle, odds are you are purchasing at least one GIS product. For the last few years, GIS has had to deal with increasing raw materials costs and muted demand growth for their products. Yet they were still able to grow earnings for 4 of the past 5 years and the dividend every year. Open our cupboards and refrigerator and you'll see General Mills' products everywhere.
Lockheed Martin (LMT)
Despite the negative outlook for defense spending, LMT has a diverse technology base including world-class radar systems and they are a major contractor for the F-35 Lightning aircraft in all its variants. I believe LMT's management has taken the steps necessary to manage the slowdown in U.S. Government spending. With a payout ratio of 53%, they have a margin of safety to maintain their dividend going forward. LMT has a radar research center 30 miles from our home and is a major employer here. We can drive by it when mom wants to see where her money is.
Meredith Corp. (MDP)
Meredith is in what is perceived to be a declining field -- publishing. Their earnings were slowly creeping downward throughout the recent recession. However, I feel with their focus on women and family topics, their broadcasting division, their web properties including allrecipes.com and the integrated marketing group that focuses marketing strategy for advertisers across different mediums, Meredith can at least maintain their earnings and dividend going forward. Forward estimates are encouraging, in fact seem a little unrealistic to me, but management has been focused on returning value to shareholders. I have to admit we don't subscribe to MDP's magazines any more but walk in the grocery store and they're right in your face at the checkout aisle. We use allrecipes.com for ideas and grandma's favorite granddaughter is a Rachel Ray, "EveryDay with Rachel Ray" is an MDP property, fanatic.
Altria Group (MO)
Despite the negative publicity of tobacco use and declining use in the U.S., Altria keeps pumping out earnings and dividends as they have for decades. Altria owns the powerhouse brand of Marlboro along with some wine businesses including Chateau Ste. Michelle, a nationally known brand. I feel that MO can at least maintain their position using price increases and diversification going forward for at least another decade. Management seems aware of the challenges facing it and I'm sure has a roadmap to the future. Grandma used to smoke when she was younger and we have family members that continue to smoke. The most common brand at family gatherings is … Marlboro.
With these 5 choices, we've now got an income stream started that adds more than $200 annually to grandma's savings.
If we look a little further out and ignore the reinvested dividends, we can get an estimate of what our income stream will look like. I like to estimate things conservatively. That way, when things don't turn out as planned, I won't be so disappointed. Maybe that's why I have extra roof shingles in my shed, an assortment of odd nuts, bolts & screws in my workshop and a few boxes of floppy disks sitting on the shelf in my office. Since we know that dividends come out of earnings, I'll use the lower of the 5 year dividend growth rate or the estimated forward 5 year EPS growth rate to project the future.
Return on amount invested
It looks like we've met our goals of increasing grandma's income stream and it can be increasing at a rate greater than inflation. At the end of the sixth year, grandma will be getting a 6.1% return on her original investment without even taking into account the reinvested dividends. This will almost cover her annual cable bill.
Going forward, we'll be monitoring the progress of these companies with the rest of our portfolios. Each month she has money left over from her income, we'll stash a little more in the account until we have enough to initiate another position.
I hope this article will give you some ideas if you have an aging parent. It make sense to take measures to improve their income stream so that they have more to fall back on someday in the future. Secondly, I hope this article inspires those who don't have many thousands of dollars to invest to start somewhere. We only took a small portion of grandma's funds to begin this project. From acorns mighty oaks are grown.
Companies already held in one or more of our accounts include: ABBV, AFL, APD, BDX, BMO, BNS, COP, CVX, EMR, GIS, HAS, HRS, INTC, KRFT, LO, MCD, MSFT, NSC, PEP, ROST, RTN, T, UTX, VOD, WAG.
Additional disclosure: All 5 finalists (COP, GIS, LMT, MDP, MO) had GTC limit orders entered slightly below the June 7, 2013 closing prices. All except MDP have been filled. The MDP order may execute at any time within the next several days.