Dividend Grouping for Dividend Income

Most dividend investors are influenced by the current yield when they enter a particular stock investment. Dividend growth investors are no different either. It is hard to blame either of these groups, as there is no point in a company that strongly raises its dividend payments, yet it might take up to two decades for the yield on cost to reach any meaningful level. Add in to that the fact that a double digit dividend growth could be supported by a double digit earnings growth only for so long. If the dividend payout ratio was low at the beginning this could extend the strong dividend growth by a few years after earnings growth slows down to a more reasonable level.

Some of the best dividend growth stocks however would always spot a low current yield, coupled with strong dividend growth for many years to come. As some might typically yield 1% or 2 %, they would be completely ignored by most investors. The trick here is that a company that yields 2% today and raises its dividend by 12% every year would double your yield on cost in just 6 years. In most cases such companies' stock prices also tend to follow the changes in the dividend payment, which could lead to strong capital gains over time. Thus, if the stock increased distributions by 12%, it is very likely that the stock price might increase by about 12% as well. This leaves the dividend yield unchanged at 2%, which doesn’t matter much for original investors, who purchased the stock 6 years earlier.

In my experience as a dividend investor I have always implemented a minimum yield criterion of between 2% to 3% when screening for dividend growth stocks. I implemented this control in order to protect myself in the event that the company I am heavily invested in stops raising distributions. That way I could at least receive some return on my investment until I try to unload my position above my breakeven price.

Looking back at the best dividend growth stories of Wal-Mart (WMT) and McDonald’s (MCD) however, my minimum criteria would have prevented me from getting aboard on these success stories. Other investors who are currently seeking high current income might also have missed out on these plays, which are delivering double-digit yields on cost for anyone who purchased Wal-Mart or McDonald’s in the 1980s.

I recently came out with a way to tweak my entry criteria of 3% minimum initial yield by grouping higher yielding and lower yielding investments with my purchase. At the end of the date, one could easily create a dividend portfolio which consists both of high yielders with slow to no dividend growth and low dividend yielders, which have the potential for strong dividend growth. If one manages to allocate the varying dividend components in their portfolio carefully, they would be able to achieve a target initial yield on cost for their stock holdings as a whole.

For example I recently added to my position in Wal-Mart Stores (WMT), which I consider one of the best run companies in USA, with a strong position in the retail market and good opportunities for growth. The low current yield of 2.20% however was too low in comparison to the 3% entry criteria I apply for new and existing investments. I do believe however that the strong dividend growth would more than compensate for the low current yield, and I see the yield on cost on an investment in Wal-Mart today doubling to 4.5%-5% by the end of the next decade. That’s why I added the high dividend stock AT&T (T) to my portfolio. For every two shares of Wal-Mart (WMT) stock, I bought one share of AT&T (T). At the current prices this mix yields 3% right now.

I view AT&T (T) as a slow grower, which might end up cutting distributions sometime in the future due to its high payout and stagnant earnings in the highly competitive telecom market. The strong dividend growth at Wal-Mart (WMT) however should more than compensate for any potential dividend cuts at AT&T (T). If AT&T (T) cuts its dividends by 50% to 82 cents/share, but Wal-Mart (WMT) managed to raise its distributions by 36%, my total dividend income would be unchanged. I believe that Wal-Mart (WMT) would be able to raise distributions by 36% over the next 3-4 years, assuming that it follows the most recent path of dividend growth.

Other stocks that I could use in dividend grouping for income could be high yielding triple net lease real estate investment trust Realty Income (O) or pipeline operator Kinder Morgan (KMP).

Disclosure: Long T, KMR, MCD, O and WMT

Comments

[mbkelly75:]

Nice idea and well written - thanks for the thought you put into it. I will have to think about how this would work for me with my stocks. I love people who make me think - it helps keep me young. Thank you once again for your work and ideas.

Nov 13 11:53 AM

[Ralph Ozork...:]

Good approach. I would use NNN instead of O for the REIT dividend. It has 20 consecutive years of dividend growth, much like O, but only pays out 75% of FFO in doing so and has a stronger balance sheet.

Nov 13 12:34 PM

[alexdg:]

Watch out for any REIT, some might be 40% overvalued (proven case for O).


On Nov 13 12:34 PM Ralph Ozorkiewicz wrote:

> Good approach. I would use NNN instead of O for the REIT dividend.
> It has 20 consecutive years of dividend growth, much like O, but
> only pays out 75% of FFO in doing so and has a stronger balance sheet.

Nov 14 08:44 AM

[bobbybutte:]

as a person who has actually achieved financial independence solely from buying and holding great dividend stocks let me give you one tip

Investing is 50% art ( instinct) and 50% science ( numbers)

Many internet gurus like to offer advice with no track record

ask to see tax returns before you buy any newsletters

Nov 14 10:38 AM

[tipalia:]

any moderator supervising this site ? you should check on PAOBEI or do you allow this on your site ? check his/ her previous messages if you don t take my word.

Nov 14 11:01 AM

[secmaven:]

This is not the 1980's or 1990's any more, guys. If you think that there is such a thing as a continuing long term dividend increaser that can be put in a buy and hold and forget porfolio you are dreaming. Back in the day this worked because the US economy was growing. No more. So how about a buy and hold strategy for Chinese stocks? Brazilian stocks? Russian stocks? Check the politics, the accounting standards used and the old boy networks that run these countries. You might as well buy any major US bank stock.

Nov 14 12:29 PM

[MattZN:]

Dividend growth is a big deal in the Energy MLP space (of which KMP is a part), as it reflects good CapEx planning and debt management on new projects. The wrench thrown into the works by the crash temporarily made div growth second fiddle to simple survival, but it has now become important again. 12% is a bit excessive, you will not see that very often, but even small amounts of div growth lead to impressive long-term results.

-Matt

Nov 14 12:45 PM

[SlamNT:]

SlamNT

I like the concept of having Walmart with a higher dividend play like AT&T, but I prefer to use Vodafhone (VOD-N) instead! Vodafhone has a much broader reach and competetive advantage over AT&T, plus there is the currency hedge.

Nov 14 04:51 PM

[realold:]

I own O, but appreciate your point and will consider it. Thanks.


On Nov 13 12:34 PM Ralph Ozorkiewicz wrote:

> Good approach. I would use NNN instead of O for the REIT dividend.
> It has 20 consecutive years of dividend growth, much like O, but
> only pays out 75% of FFO in doing so and has a stronger balance sheet.

Nov 15 02:28 AM

[realold:]

A big holding of Vodofone is Verizon. So, you are getting a T look alike and some other exposure.


On Nov 14 04:51 PM SlamNT wrote:

> SlamNT
>
> I like the concept of having Walmart with a higher dividend play
> like AT&T, but I prefer to use Vodafhone (VOD-N) instead! Vodafhone
> has a much broader reach and competetive advantage over AT&T,
> plus there is the currency hedge.

Nov 15 02:28 AM

[realold:]

Or just give up and buy a .2% CD and lose money every year to depreciation of the dollare?


On Nov 14 12:29 PM secmaven wrote:

> This is not the 1980's or 1990's any more, guys. If you think that
> there is such a thing as a continuing long term dividend increaser
> that can be put in a buy and hold and forget porfolio you are dreaming.
> Back in the day this worked because the US economy was growing. No
> more. So how about a buy and hold strategy for Chinese stocks? Brazilian
> stocks? Russian stocks? Check the politics, the accounting standards
> used and the old boy networks that run these countries. You might
> as well buy any major US bank stock.

Nov 15 02:30 AM

[MexCom:]

As long as your picks work out this is a good theory but what would happen if one or more were like GM or Nat. Lead? These were "good" dividend picks in their day. The few you mention do not offer enough diversity - never allow more than 3% of the potfolio to any one investment. Put some fixed income into the mix and look at preferred stocks. For the past year, not one of my preferred stocks have held back their dividends and I was buying them at double digit yields less than a year ago - this includes all the banks, brokerages and REITs.

Nov 15 07:26 AM

[StockMaster...:]

I feel the same way and was lucky to get in on MCD before they raised the dividend this year. Just because the yield is low now on certain stocks doesn't mean it will be 5 years from now. However, I would never pair it with a stock I anticipated would get its dividend cut. I don't really like that part of your strategy, but looking at 2-3% dividends on growth stocks makes sense. It wouldn't yield 5% if it is having double digit growth year after year. That is reserved for utilities or phone companies which are basically utilities for communications.

Perhaps Apple should start paying a dividend with all that cash they have, then I'd take a look

Nov 15 09:51 AM

[granger:]

Good article, thank you. I have passed the link on to some friends and family members.

This on of the best explanations of dividend growth I have seen. The idea of dividend grouping is new,I will have to think about some more.

Nov 15 10:46 AM

[bobbybutte:]

Daed wrong about how this cant work today

In 2000 in bought atsock and then watched it drop 20% . The stock had alow Pe and a great history of increasing dividends

Despite this supposed lost decade it has helped me make 17% annual compounded

As a person who has achieved financial independence SOLELY from allocating capital and have writtena book and newsletter based on buffett's teaching I am living proof that buy an dhold works

Nov 15 10:50 AM

[Plan B Econ...:]

Dividends were the primary way to evaluate investments 100 years ago. People didn't want false promises...they wanted tangible return. It only makes sense.

Anyone interested to see why dividend investing works should read the following:

www.planbeconomics.com.../


On Nov 15 10:50 AM bobbybutte wrote:

> Daed wrong about how this cant work today
>
> In 2000 in bought atsock and then watched it drop 20% . The stock
> had alow Pe and a great history of increasing dividends
>
> Despite this supposed lost decade it has helped me make 17% annual
> compounded
>
> As a person who has achieved financial independence SOLELY from allocating
> capital and have writtena book and newsletter based on buffett's
> teaching I am living proof that buy an dhold works

Nov 15 01:05 PM

[iel76:]

All the banks cut their dividends, Pfizer and Dow cut their dividends; General Maritime cut its dividend and probably countless other companies with which I'm not familiar. Managements don't care about anything but institutional investors and institutional investors don't care about dividends.

Forget investing in individual stocks and buy mutual funds or closed -end funds with a healthy fixed income component. That's what the income-oriented investor should be doing.

Nov 15 09:49 PM