One of my favorite techniques when trying to think about generating financial independence income is to assign each security "the job" of generating $1,000 in annual dividend income. If you want to accomplish this goal somewhat quickly, there are two categories of companies that should dominate your focus: those companies that have a sustainably high current yield, and those companies with high dividend growth rates. Royal Dutch Shell (NYSE:RDS.B) is one such company that falls into the first category.
It doesn't get a whole lot of attention because it fits the definition of a slow-moving behemoth: sales have only grown at a 5% pace this past decade, cash flow has only increased at a 3% rate, and the dividend has grown in the 6-7% range. But what makes it appealing is the fact that you are able to get its 4.5% dividend yield in conjunction with its moderate dividend growth.
And better yet, if you choose to reinvest, the annual dividend income tends to increase at a triple rate (technically 2.93) over a ten-year stretch if the coming decade is similar to what Royal Dutch Shell delivered over the previous decade.
Put simply, to get $1,000 annual dividend income from Royal Dutch Shell, you would need to put yourself in the position to get $333 in annual Royal Dutch Shell income today, and then reinvest the dividends for the next ten years. Given Royal Dutch Shell's annual dividend of $3.76 per share, that means you need to get your hands on just 89 shares today.
To make this work, there is one important assumption that need to come true: the long-term growth of the dividend needs to be at least 6%. More specifically, earnings and cash flow need to increase by at least 6%, because Royal Dutch Shell does not have much room to expand its dividend payout ratio (right now, Royal Dutch Shell's dividend payout ratio clocks in at 51%, which is the highest payout that Royal Dutch Shell has experienced in the past fifteen years).
When I study Royal Dutch Shell, what I enjoy seeing is the fact that volumes are starting to increase across the company's cumulative operations. The past couple of years have been characterized by negligible growth and even some declines. To put some numbers on it, the company saw its oil production decline by 6% last year. It saw the sales figures for its chemical division decline by 7%. And its natural gas production only increased at a 2% rate. With those kinds of figures, it's hard to boost your earnings per share numbers.
Shell is getting better: by the end of 2015, Shell is expected to deliver total sales per share of $152.50. Last year, that figure was at $143.35. That estimated 6.0-6.5% growth in sales is why are you seeing analysts estimate that Shell will deliver cash flow per share of $12.85 this year, up from $12.03 in the last. That 6.81% cash flow growth would grant the Shell Board the ability to give shareholders a dividend raise somewhere in the 6% range.
I should first note, however, why I find the cash flow per share for Shell to be a more appropriate measuring stick than earnings per share. In the past two years, Shell management has needed to write down the performance of many of its North American natural gas assets that have been performing much worse than anticipated. In other words, the current earnings figures do not adequately present the profit-generating power of the oil giant.
Someone who only looks at Shell's earnings would think the company is falling apart; after generating $8.67 per share in 2011 and $8.48 in 2012, the company only reported earnings per share of $5.20 per share in 2013. Someone looking only at earnings would think that Shell was only generating 60% of profit in 2013 compared to 2012. But that's not the case, because one-time events skewed the performance-despite the lower natural gas performance in North America, Shell's cash flow per share managed to remain steady in the $12-$13 range.
Since writing down the North American natural gas assets, Shell has been showing some significant improvements. Its operating margins have increased from 10.7% to 11.5%, its net profits have increased from 3.6% to 5.0%, and its return on shareholder equity has increased from 9.1% to 12.0%. Shell is a company on the mend, and the oil giant's detractors may be employing recency bias to conclude that the mismanagement with the natural gas operations in North America is indicative of future problems. That's not the case, as Shell's core metrics of profitability listed above seem to indicate a company serious about rebounding from past management errors.
For investors that want to reverse engineer their way to $1,000 dividend checks with Royal Dutch Shell as a cornerstone of their portfolio, they can do it within ten years by doing the following: acquiring 89 shares today, achieving a long-term dividend growth rate of 6%, reinvesting dividends, and holding the stock for ten years. Some people may find the 6% dividend growth rate unduly optimistic, and if that's a problem, they should refrain from investing. That's fine. But the numbers seem to tell a more optimistic story: sales per share is on the rebound, cash flow per share is primed to increase in the 6-7% range, and the company's core metrics of profitability have been increasing since the North American natural gas writedowns. For some, that ought to make Royal Dutch Shell an intriguing long-term hold.
Disclosure: The author is long RDS.B. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.