Building A Dividend Machine For Retirement

| About: Altria Group, (MO)

When I read the recent announcement that Altria (NYSE:MO) was hiking its quarterly dividend from $0.38 per share to $0.41 per share -- which should come as no surprise to long-term Altria shareholders -- I was thinking about what life would look like for someone who invested $5,000 into Altria stock each year from 2008-11 in a Roth IRA. We’ll assume that the investment started after Altria’s spinoff of Philip Morris International (NYSE:PM) and stipulate that the $20,000 investment in Altria was bought at Altria’s average daily price of $21.83 since the spinoff. That would give you 916 shares of Altria on your initial investment, and you would have generated 200+ additional shares if you had reinvested the dividends diligently along the way.

Let’s say that as things stand in 2011, you are the owner of exactly 1,000 shares of Altria stock in a tax-free Roth IRA account. I’m rounding down to not only make the estimates of this exercise very conservative, but also to allow for people who may have bought Altria shares at a higher price than its average since mid-2008. Every January, April, July, and October, you would receive a tax-free check from Altria in the amount of $410, or $1,640 annually.

Historically, the best way to achieve the superior returns with this stock is to reinvest the dividends. But I have my concerns about putting all my eggs in one basket with this stock, mostly due to restaurants, bars, and even cities banning smoking; the declining volumes of cigarette shipments; heavy taxes on smoking; and my fear of heavy-handed government intrusion in the sector. So I would hedge my bets a bit, and in the security of a Roth IRA, I would use the $1,640 in annual dividends to create my own diversified machine of earnings, fueled by Altria.

Let’s say in 2011, you see PepsiCo (NYSE:PEP) trading at $63. Use the $1,640 in dividends to purchase 26 shares of PepsiCo. That’s paying a $0.515 per share quarterly, so Pepsi will generate $53.56 a year for you in dividends. Marching on to 2012, you see Warren Buffett’s Berkshire Hathaway (NYSE:BRK.B) selling for $68 per share, so you gobble up 24 shares of the investing legend’s iconic holding company. In 2013, ExxonMobil (NYSE:XOM) catches your eye at $71 per share, so you purchase 23 shares of the world’s largest oil company, which is paying out $0.47 per share quarterly at today’s rates, giving you $43.24 in annual income. Oh, what’s that? Johnson & Johnson (NYSE:JNJ) is trading at $68 in 2014? Cool. Buy 24 shares of JNJ. That will generate $54.72 per year for you in dividends at today’s rates. Wash. Rinse. Repeat. And if you feed the monster by continuing to make $5,000 annual contributions to your Roth IRA after the initial four-year time frame, the potential returns will go gangbusters and accelerate sharply.

If the 20th century to the present is any guide, Altria will continue to raise its dividends, allowing you to make ever larger initial purchases in undervalued blue-chips that catch your eye. Over the course of 10-15 years, you could build quite the substantial dividend-generating machine, with the off-shoot purchases of your Altria dividends gushing out as much money annually in total as your Altria dividends. To me, it’s a phenomenal hedged concept. No matter what’s going on in your life, if you have the discipline to spend four years putting the maximum allowable contribution of $5,000 into Altria stock in your Roth IRA, you could literally sit on your keister all day long while the Altria dividends roll in and help you quietly build a collection of blue-chip stocks. And if Altria continues to grow its dividend by 10% a year, and you invest the dividends in blue-chips that grow their dividends by 10% a year, you would be creating a lollapalooza effect that would most likely make you very happy in about 15-20 years. And the icing on the cake is that this would all be tax-free.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.