How To Build A Dividend Machine For Free

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Includes: AXP, BRK.B, DIS, HSY, KO, MCD, PG, UNP, XOM
by: Drew Allen

Summary

My last article touched on the concept of inventorying your wealth.

It is possible to store wealth away on a systematic, monthly basis for no fees.

Following is not a prescription, but is rather a description of a strategy.

In my last article, I detailed my investing strategy and elaborated on the why of our portfolio. This strategy meant treating our household income as a business, and seeking to diversify away from our largest source of revenue (our salaries). Since our household is viewed as a business, we are also seeking to minimize our expenses just as any good business would. This means not only our day to day living expenses, but also the operating expenses of our stock portfolio. Currently, most costs are spread between taxes and trading commissions. A good portion of taxes can be avoided through a buy and hold strategy, but commissions can be unavoidable in many circumstances. However, it is possible to run a fairly diversified and strong portfolio with stock purchase expenses of approximately $.02 per month. This article will attempt to see how to operate this strategy on a low-fee, automated basis and demonstrate how small systematic purchases can lead to big wealth

The Strategy

The logistics for executing this are fairly simple. First, a number of stock brokerages have opened up that allow you to buy and sell stocks for free. The most prominent of these are Loyal3 and Robinhood and I have grown most comfortable with Loyal3 over the past couple of years. Pros and cons exist with both, but Loyal3 is most conducive to what I am trying to achieve here. It is a platform that allows you to buy shares in leading consumer companies, and all fees are paid by the company you are investing in. Loyal3 also works with the companies on its platform, which implicitly creates a seal of approval of the platform. This allows them to have an easy source of funding that doesn't dilute shareholders too much, and gives them a stable ownership base. However, this limits the stock selection and means you won't find GE on this site. Also, all client purchases are bundled together and executed at 2pm daily. This may leave you exposed to a swing in market value. However, the benefits outweigh the negatives in my opinion, and therefore the first step of the strategy is to open an account at Loyal 3.

Stocks At Loyal3

Next, we need to select which stocks we would like to purchase. Again, my strategy is to redeploy cash flow from my day job and store those funds in high-quality dividend paying stocks. This will automatically eliminate a large majority of the stocks available for purchase here. Next, we want blue chip stocks with a history of dividend payouts, and that have strong earnings. A few contenders stand out, but the ones I would chose are as follows:

American Express (NYSE:AXP): American Express offers credit and charge card services, expense management for companies, and travel related services through four different business lines. They compete against Visa and Mastercard in payments, but are more diversified and have other sources of revenue like Discover Financial. It is currently trading around $65 per share with an EPS of $5.07, which gives a PE ratio of approximately 13. It also pays a $1.16 in dividends, which is a yield of 1.78%. The yield leaves something to be desired, but the payout ratio is below 25% and appeals to my sense of stability in the dividend. AXP also pays their dividend in the second month of the quarter, which is a plus as it is hard to find a company that pays in the second month.

McDonald's (NYSE:MCD): McDonald's franchises and operates their restaurants across the globe, with more than 80% of them franchised. The company is geographically diversified and operates in nearly every country around the globe. MCD is currently trading around $125 a share and generates $4.82 in income per share, which is a PE ratio of approximately 26. It is overvalued at the time, but since this is a dollar cost averaging program, overvaluations will be smoothed out over time. They pay $3.56 in dividends a year for a payout ratio of 73.85%, which is right at my desired maximum.

Coca-Cola (NYSE:KO): Coca-Cola makes and licenses over 500 different beverage brands across the world. This includes the flagship Coca-Cola product and three additional of the top five best selling non-alcoholic beverages in the world. Like McDonald's, they also operate in nearly every across the global. KO is currently trading around $45 a share and delivered a $1.67 in earnings last year for a PE ratio of 26.94. Again, this stock is overvalued, but dollar cost averaging will take care of over-valuation in the long term. The company pays a dividend of $1.32 annually for a payout ratio of 79%. This is above my maximum, but KO's company history has earned an exception.

Disney (NYSE:DIS): The Walt Disney Company operates media networks, theme parks, move studios, and consumer product lines. A good portion of their revenue is derived from ESPN, leaving them vulnerable to cord cutting, but their earnings base has stability from their other sources. The company is currently trading around $100 per share and produced $4.90 a share in earnings last year, good for a PE ratio of 20.4. It has a low dividend payment of $1.42 per share, but the payout ratio is only 29%. One thing that can make the sting of the lower dividend is Disney only pays their dividend twice a year, which can make the payments seem higher.

Berkshire Hathaway (NYSE:BRK.B): Berkshire Hathaway is a conglomerate that operates in dozens of industries, but most of their earnings power is derived from their Insurance, Energy and Railroads business. A share of their B series stock trades around $145, and each share generated $9.80 in earnings last year for a PE ratio of 14.69. They do not pay a dividend currently, but should same day. There is a good chance the company will spin off a large portion of its businesses someday, which will be the mother of all spin-off undertakings and leave shareholders with a strong base of companies in their portfolio.

Hershey's (NYSE:HSY): Hershey's produces, sells and distributes more than 80 confectionary brands worldwide, including the ubiquitous Hershey's Chocolate bar. It is not limited to just candy, and sells items such as gum and beef jerky. Only 17% of their sales are derived from outside the US, so there is an opportunity for international growth. A share will run you around $91 right now, and each share produces $2.32 in earnings for a PE Ratio of 39.22. This is incredibly high, but one time impairments related to Chinese expansion led to a decrease in earnings of $1.28 per share. With this excluded, the PE would be a much more acceptable (but still high) 25.27. Total dividends are $2.33 a year for a yield of 2.56%.

Now that you have your stockholdings, make a one time purchase of each to initiate a position in each one. The amount can be anything from $10 to $2,500, and for an initiating position, I would recommend $200 for each. This requires you to only have $1,200 on hand now for these purchases.

Next, set up automatic monthly purchases for each stock. If you want, stagger the purchases throughout the month. For me, staggering them throughout the month allows me to see my strategy put into place almost twice weekly, and quells my desire to do something. Set the purchases from $10-$100 each. I recommend $50 for each, as $300 a month is a relatively low amount to commit to this strategy.

Stocks at Computershare

Now that your portfolio and purchases at Loyal3 are setup, head over to Computershare. They are a stock-transfer agent that also operates the largest number of direct-stock purchase plans and dividend-reinvestment plans in the world. Investing here is similar to investing in Loyal3, but not every plan is free. Also, you must enter your bank account information for each stock that you purchase instead of once when you open your account like at Loyal3. This is because each stock is held individually at Computershare, and not in street-name like an account at a brokerage (Your stock is held in street name at Loyal3). At Computershare, you are the direct owner of the stock, and it is not held for your benefit at a brokerage.

The stock selection at Computershare can also seem endless and is much more robust than Loyal3, but many of them are attached with onerous fees that can offset the benefit of bypassing a brokerage. Therefore, your selections will be relatively limited, and to operate this plan, positions will need to be opened in these four free/low fee stocks:

Union Pacific (NYSE:UNP): Union Pacific is one the largest railroads in North America and operates over 32,000 miles of rail mostly in the western portion of the United States. They ship agriculture, cars, coal, industrial products and likely any other product you could think of. Currently the stock is trading around $88 a share and earned $5.49 per share in 2015, which is a PE ratio just around 16. They pay out $2.20 in dividends, which is a low 40% payout ratio. The business is experiencing a mild-downturn, but will continue to be profitable over the long term.

Exxon Mobil (NYSE:XOM): Exxon Mobil is involved in oil and gas exploration, and also transport, manufacture and sell various petroleum products. They are considered to be one of the strongest oil companies on the planet, and is a direct corporate descendant of John Rockefeller's Standard Oil Empire. They are currently trading around $90 per share and earned $3.85 per share last year for a PE ratio of 23.37. Exxon also pays a dividend of $3.00 per share for a payout ratio of 78%. This is a high payout ratio, but earnings are depressed due to the downturn in oil prices that began in summer 2014. In a normal year, the payout would be around 25-30%. There is no fee to invest in Exxon, but the initial investment must be $250 or more.

Just like at Loyal3, make a one time investment to initiate the position, only the amount should be $250 for each stock for this plan. This will bring your total expenditures to start your portfolio to $1,700.00. Next, set up monthly purchases for each stock in the amount of $50 monthly. This $400 monthly will buy you additional stakes in eight of the most profitable and powerful corporations on the planet.

The Final Portfolio

So what does the final portfolio look like after it is assembled? Well, you will have $1,700 initially invested that will entitle you to $37.82 in annual income for a yield of 2.22%. This is a low yield, but some of the low yield is derived both from current overvaluations and the lack of the dividend at Berkshire Hathaway. The total PE ratio is 19.68, which is about 18% below the current PE ratio of the S&P 500. These ratios are sure to adjust downward due to resumption of business as usual at Hershey's and Exxon, and through normal reversion to the mean.

Shares

Total Investment

Price

Dividend Payout

Yield

Total Annual Dividends

AXP

3.06

$ 200.00

$ 65.31

$ 1.16

1.78%

$ 3.55

MCD

1.62

$ 200.00

$ 123.26

$ 3.56

2.89%

$ 5.78

KO

4.51

$ 200.00

$ 44.38

$ 1.32

2.97%

$ 5.95

DIS

2.00

$ 200.00

$ 99.86

$ 1.42

1.42%

$ 2.84

BRK.B

1.39

$ 200.00

$ 144.08

$ -

0.00%

$ -

HSY

2.19

$ 200.00

$ 91.36

$ 2.33

2.55%

$ 5.11

XOM

2.77

$ 250.00

$ 90.26

$ 3.00

3.32%

$ 8.31

UNP

2.85

$ 250.00

$ 87.58

$ 2.20

2.51%

$ 6.28

$ 1,700.00

2.34%

$ 37.82

Click to enlarge

Your monthly $50 outlay to each stock will purchase an additional $9.11 in annual income. With that in mind, what will this portfolio look like in 10 years? First, some assumptions. Let's assume earnings will increase by 8% annually due to buybacks, increase in business earnings, and the loss of one time impairments. Next, we will assume that PE Ratio compression will take 2% annually off the portfolio as ratios return to their normal level. This means our shares will return 6% annually. Third, we will assume that all purchases throughout the year are made at the same price for simplicity's sake. Fourth, we will be conservative and assume a 5% dividend growth rate. Last, every dividend will be taken as cash so as to seed other investment ventures.

Shares

Price

Dividend Payout

Yield

Total Value

Total Annual Dividends

AXP

48.14

$ 116.96

$ 1.89

1.62%

$ 5,630.49

$ 90.96

MCD

23.35

$ 220.74

$ 5.80

2.63%

$ 5,630.49

$ 135.40

KO

64.85

$ 79.48

$ 2.15

2.71%

$ 5,630.49

$ 139.44

DIS

28.82

$ 178.83

$ 2.31

1.29%

$ 5,630.49

$ 66.66

BRK.B

19.98

$ 258.03

$ -

0.00%

$ 5,630.49

$ -

HSY

31.50

$ 163.61

$ 3.80

2.32%

$ 5,630.49

$ 119.66

XOM

32.44

$ 161.64

$ 4.89

3.02%

$ 5,720.03

$ 158.52

UNP

33.42

$ 156.84

$ 3.58

2.28%

$ 5,720.03

$ 156.70

1.98%

$ 45,221.15

$ 830.41

Click to enlarge

At the end of the period, you will now have accumulated over $45,000 in stock with outlays of only $33,750 and have collected $2,000 in dividends. The portfolio will also be generating $830.41 in annual income that can be deployed into other opportunities. Dividends could be sent into high-yielding shares of AT&T, which would instantly add over $40 in annual income and would add diversification. With a collection of relatively small monthly contributions, you have just created a rock solid portfolio that will serve as a bulwark in good markets and bad markets. Here, the power of systematic purchases in inventorying your wealth stands out.

Conclusion

Obviously there are drawbacks with both this analysis and this investing approach. First off, the real world accumulation of shares and income will not proceed as smoothly as depicted. Earnings will crash and rise, as will stock prices over time. Dividends could be decreased, but the companies chosen were done so to lower the probability of a cut. Fees could also be increased, which would affect total return.

The stock sectors represented in the portfolio also leave something to be desired. Consumer stocks are vastly overrepresented, which is due to the nature of the stocks offered through these platforms. Industrials, tobacco, healthcare, telecommunications and REITs are also woefully underrepresented. Opportunities exist to invest in all of these through automatic purchases, but the fees for these stocks were prohibitive for this approach. You would be much better off diversifying by buying larger chunks at a brokerage every few months instead of looking at systematic purchases for them. Also, you could explore utilizing Robinhood for diversification as you can buy stocks in any company, however, they do not allow automatic purchases. This would take away the automatic set it and forget it approach that is a key portion of this strategy.

Lastly, the stocks presented here are not necessarily good or bad stocks to invest in, nor am I recommending that you invest in them. You will have to do your research to determine which stocks would best fit your goals. There are also other stocks that easily could have been selected including Realty Income, Dr. Pepper, Nike, Unilever, Phillips66 and McCormick, just to name a few. The ones selected are simply presented as examples of how to store and grow your wealth using the power of systematic purchases. Time, patience and discipline can all help to grow your portfolio with both minimal efforts and minimal funds.

Disclosure: I am/we are long KO,AXP,MCD,PG,XOM,HSY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Update - I updated this article as it included P&G as a firm for this strategy. P&G has since switched to Wells Fargo and no longer low fee, therefore, I replaced it with Union Pacific.