Dividend Growth Investors: Pretend You've Got A Punch Card In Your Pocket

Includes: BRK.B, EMR, GE, ITW, JNJ, PG
by: Tim McAleenan Jr.

There are plenty of Warren Buffett excerpts out there that provide great insights into investing philosophy, but I suspect that there is a limit to how many times we can stomach hearing an article repeat "Be fearful when others are greedy, and greedy when others are fearful." That's why I spent the past hour or so searching for a bit of Buffett's investing philosophy that deserves more air time than it gets. Eventually, I came across Buffett's "punch card" analogy that I think is a brilliant mental framework for investors to consider with their stock selections.

Charlie Munger, the Vice Chairman of Berkshire Hathaway (NYSE:BRK.B), summarized it succinctly here:

When Warren lectures at business schools, he says, "I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches-representing all the investments that you get to make in a lifetime. And once you'd punched through the card, you couldn't make any more investments at all. Under those rules, you'd really think carefully about what you did, and you'd be forced to load up on what you'd really thought about. So you'd do much better."

Wow. That's a fantastic way of approaching investing because it forces you to consider each stock in relation to another. In other words, it transforms your thought process from "Is this a good place to put my money?" to "Is this the best place to put my money?" Instead of just cavalierly thinking, "Yeah, Emerson Electric (NYSE:EMR) looks good to me right now," you have to take an additional step. You then have to ask yourself, "But is Emerson more compelling to me than Illinois Tool Works (NYSE:ITW)? Or would buying General Electric (NYSE:GE) give me more bang for my buck?"

This type of "twenty-hole punch" logic forces you as an investor to maintain the necessary discipline to avoid falling victim to owning a random collection of odds and ends that will most likely mirror the S&P 500 (or maybe worse). And while Buffett's advice sounds like it applies more to total return investors than dividend-focused investors, that's not necessarily so. Let's say that you heard about Procter & Gamble's (NYSE:PG) recent 7% dividend increase to $0.562 per share, and you are thinking about loading up on shares of the consumer products giant at the current 3.37% dividend yield. By adopting the punch-card mentality, this thought would come to the fore of your mind, "Yes, Procter & Gamble might provide me with some good income growth going forward, but is this really the best thing that I can do with my money?"

If I were performing this exercise, I'd put Johnson & Johnson (NYSE:JNJ) on the balance beam next to Procter & Gamble to see which is the more attractive investment. I'd think something along these lines: not only does Johnson & Johnson offer a more favorable 3.60% current yield to Procter & Gamble's current 3.37%, but Johnson & Johnson has yet to announce its dividend increase this year, while Procter & Gamble already has its 7% increase baked into the price. If you figure that Johnson & Johnson raises its dividend to at least $0.60 per share for the next quarterly payout (from the current $0.57 quarterly), then its dividend yield would rise to 3.79% relative to Procter & Gamble's 3.37%. If I were an income investor who thought that each company had similar moats, balance sheets, and earnings/dividend growth opportunities, then I'd likely put my money into Johnson & Johnson, even though Procter & Gamble is a good investment in its own right.

I'm inclined to think that the "punch card" mentality offers income-focused investors the opportunity to take their investing game up a notch from good to great. David Fish's CCC list features hundreds of companies to sort through, and if you take a "I can only invest in 20 of these suckers" attitude toward your analysis, you're going to naturally have the discipline to avoid looking at companies that distract you from your focus on finding the best combination of current yield and future dividend growth. I mean, Barron's Magazine comes out with a list of different stocks to consider each week. Heck, Seeking Alpha gives you a list of stocks to consider each day. It's easy to get lost in the noise of what's trending lately. The Buffett punch-card analogy provides investors with some much needed ear plugs.

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