When considering the legend of John Chapman, better known as Johnny Appleseed, I think of a wispy carefree chap (pardon the pun) easily hauling a leather satchel filled to the brim with apple seeds. Perhaps you have a similar concept in mind from your youthful folklore. So what can we learn from such a seemingly untroubled and perhaps less than financially motivated man? That's a reasonable question and I'm looking forward to working through the answer. Now to be perfectly frank this ideology isn't likely to be a novel concept; but I thought that the analogy provided a worthwhile mental exercise nonetheless.
The first step in developing the "Johnny Appleseed Approach to Investing" is to debunk, if only partially, a common misconception: Johnny's inattentive and happy-go-lucky approach to planting seeds. A quick search of "The story of Johnny Appleseed" leads you directly to my first point:
"Although legend paints a picture of Johnny as a dreamy wanderer, planting apple seeds throughout the countryside, research reveal him to be a careful, organized businessman, who over a period of nearly fifty years, bought and sold tracts of land and developed thousands of productive apple trees."
Perhaps I haven't convinced you just yet, but a workable illustration is forthcoming:
When thinking about Johnny Appleseed, it should come as no surprise that one imagines the man with apple seeds in tow. But I think we're skipping a step or two here. How did he get the seeds? In reality he collected them from free at cider mills. But for us, things are slightly more difficult. In applying the Johnny Appleseed investing approach, our 'apple seeds' are actually cash dollars; unfortunately these do not come free. So our first step is to find money that we can invest. Incidentally, I have previously detailed a very practical way about this. Essentially the idea is to have a solid foundation built on an adequate emergency fund and the elimination of debt. From there, as long as one is making more than they spend then there should be an adequate surplus of available funds. If this surplus does not come easily, there are two basic options: make more money or spend less money. It seems simplistic and inherently intuitive, but really if you do not have the fundamentals down then neither this strategy nor any other one will be of much use.
Planting the seeds, or in our case investing our earned dollars, is likely to be the most important stage in the process. Notably, the same rules that apply to planting also apply to investing. First and foremost, we want to make sure that our seeds are of the utmost quality; no need to spend months nurturing a plant that will never come to the fruition that we had anticipated. For investing this means that we only invest in the best companies that we can imagine. For example, if you are following a dividend growth strategy (which we will assume for the remainder of this article) you would focus on companies like Coca-Cola (NYSE:KO), PepsiCo (NYSE:PEP), Johnson & Johnson (NYSE:JNJ), Colgate-Palmolive (NYSE:CL), McDonald's (NYSE:MCD), Procter & Gamble (NYSE:PG) and Target (NYSE:TGT). But of course like any shopping list, it is important to not only consider the quality of the product, but also the relative value that it is offering. To relate this back to this planting, this is directly applicable to knowing the correct season in which to plant. No matter how fantastic the seeds might be, planting them in fertile soil during the correct season is apt to provide a much healthier yield than say burying the seeds in snow during an incorrect season. Not only is it important to plant in the correct season, for investing this means buying at the right price, it is also important to make sure that you have say a Red Delicious seed on your hands rather than a citrus fruit. This is especially important if you happened to live in say the Northeast or an otherwise uninhabitable region for the citrus fruit. That is, with both planting and investing, you want to find not only the best available quality but also the most suitable endeavors. Johnny Appleseed did not just spread seeds randomly and neither should you.
If you are not already engrossed in the Johnny Appleseed parallel to investing, then perhaps this harvesting correlation will win you over. With planting, especially when it comes to fruit trees, it takes many years for that seed to turn into fruit bearing limbs. Likewise with dividend growth investing it usually takes many years to see substantial dividend checks start to roll in. Within this process it is important to both realize this substantial time commitment and to carefully monitor your growing fruit trees. Unlike the short-term timeframe of the hordes of analysts and advisors, you know that a tree, even those that are of the utmost quality, take a while to demonstrate their applicable fruits. But that doesn't mean that you can ignore your investments completely. Just like Johnny Appleseed did not just plant a seed and forget about it forever; he built nurseries with fences and periodically checked back in on them. In the same manner, we should check back and monitor our investments regularly. And this is regardless of their fundamental strength or size; in fact the larger the tree, the harder the fall.
Incidentally, I derived this Johnny Appleseed concept from a recent book that I read entitled Buffettology by Mary Buffett. Within this book, Mary detailed a fundamental difference between Warren Buffett and his famed mentor Ben Graham. Graham would buy companies far below what he considered to be their fair intrinsic value and then sell these firms when they approached what he thought was a more reasonable valuation. Warren Buffett still looks to find great companies below intrinsic value but he doesn't necessarily look to sell them, even if they happen to reach a more reasonable valuation. Mary Buffett discusses Warren's view on these types of businesses more succinctly with examples of GEICO and the Washington Post Company (WPO):
"These are companies that [Warren] sees as having an expanding value that will benefit him greatly over the long-term. Even though they periodically sell at prices in excess of their Grahamian intrinsic value, Warren has continued to own them. One removes weeds from the garden, not shoots of green that are flowering and bearing fruit."
Within our example, why would you cut down a fruit bearing tree the moment it started to show signs of a profitable yield? Yet this is exactly what you would be doing when you sell a profitable partnership. Admittedly, this concept is somewhat limited by our constraint of focusing on a growing stream of income over time. However, I personally partner with businesses because I believe that they will make more money in the future. It seems illogical to sell them for precisely the same reason; although that is not to say that there aren't circumstances that would effectively "make me sell".
So here we are, it's many years later and your increased earnings or diminished expenditures have literally paid you dividends; that is, your apple tree is producing apples on its own now. Given that you are focused on creating more apples in the future, we know that you wouldn't dare cut down that tree or group of trees. Monitor them through time and perhaps exchange them for different trees at times sure, but not eliminate them entirely. So what are you going to do with your apples? Personally I might advocate enjoying at least a sampling of the "fruits of your dividend labor". Next I would take those seeds and plant more trees, simple as that. Within investing this is as simple as reinvesting dividends. Better yet, these rewards usually come on a quarterly basis rather than say every 5 years. Like most things, success is merely a function of time and effort; in this case both are enhanced by reinvesting dividends.
Finding More Seeds
Now you could just sit around and wait for your apple tree to produce more apples, which it will. The same is true of investing in dividend growth stocks; your income will likely grow whether you do anything else or not. But if you're just sitting around, it seems to me that you could be doing something a bit more productive; something that increases your future dividend income and gets you closer to your end goal. I would liken this to Johnny Appleseed planting trees for 50 plus years. You find the seeds, plant the seeds, monitor them through time and re-plant a solid portion of your bounty. Within investing, you earn more money or spend less money, invest in quality companies at the applicable times, monitor them through time and reinvest the majority of your dividends.
Living Off Apples
Obviously this is the equivalent to "living off dividends"; that is, creating a growing income stream that covers your fundamental expenditures. Eventually you will have more trees than you know what to do with and all the apples you could eat, plus enough to trade for whatever else that you might need. It is not a simple or particularly short-lived prospect, but rather a long-term endeavor that quite literally rewards you with a fruitful bounty.
Bonus Section: Figuring Out What Season It Is
Within the "planting" section I briefly mentioned that it is important to not only figure out the "what" in one's portfolio, but also the applicable "when". It should be noted that this is much trickier to do in practice than in theory. I would suggest that it is at the very least reasonable to assume that with the truly wonderful companies and enough time you will likely do just fine regardless of the season. However, if you can find the most sensible times to plant then your investing results will be compounded to an even greater extent. As an added bonus, I have included a "F.A.S.T. graph" developed by fellow Seeking Alpha contributor Chuck Carnevale. I just recently stumbled upon Chuck's work, but I would presume that a great many of you out there are already familiar with the exceedingly worthwhile F.A.S.T. graph tool.
Here we see the earnings and dividend growth for Coca-Cola from 1998 until today. From the business-end, Coca-Cola management was doing an absolutely fine job: operating earnings had been growing at just under 7% a year and dividends had been growing at nearly 15% a year. However, during this same time period one saw a capital appreciation of just less than 1% a year for Coca-Cola and a total return just over 2%; lagging the S&P 500, but more importantly lagging Coke's actual business results. The problem was that it wasn't the correct season to be buying Coca-Cola. (For that matter, the late 1990's likely weren't a favorable season for many companies; with or without favorable economics) On the other hand, one knocks the cover off of the ball when a company's price is more sensible. (2009 for many companies would fit this category) The underlying point of this short aside was to underline the balance that must be struck between quality and value.
So what have we learned from happy-go-lucky Johnny Appleseed? That's easy. In order to eventually enjoy the fruits of your labor, you're going to have a long standing commitment. First and foremost you need capital to invest, thus reduced expenditures or else enhanced earnings power are probably a good bet. Next we move onto the planting stage whereby we are not only looking for the best quality companies, but most importantly the best qualities companies at sensible prices. We will periodically review these partnerships, testing them for their strength and sustainability, but realistically you won't have to do much more than monitor your goals from time to time. And remember this is a lengthy process; apple trees don't grow overnight. Once we start to receive meaningful sums from our bounty, it's ok to enjoy a bit of our dividend fruits. But the majority of them should likely be strategically redeployed. Developing a group of dividend income plants is a good start, but more time and effort is likely required. Eventually your goal of living off of dividends will be as true as Johnny Appleseed's still standing string of apple trees. When I consider Johnny Appleseed I think "man, that Johnny sure liked his apples". Perhaps someday people will be saying "man, that Eli sure liked his dividends".