Dividend Growth Investor's  Instablog

Most investors have specific goals in mind they pick a certain strategy to utilize. They then get to pick strategies that could help them achieve those goals. The end result from this exercise is that too often investors end up bailing out on strategies at the worst possible times. The reason for that is that they weren’t prepared for the rocky rides that would ultimately lead them to reach their goals later.

Some investors are comfortable utilizing strategies that deliver small positive results to them in a consistent manner. Dividend investing is one such strategy, where investors are frequently rewarded for holding a portfolio of the best dividend stocks, by receiving dividends. Selling covered calls is another example of a strategy where investors are rewarded frequently with small gains.

Other investors however are more comfortable to shoot for the big payout coupled with a lot of small losses. The big payout could erase any small losses previously incurred. Purchasing out of the money call or put options, which is what Nassim Taleb does, or purchasing speculative biotech stocks hoping for a positive FDA announcement are two examples of such approaches.

It is important to understand your strategy very well in order to make sure that it fits your investor profile. Dividend investing is a pretty slow and sometimes boring process of selecting companies that have raised distributions for a define set of years, provided that they are trading at attractive valuations. It involves a little bit of work when dollar cost averaging at regular intervals, rebalancing portfolio weightings and reinvesting dividends selectively. Other than that however it is nothing “exciting” to talk about in the first few years of employing this strategy. Only after a few years later however, as the stream of dividend income becomes larger and exceeds what you could be making at a part time job, does the enterprising dividend investor begin to see a material effect of employing this strategy.

In the meantime the boredom could play mind tricks on dividend investors, which are constantly bombarded with news about the stock market and the economy. Sometimes the information overload could generate intense urge for meaningless action, which would be disastrous to investment returns over time.

For example, some investors consider yields on cost of 10% as a pretty good thing. The way that most novice investors deal in attaining this goal however is by purchasing companies yielding 10% or more, without checking the fundamentals and sustainability behind this dividend payment. Back in the summer of 2008 Bank of America (BAC) was yielding over 10% on several occasions. Investors hoped that the dividend won’t get cut and that a rise in the stock price would bring the yield back to normal levels. Little did they know that the company would cut dividends twice in 6 months and end up yielding less than 0.25%.

The strategy that has worked best for many dividend growth investors is to purchase stocks in strong brand names such as Procter & Gamble (PG), Johnson & Johnson (JNJ), Wal-Mart (WMT) and Pepsi Co (PEP). Such stocks have the ability to generate strong earnings growth, which then trickles back to increased dividend payments. Some investors still ignore such investments however, since they have dividend yields of 3% - 4%. What these investors fail to see is that if these companies could grow their distributions at least at a rate of 7% annually, they would end up doubling their distributions every decade. A 4% yielder with sustainable dividend payout ratio today would likely generate an 8% yield on cost after ten years.

The following dividend aristocrats are good starting positions for many dividend investors:

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. This dividend aristocrat has increased distributions for 47 years in a row. (analysis)

PepsiCo, Inc.(PEP) manufactures, markets, and sells various snacks, carbonated and non-carbonated beverages, and foods worldwide. This dividend aristocrat has increased distributions for 37 consecutive years. (analysis)

The Procter & Gamble Company (PG) engages in the manufacture and sale of consumer goods worldwide. The company operates in three global business units (GBUs): Beauty, Health and Well-Being, and Household Care. This dividend aristocrat has increased distributions for over 53 consecutive years. (analysis)

Wal-Mart Stores, Inc. (WMT) operates the largest chain of retail stores in various formats worldwide. This dividend aristocrat has consistently increased distributions for 35 years. (analysis)

At the end of the day, what truly matters is that you reach your financial goals, not when you started investing or how fast you were going. There truly aren’t any short cuts to investing other than the fact that slow and steady always wins the race, while the hare would most likely spend most of their time catching up.

Full Disclosure: Long JNJ, PEP, PG and WMT

Relevant Articles:

- What Dividend Growth Investing is all about?
- 10 by 10: A New Way to Look at Yield and Dividend Growth
- Why do I like Dividend Aristocrats?
- Dollar Cost Averaging

Ever since the markets hit a milti year low in March, investors have been wondering how sustainable the advance is. Some claim that the bear market is over, while others believe that the worst is yet to come in the grand scheme of events.

Intelligent dividend investors are not worried about short-term fluctuations in the markets however. They understand that if they follow a rigorous screening process and acquire a diversified mix of the best dividend paying companies in the world, their distributions would provide a positive return in any market. In a previous post I identified 12 attractively valued dividend stocks to acquire now. It is important however not to overpay for stocks, even those with exceptional moats, as this could lead to underperformance relative to their benchmark over time.

If the markets were truly overstretched, then a slight retracement from markets recent highs would be a welcoming sign for income investors, who are looking to exploit these conditions by acquiring great franchises on dips. Pockets of opportunity allow dividend investors to buy solid businesses at reasonable prices, decent yields and acceptable dividend growth rates.

In order to capitalize on such opportunities, I have screened for companies, which have raised their dividends for more than 25 consecutive years. My criteria were are follows:

1) Stock has increased dividends for more than a quarter of a century
2) Price/Earnings Ratio of less than 20
3) Dividend payout ratio of less than 50%
4) Dividend yield is more than 2%, but no more than 3%

The companies, which I identified in the screen, are listed below:

                                            (Open as a spreadsheet)

I require a 3% initial dividend yield before initiating a position in a stock. Thus the above-mentioned stock list should be acquired only on dips below the target price. Another strategy for enterprising dividend growth investors is selling cash secured puts on the stocks below, with strike prices close to the target price mentioned above. I have provided some explanation why I require at least some yield below.

Investors often overpay for stocks because of the recency phenomenon, where they discount double-digit growth indefinitely. This leads to purchasing stocks with unacceptably low dividend yields, high P/E ratios and rosy predictions for strong dividend growth for eternity. Such conditions are simply unsustainable.

Thus by buying a stock with a dividend yield of at least 3% an investor’s income is relatively well covered in a scenario where the company stops growing its distributions. With this margin of safety the investor still generates some dividend income until they manage to sell the stock and re-invest the proceeds in a more promising dividend growth stocks. With a 1%-2% yielder, it would take forever for our enterprising dividend investor to earn a reasonable dividend income if distribution growth slows down or grinds to a halt.

Full Disclosure: Long MHP, MMM, SHW and WMT

I recently managed to get a hold of the letters of the original Buffett Partnership. In those letters Warren Buffett describes the investment strategies employed by the partnership, the structure of the partnership as well as the fees that the limited investors paid for performance.

These partnership letters are different than Berkshire Hathaway’s (BRK.a, BRKb) letters to shareholders. Buffett wrote them between 1959 and 1969 and sent them out to the limited investors of the Buffett Partnership. He also provides additional information, which allows aspiring value investors to better understand how the young Buffett made his investment decisions early in his career.

The fees that Buffett was charging his limited partners were solely based on his performance. After all the partnerships merged into a single one in 1962, Buffett would get 25% of any profits over 6% that he partnership generated. In other words, if the partnership earned less than 6%, which was most probably how much it could have earned in fixed income, Buffett would get not compensation.

In one of his 1962 letters to limited partners, Buffett explained in detail the strategies he used to generate excessive returns.

The first group of companies (generals) he invested in was undervalued securities, where his partnership would hold about 5-10% of total assets in 5-6 companies and smaller positions in another ten or fifteen stocks. This group of stocks provided a relative margin of safety when purchased but behaved just like the market. Overall his portfolio in this section was relatively diversified, and but had a very good chance to generate excessive returns in up markets. One site that provides good ideas on generals is Old School Value.

The second group of companies that Buffett Partnership LTD tended to focus on was workouts. Those were stocks affected by corporate events like mergers and acquisitions, spin-offs, reorganizations and liquidations. Buffett did mention that this strategy would produce relatively stable earnings from year to year, which would make this portion of his portfolio outperform the markets in bad years, but underperform in strong markets. An example of such activity is the Pfizer/Wyeth merger announced in January 2009.

The third strategy where the Buffett Partnership concentrated was control situations. These were events where the partnership would initiate a large enough position in a company and try to influence corporate policy. A famous control situation is Berkshire Hathaway (BRK.A), which started out as an undervalued position.

Another important fact is that Buffett put his money where his mouth was – most of his net worth was invested in the Buffett partnership. In my research of successful companies I have found out that management which has a large chunk of their net worth in company stocks, tend to deliver more and are less likely to de-fraud individual investors. Companies where owners hold a large chunk of their net worth include Bill Gates holdings in Microsoft (MSFT), Richard Kinders holdings in Kinder Morgan (KMP) and John D. Rockefeller’s Standard Oil in the late 19th and early 20th century.

You could download them all from this link.

Here’s a timeline of the life of the Buffett Partnership:

1956 - Benjamin Graham retired and closed his partnership. At this time Buffett's personal savings were over $174,000 and he started Buffett Partnership Ltd., an investment partnership in Omaha.
1957 - Buffett had three partnerships operating the entire year.
1958 - Buffett operated five partnerships the entire year.
1959, -The company grew to six partnerships operating the entire year.
1960 -Buffett had seven partnerships operating: Buffett Associates, Buffett Fund, Dacee, Emdee, Glenoff, Mo-Buff and Underwood. In
1962- Buffett merged all partnerships into one partnership.
1966 -Buffett closed the partnership to new money.
1969 - Following his most successful year, Buffett liquidated the partnership and transferred their assets to his partners. Among the assets paid out were shares of Berkshire Hathaway.

More »

At the end of 2008 I was invited to participate in a passive stock-picking contest between several US and Canadian bloggers. The goal of the competition was to select the four best stock ideas from each blogger. The rules did not allow active buying and selling, which means that once you select your picks; one can’t go back and change them. Check out my original post for the rationale behind my picks.

The companies I selected were representative of four high yielding sectors- real estate, energy transportation, utilities and tobacco. Despite the high yields, the dividend payments seemed sustainable enough even during the financial meltdown. The average yield on the four stocks mentioned below is 6.88%. The riskiest stock of the four seems to be Realty Income (O), since real estate is one of the hardest hit sectors in the US. Kinder Morgan (KMP) and Con Edison (ED) are pretty much utility like investments, while Phillip Morris International (PM) should do fine in a crisis, as smokers find it tougher to quit.

Realty Income (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The monthly dividend company ended 2008 at $23.15 and has distributed $0.85 in dividends so far this year. At the current price of $21.92 the investment is underwater by 1.64%. This dividend achiever, which has consistently increased its distributions several times/year since 1994, currently spots a very attractive 7.90% yield. Check out my analysis of Realty Income.

Consolidated Edison, Inc. (ED), ended 2008 at $38.93. At the current price of $37.42 plus the $1.18 in dividends collected during the first two quarters the investment in this provider electric, gas, and steam utility services has lost 0.85%. Currently this dividend aristocrat yields 6.30%. Check my analysis of Consolidated Edison.

Kinder Morgan Energy Partners, L.P. (KMP) owns and manages energy transportation and storage assets in North America. One of the largest master limited partnerships in the US has generated a total return of 16.33% in 2009, one third of which came from this dividend achievers generous distributions. The units of this partnership currently yield 8.30%. Check my analysis of Kinder Morgan.

Full Disclosure: Long PM,O, ED and KMP

More »