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Norman Tweed
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Retiree interested in stocks and financial instruments, especially dividend producing stocks. In the 20th century, I was an electrical engineer with Dominion Resources. I use a dividend growth investment style. Quick rules of thumb for complex questions, like fair value p/e using the Gordon... More
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  • Retirement Portfolio for Do it Yourselfers

    When I was young (43) my wife said to me “I want my dream house”. I told her I didn't have the money and she said build it yourself. We made a deal. The two of us would build it together. It took 4 years, but after she learned to lay brick and block, do flooring and tile and get permits, the result looked the way she had always dreamed it would.

     

    The same can be done for your retirement. When I started work (1967) my company had no 401k plan. However, we had a thrift plan that matched up to 3% of the employee's contribution to purchase company stock. This evolved over time into a 401k plan, in which you could invest in several different index funds held by BNY/Mellon Bank, or you could invest a portion in company stock. I wished that I could invest in other individual stocks, back then and finally was able to when I retired in 2000 and rolled the 401k plan over into an IRA.

     

    Recently, a friend who is still working sent me a list of dividend growth stocks which has had a good income growth since 2006. He asked me to present the results and here they are.

     

    The portfolio consists of 10 dividend growth stocks: Abbott Labs (NYSE:ABT), Colgate (NYSE:CL), Johnson & Johnson (NYSE:JNJ), Coca Cola (NYSE:KO), Procter & Gamble (NYSE:PG), AT&T (NYSE:T), Exxon Mobile (NYSE:XOM), Kimberly Clark (NYSE:KMB), McDonald's (NYSE:MCD), and Wall-Mart Stores (NYSE:WMT). An initial investment (01/04/2006) of $100,000 was divided equally into 10 positions and the dividends were not re-invested. These are all Dividend Champions with 25 or more years of dividend increases. The results are as of 12/31/2010. Although this portfolio grew over the 5-yr period through price appreciation, the point of interest is the income and income growth over the period. Dividends and Income growth are presented below:


    2006 2007 2008 2009 2010
    Total Div
    ABT $290.33 $320.63 $329.46 $393.84 $434.23
    $1,768.49
    CL $224.98 $251.98 $280.78 $309.58 $365.37
    $1,432.69
    JNJ $232.50 $258.87 $286.83 $308.40 $337.17
    $1,423.77
    KO $303.78 $333.18 $372.38 $401.78 $431.18
    $1,842.30
    PG $205.47 $230.94 $263.20 $292.07 $320.16
    $1,311.83
    T $534.35 $570.51 $642.83 $658.90 $674.97
    $3,081.56
    XOM $218.54 $233.91 $264.64 $283.42 $297.08
    $1,297.59
    KMB $321.88 $348.70 $380.55 $399.00 $432.52
    $1,882.65
    MCD $295.68 $443.52 $480.48 $606.15 $668.24
    $2,494.09
    WMT $140.87 $178.65 $201.32 $227.76 $254.75
    $1,003.34








    Income $2,768.39 $3,170.89 $3,502.48 $3,880.90 $4,215.67   $17,538.33

     

     

    The power of this income growth can better be seen graphically:

     

     

     

     

     

    The key to this growth is compounding. The dividend growth rate multiplies the income by a factor of 1.52 in just 4 years. The next question is “How well was the original capital preserved?” Stock Charts for the 10 companies are presented below:

     

     

    It can be seen that all companies held up well, even during the Great Recession. It is especially fortunate that MCD, KO, and CL were included to create price appreciation. However, preservation of capital is all that was required. The income that was thrown off by this portfolio was what the retiree would live on.

     

    If one was looking for more income, while still in the accumulation phase of life, the dividends could be reinvested and additional investments could be made to increase the income stream. The stocks selected are not high dividend paying stocks. If a do-it-yourselfer can find better stocks, the income stream can be even better.

    Sep 05 12:54 PM | Link | 8 Comments
  • 3 Dividend Growth Stocks selected by Gordon Model

    Myron J. Gordon wrote the classic paper Dividends, Earnings, and Stock Prices back in May 1959.

     

    http://www.wiso.uni-hamburg.de/fileadmin/sozialoekonomie/bwl/bassen/Lehre/International_Finance_I/Assignments/1959_Gordon.pdf

     

    In his paper he argued that the investor buys the dividend when he acquires a share of stock because the dividend is literally the payment stream that he expects to receive. In implementing the hypothesis it must be recognized that the stockholder is interested in the entire sequence of dividend payments that he may expect and not merely the current value. “For the purpose of arriving at an operational model we may represent this infinite sequence by two quantities, one the current dividend and the other a measure of the expected growth in the dividend.”

     

    This model can be simplified and written as P=D+G. Where P is the price of the stock today, K is the required return, G is the dividend growth rate (Gordon speaks of 5-yr average dividend growth rate in the paper, but mathematically derives it for perpetuity), and D is next year's dividend.

     

    This formula has been simplified and rewritten as: P= ΣD*(1+G)t/(1+k)t, summing the infinite series we get, P=D*(1+g)/(K-G) but it is only meaningful in this form if K>G. I further modify it into K=D/P +G in which D/P is current %yield and G is dividend growth %. What this tells you is that constant future dividend growth is additional yield. Gordon speaks about earnings growth also in the paper. However, this is a highly conservative usage, leaving out pure growth stocks and concentrating on yield only. It is most applicable for utilities and slow growth rate stocks.

     

    With these bond-substitute stocks, p/e is determined as 1/yield. Thus if the yield is 5%, then the p/e is 20. If the yield is 10% then the p/e is 10. Gordon talks about companies having earnings per share growth rates of 4-10%. Thus in this small range, the yield + dividend growth rate provides a fair value of p/e.

     

    • My first example is Dominion Resources (NYSE:D): The yield is 4%. The 5-yr dividend growth rate is 6.4%. Thus the Gordon yield would be 10.4%. The fair p/e would be 1/ Gordon yield=9.61. The higher the dividend growth rate, the more the stock is improperly modeled—due to its deviation from bond status. In practice, I simply add the yield + dividend growth rate to get a fair p/e of 10.4. At the time of this writing, the actual p/e is 15.4 (First Call).

    • My second example is Southern Company (NYSE:SO): The yield is 4.62%. The 5-yr dividend growth rate is 4.1%. The fair p/e would be 1/ Gordon yield=11.46. The actual p/e at time of writing is 17.3 (First Call). My simplified formula would provide a fair p/e of 8.72.

    • My final example is Frontier Communications (NASDAQ:FTR): The yield is 10.3%. The 5-yr dividend growth rate is 0. Thus the Gordon yield would be 10.3%. The fair p/e would be 1/Gordon yield=9.7. The actual p/e at time of writing is 28.8 (First Call). My simplified formula would provided a fair p/e of 10.3.

     

    What should we get from this rule of thumb? Well, it is a highly applicable first screen for dividend stocks, especially utilities and telecommunications stocks. It should not be used on growth stocks. It is only a first cut tool, one must study the company to see if the dividends are covered by cash flow and be sure that the earnings are growing to provide for dividend growth. In times of frothy markets, like today, it is important to get the income stream, regardless of price swings, especially if you are retired. I personally require a minimum 4% yield before I calculate any growth factors for dividends or price appreciation in the stock.

     

     

    Aug 30 3:40 AM | Link | Comment!
  • Buy NUE @ $36.25

    Nucor Corp is a steel maker and recycler. Their segments are: Steel Mills, Steel Products, and Raw Materials. It is a basic materials sector stock, which is a highly cyclical sector. The price is averaging $40 per share since October 2008 and with any dips it can reach the 4% yield point of $36.25, based on current dividend of $1.45.

     

    EPS growth 2011-2012

    EPS 2010

    EPS 2011

    EPS 2012

    EPS 2013

    Price 7/29/2011

    4% yield

    40.30%

    $0.44

    $2.68

    $3.76

    $4.24

    $38.89

    $36.25

     

    NUE is a Dividend Champion with 38 years of consecutive dividend increases, through crashes and high times. The 5-year dividend growth rate is 36.9%, while the dividend growth rate last year was only 2.1%. The ttm p/e ratio is 26.28, but current p/e is 14.62 and forward p/e for 2012 is 10.37.

     

    One must watch out in a cyclical industry for the crash, like May 2008. However, dividend yield can be good when purchased at the 4% yield point. The company has only 48.8% debt to total assets ratio.

    Jul 31 3:20 PM | Link | 2 Comments
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