Harry's Plan: Buy, Hold, And Collect

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Includes: ADM, CMI, DWDP, GPC, HON, ITW, JNJ, LLY, MMM, MO, MUR, NUE, PFE, PH, QCOM, SLB, SO, TXN, VFC, XLNX
by: Backroom Analyst
Summary

One always hears about "Buy and Hold," but I have a friend who takes that concept to the extreme.

It is possible to buy a basket of high dividend stocks, and never do another thing after that.

My friend is just one example, but there is also a powerful screen that will help the dividend investor.

www.freedigitalphotos.netIntroduction

I was once a financial advisor for a large Midwestern firm. I learned much from them with success, but found my life going in a different and happier direction. I met many interesting people from those years, and cherish the relationships I developed from that period. One person in particular, an 89-year-old retiree is one with whom I still maintain contact.

Retired since 1975, Harry is an experienced investor who has been able to survive and thrive from his initial investment decisions. When I see him, we talk mainly about the stock market, and how to be successful in it. During my last chat with Harry, I asked him whether he has ever sold a stock. His answer surprised me. He said, "No."

Think about that. Here is someone who invested roughly $700,000 in a basket of stocks, and has never sold a single company he bought in the last 40 years. That is not to say he has not bought anything since 1975. He does reinvest his dividends in new companies, and due to mergers and acquisitions, he will come into new cash that he can invest. He told me this, "I have over five million people working for me right now, and they pay me 9¢ each to work for me." He told me he is paid $450,000 in dividends from his initial investments in 1975. This is a man who literally survives primarily on his dividend income.

Harry's Favorites

I asked Harry which companies are his favorites. He has several, but he highlighted Southern Company (NYSE:SO) and Honeywell (NYSE:HON). I asked him why, and this was his response. "Southern Company just increased their dividend 3.4%. Would you take a job that would give you a pay raise like that?" Honeywell increased its dividend 15.1% last year. There is the key to Harry's style of investing. The two following charts show how Southern and Honeywell have increased their dividends over time. Both have averaged 4.9% increases since 1975 and 1982 .

Chart 1

Chart 2

Harry had some basic advice for me for finding companies that will help anyone make money. First, stay with large companies; they're safer. Second, look for companies that pay a dividend. Lastly, and the focus of this piece, look for companies that consistently increase their dividends. It is with this in mind that I developed a screen to look for dividend paying companies that have a history of increasing dividends over time.

The Screen

When I screened for large companies with a history of raising dividends, the list was longer than one should have to manage. It became necessary to cull the list down from 180 companies to a much shorter list. I did remember Harry telling me to find financially sound companies, so I incorporated my modified "Bulletproof" criteria to find companies that are less likely to run into financial trouble. Just like Harry, there is no rebalancing or sell indicators. Here is the screen:

  • Large Cap Stocks Only
  • Positive Free Cash Flow
  • Current Ratio > 1.5
  • Quick Ratio > 1.0
  • Debt to Equity < 0.4
  • Net Profit Margin > 0
  • Increased dividend each year for the past 10 years
  • Current dividend yield is greater than 2%

The financial criteria narrowed the list on average to about 4 companies. In January 1999, there were exactly 3 passing companies:

Ticker

Name

GPC

Genuine Parts Co.

ROH^09

Rohm and Haas Co.

UST.1^09

UST Inc.

Table 1

With this list, I assumed a $100,000 initial investment. Given that there are many individual investors who use this site, I assumed equal allocations in each company through a discount broker ($7 per trade). Table 2 shows how many shares of each company were bought. It also shows how much in dividends would have been paid out in the subsequent 16 ½ years. All share data is split-adjusted.

Ticker

Name

Price ($)
01/04/1999

Shares

Initial Yield

Total Dividends

Notes

GPC

Genuine Parts Co.

32.75

1,017.60

2.99%

$25,586.48

ROH^09

Rohm and Haas Co.

31.13

1,070.73

2.39%

$10,696.55

Bought by Dow Chemical (NYSE:DOW) in 2008 for $79.00/share

UST.1^09

UST Inc.

34.88

955.59

4.82%

$17,659.37

Bought by Altria (NYSE:MO) in 2009 for $69.50/share

Table 2

This portfolio would have given us an initial 3.4% dividend yield, providing around $3,400 in initial annual income. This is a nice start for a retiree in 1999.

The Acquisitions

Just as in real life, one occasionally finds that companies they own are acquired by other companies. This type of event created two buying opportunities for our sample portfolio, so we took the cash from the acquisitions, and bought additional stocks using the same screen. The following tables show which companies were bought with available proceeds from the mergers.

Rohm and Haas Buyout ($84,587.32 investment)

Ticker

Name

Price ($)

09/02/2008

Shares Bought

Initial Yield

Total Dividends

GPC

Genuine Parts Co.

42.24

42.72

3.68%

$4,117.74

ITW

Illinois Tool Works Inc.

49.79

36.25

2.50%

$2,607.44

JNJ

Johnson & Johnson

71.51

25.24

2.61%

$2,935.64

LLY

Eli Lilly and Co.

46.91

38.47

4.03%

$4,054.36

MMM

3M Co.

70.83

25.48

2.79%

$3,066.59

NUE

Nucor Corp.

48.84

36.95

2.44%

$2,684.82

PFE

Pfizer Inc.

19.20

93.99

6.70%

$4,403.29

VFC

V.F. Corp.

21.09

85.57

2.93%

$3,243.83

Table 3

This basket of stocks, similar to our original selections, averaged a yield of 3.46%.

UST Buyout ($66,413.77 investment)

Ticker

Name

Price ($)

01/07/2009

Shares

Initial Yield

Total Dividends

GPC

Genuine Parts Co.

37.37

37.88

3.96%

$2,305.43

ITW

Illinois Tool Works Inc.

37.00

38.26

3.38%

$1,952.66

JNJ

Johnson & Johnson

59.02

23.98

3.03%

$1,934.88

LLY

Eli Lilly and Co.

38.81

36.47

4.83%

$2,423.87

MMM

3M Co.

58.58

24.16

3.38%

$2,102.95

MUR

Murphy Oil Corp.

42.78

33.09

2.11%

$1,558.64

PFE

Pfizer Inc.

17.65

80.20

7.01%

$2,405.91

PH

Parker Hannifin Corp.

43.20

32.77

2.21%

$1,745.80

VFC

V.F. Corp.

13.65

103.70

4.15%

$2,848.45

Table 4

This basket saw another increase in our yield at 3.78%.

The Returns

Harry's main goal is to collect dividends. What is most interesting about him, is he owns no bonds; doesn't really understand how they work. He does, however, understand that as part owner of a company, he's entitled to share in its profits in the form of a dividend. If one were to stick with our example portfolio, it would have generated dividends around $10,588.77 (2.52% current yield) the next 12 months; not bad from the initial $100,000 investment. It looks even better if one realizes this expected dividend total is more than 214% over our initial $3,400 amount. That is an annual increase of 7.13%. As we say in the business, any investment that provides pay raises while you wait for it to go up in value is a good investment. This is a good investment strategy.

Using this model, our investor would have realized $100,534.71 in dividends over the 16 ½ year period from their initial $100,000 investment. That is an average return of 5.99% per year just from the dividends. Add to that the portfolio is now worth $419,555.92. Altogether, our beginning investment of $100,000 has averaged a total return of 10.51%. What did the S&P 500 do since 1999? Including dividends, it averaged only 5.02%.

Of course there are risks. Outside of market risks, the main risk to dividend investing is that companies can, and will, reduce or eliminate a dividend if needed. The recession of 2008 saw a few companies do just that. Nucor and Pfizer both reduced their payouts, but they have increased since then. Like Harry, we didn't sell anything, since that is something we just don't do.

Robustness

This is just one example of how this strategy works. It is important to show whether it works for different time periods. This particular screen holds up quite well. Using one-year holding periods at four-week frequencies since 1999, this screen averaged 10.38%% (±11.52%) compared to the overall market's 4.54%. There is one caveat; there are times when this screen will generate no passing stocks. That is not always a bad thing, because during those periods the S&P 500 averaged a loss of 7.00% (±15.28%). As I have written before, that might a time to be patient, and wait for better opportunities.

If one is interested in looking for financially sound companies that have a history of increasing dividends, these are the passing companies as of July 9, 2015. Interestingly, some of the same companies are already in our sample portfolio. Johnson & Johnson, 3M, and Parker Hannifin, are all-stars for this kind of investing.

Ticker

Name

Current Yield

ADM

Archer Daniels Midland Co.

2.38%

CMI

Cummins Inc.

2.44%

HON

Honeywell International Inc.

2.05%

JNJ

Johnson & Johnson

3.05%

MMM

3M Co.

2.67%

PH

Parker Hannifin Corp.

2.23%

QCOM

Qualcomm Inc.

3.10%

SLB

Schlumberger Ltd.

2.39%

TXN

Texas Instruments Inc

2.83%

XLNX

Xilinx Inc.

2.96%

Table 5

This portfolio will provide an initial dividend yield of 2.61%. That is a nice start for any retiree looking for future pay raises.

Conclusion

I asked Harry about this list, and as I went through each company, he said, "That's a good one." I assumed he owned some of them, because companies like Johnson & Johnson have a long history of raising dividends; JNJ has increased its dividend for 53 straight years. I asked Harry why he does not own JNJ, and he said, "I didn't have any money at the time when it was the right time to buy." Remember, Harry never sells a stock. It was nice to know Harry gave the list a passing grade.

Harry's style and this anecdote are extreme examples of passive investing. Harry does not own a computer, and just uses index cards to keep up with his data. His is not high maintenance investing. With both, you have examples of buy and hold forever. In the meantime, just start collecting the dividends.

While dividend investing is not for someone who is trying to hit homeruns, it is for people who want to find a company that provides a pay raise while they wait for it to go up in value over time. One should not focus on current yields, but future payouts as well.

That sums up how one man was able to fund a very long retirement.

Happy Investing!

Disclosure: I am/we are long CMI, QCOM. 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.