A Cheapskate's Guide To Getting Free Capital

by: Investment Pancake
Summary

Invest in companies that pay you back your initial investment with dividends.

After that, you've gotten the stock for free.

Do it all in a ROTH IRA and get your free capital without sharing.

You know, I used to think that the best way to get filthy rich was to use someone else's money, get someone else to do all the work, and to then keep all the profits. But while this may be a time honored and laudable approach that's worked for many rich people, frankly, I'd rather just sit around and wait to get free stuff. Free stuff like.... oh, let's say... a few million dollars worth of blue chip stocks spitting off hundreds of thousands of dollars worth of free dividends.

Go ahead and call me cheap, but I really don't understand why I should have to pay so much as one single penny of my own money to get millions of dollars worth of free shares in wildly profitable multinational corporations. And fine, if you want me to wait around for 15 years to get millions and millions of dollars of capital for free, I don't mind. It's not like I have anything better to do.

But don't even talk to me about paying taxes on any of that free capital that I'm waiting around to get. Or the income it will generate, either! My god do I hate sharing my stuff - especially with the government.

Even if you aren't as cheap and stingy as I am, it still pays to not pay for your investment capital. The reason why is because it's hard to make investment mistakes when your investment cost is zero. The returns you'll earn are mouthwatering. If you've invested zero, then whether you make back a million dollars or a fraction of a penny, your total return is still going to be infinity percent. And the investment risk is asymmetrically skewed in your favor if your investment cost is zero. The more iterations you play of the game "heads I don't lose anything, tails I win something", the greater the statistical certainty that you are going to make money. Games with terms like that give you the warm, fuzzy feeling that you're sort of cheating... and getting away with it!

Here's a funny story: While I was still working as a lawyer, I made a point of maxing out my 401(k) each year. Blood, sweat and tears of boundless tenebrific misery went into funding those 401(k) plans with a share of my pre-tax salary. I rolled those 401(k)s into IRAs each time I hopscotched from one law firm to another. Then the financial crisis of 2009 hit, sending my IRA balances down by maybe 50% (or more). That happy event lowered my tax bill by 50% (or more) when I rolled some of that depressed IRA balance into a new ROTH IRA. Of course the market bounced back and restored that balance back to where it was before the financial crisis, but all the gains from that recovery are forever tax-exempt. Thanks, Mr. Market! Thanks, Uncle Sam! That was so much fun that nowadays, whenever a stock I own in my IRA crashes by, let's say, 20%, I roll that stock over into my ROTH IRA and take a 20% discount on the income tax bill I pay whenever I convert IRA assets into ROTH IRA assets.

But getting back to the original point of the story, I invested my ROTH IRA assets into dividend producing stocks - mostly real estate investment trusts, or REITs, which pay no corporate level income taxes. All of the dividends I received over the years from these REITs (and from other companies that I own in my ROTH) are obviously tax-exempt as well. Saving not one, but two layers of income taxes really sped up the amount of time it took before the total dividends I'd received in my ROTH IRA equalled the total amount of contributions that I'd put into those 401(k) accounts in the first place.

The day that happened, I could confidently say that I owned each share of stock in my ROTH IRA completely for free. Everything that's come into my ROTH IRA after that point has been pure gravy, doused onto a juicy net personal investment of zero (cue up the sound of a chorus of angels singing "permanently income tax free").

This is not like rocket science. More like watching grass grow. All I needed to do was to temporarily invest my own money into companies that would pay me back with dividends, wait around to actually get paid back, and then continue to get paid additional free money for the rest of my entire life. I suppose you could say that I did some work to get all that free money, but nothing compared to all the work that the CEOs, managers and employees of all the businesses that I now own for free. I'll admit that I certainly worked soul-draining hours to get the money that I temporarily invested, but that doesn't count since I eventually got it all paid back again in the form of dividends.

Oh sure, it might have gone down differently. Some of the companies I bought could have (and in a few cases, actually did) cut or eliminate dividends. That's why I stayed highly diversified, because the other companies I owned continued to pay and raise their dividends, which more than made up for the naughty companies that cut or eliminated theirs. It just meant that I had to wait a little while longer before I got all the stock for free. Which is fine. I don't have anything better to do.

Stingy. Cheap. Lazy. But also greedy and impatient! Did you know that sometimes, I actually want to get even more tax-exempt capital for free? Fortunately for me, every now and then and for no good reason, the stock market unpredictably launches the share price for something I own into the stratosphere. That happened recently, and I wrote about that in an article here on SeekingAlpha: Rotating Stocks to Grow Portfolio Earnings. I suddenly found that my investment in Church and Dwight (CHD) that I had in a ROTH IRA had surged by $7,000 more than I'd paid for the stock just a few months earlier. The stock seems wildly overpriced now, so, I sold the shares, took that $7,000 of free money and invested into shares of Apple (NASDAQ:AAPL) and Altria (MO) for a combined yield of just under 5%. That's $350 of annual free dividends (let me say the happy joy words again..... tax free), growing at maybe 8% a year for the rest of my life.

There is a saying in Spain: "la mala hierba nunca muere." The bad grass never dies. It means that nasty, stingy cheap bastards like me always end up living to be much older than anyone else around us would prefer for us to do. I'm going for another 50 years before I croak. That's $200,819 of free dividend income over the next 50 years on a $7,000 investment in (AAPL) and (MO) that I never even paid for in the first place. And of course I will be investing that $200,819 of free dividend money into even more income producing shares of whatever other blue chip company seems cheapest to me at the time. The income from those $200,819 worth of investments will also proliferate... like a bad case of head lice in a kindergarten classroom where everyone shares hats. Even if it doesn't - who cares! It was $7,000 of free money to begin with, so it's a classic "heads I don't lose anything, tails I win something" game that always gives me that delicious sensation of cheating.... and getting away with it (which only makes me want to play even more).

This is why when you visit Lisbon and notice that bald tattoo guy tap dancing down the street, carnation in his lapel, snapping his suspenders and whistling a jaunty tune whilst wearing an unnaturally wide grin, you'll know exactly who it is. Why shouldn't I be the happiest man alive? I'm getting stuff for free all day, cheating, not sharing, and basically behaving precisely as my nursery school teacher tried to teach me not to (without success, obviously).

I'm not proud. Nevertheless, I don't mind peeling back that old financial kimono in public to show what's going on underneath (to the sound of gasps and titters, and even a few salacious whistles and overly-encouraging catcalls from the less restrained members of the audience). Oh, well, it's all worth it to me - you just never know what's under that kimono that might be of at least some value to even just one reader.

So. With that in mind, I keep a spreadsheet that tracks the average current dividends (including my guess as to any special dividends) and current prices for every stock and fund that I own. I also include my best guess about the future dividend growth rates. To make those guesses (and they are just that - guesses), I look at historic dividend growth rates on a webpage called Gurufocus.com, which I then average out by each company's earnings growth rates. I do this because if a company's earnings are growing at 10% but the dividend is growing by 15%, it's likely that 15% dividend growth rate won't continue forever. And I make sure to inject a stout dose of my own pessimistic business judgements into the sustainability of the dividend growth, too. There is no good formula for projecting the future of anything, especially dividend growth rates.

The spreadsheet then calculates the future value of each company's dividend income at the dividend growth rate I've assumed, compounded over a ten year timeframe. With this chart, I can then see minute by minute how much of the current stock price could be recovered in ten years with the company's own dividends. The greater the potential investment recovery, the "cheaper" the stock looks to me. And... oh ho ho.... I'm all about cheap.

Here's snapshot for you:

Using this little tool, I can see where I might want to focus whenever I reinvest dividends. If I buy more shares of AXA SA (OTCQX:AXAHY), Main Street Capital (MAIN) or Oneok (OKE) at today's prices, for example, I might stand to get my entire investment back in less than ten years, which means I'll own the company for free. The sooner I get paid back my initial investment, the sooner I can start the "heads I don't lose anything, tails I win something" game. On the other hand, if I buy American States Water (AWR), I might only make back 25% of my initial investment with dividends in ten years. I'll need to be way more patient with that one if my goal is to get free stock ASAP.

Which isn't to say I wouldn't buy AWR. For a change of perspective, I could calculate my payback period not with dividends, but with earnings per share instead. No reason not to do that - but I have to admit that I sort of feel like money isn't real until I can put my hands on it. Roll around on it like a cat on a pile of suspiciously strong catnip. I just can't seem to do that to my satisfaction while the company's earnings are tied up somewhere on its balance sheet. Corporate earnings are a bit abstract for someone like me, just as flitting stock prices seem ethereal and unreliable. By contrast, I sort of "get it" when it comes to checks arriving in the mail, and so that's how I structure my investment thinking. You want to analyze investments in the way that feels the most real and comfortable for you.

Like I said, the dividend data I've entered isn't guaranteed accurate - companies like MAIN and FFG, for example, pay special dividends that may or may not repeat in the future. And the dividend growth rates are debatable. If you like, though, you can copy this tool and adapt it for your own purposes, and plug in your own data or estimates. Dividend Payback Tool. Enjoy it, all you cheap bastards!

Disclosure: I am/we are long AXAHY, MAIN, OKE. 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.

Additional disclosure: Nothing in this article or the attached spreadsheets is investment advice or tax advice, and nothing in the article can be relied upon for factual accuracy or any other reason besides entertainment value. I am not a tax adviser or an investment advisor. The only purpose for this article is entertainment value, and nothing more.