# Protected Principal Retirement Strategy: Retiring Without A Million-Dollar Nest Egg - A Few Analytical Tools

|
Includes: EPD
by: Akaralph

There exist many, many analytical tools with which one can analyze dividends, stocks and even entire portfolios - some good and some not so good.

I want to touch on two that I consider valuable for analyzing dividend-paying stocks: the Compound Annual Growth Rate (C.A.G.R.) and the Gordon Growth Model.

Compound Annual Growth Rate

By definition, the compound annual growth rate measures the year-to-year growth rate of a dividend, a stock's earnings, return of investment for an individual stock, or the return for an entire portfolio.

It is a relatively simple tool (I probably oversimplify it here) that gives a good indication of past growth, and if one has projections for earnings and/or dividends on hand, it can give a fair estimate of future growth.

Investopedia provides information on C.A.G.R.s, and a calculator for use in determining C.A.G.R. (here).

For those of us wishing to calculate this for ourselves, the formula for determining C.A.G.R. is as follows:

CAGR = (Ending Value/Beginning Value) (1/Number of Years) - 1

There are many websites that address C.A.G.R. that can be found just by Googling the term. I will mention specifically the C.A.G.R. research that has been accomplished by more than one author on the iVillage MLP page contains far, far more detail than what I present in this article, and is worth the price of admission - literally.

In addition, Yahoo Finance presents the past and forward five-year annual C.A.G.R. for many stocks - although I must say that in some cases I have found it to be inaccurate. To find it on Yahoo, enter the stock symbol, click on Analyst Estimates on the sidebar, scroll to the bottom under Growth Estimates, and the C.A.G.R. appears in the rows titled "Past Five Years (per annum), and Next Five Years (per annum)". In the next column you can view the C.A.G.R. for the industry group in which the stock is a part.

While it is important to have a handle on C.A.G.R. for virtually any stock, I apply it more to master limited partnerships [MLPs] and business development corporations [BDCs] than other asset classes. With the Protected Principal Retirement portfolio currently heavily weighted to MLPs it is especially relevant.

It seems as if more attention is given to forward five-year C.A.G.R.s than is given to the past five years. I like to examine past five-year trends, together with forward C.A.G.R. since a stock that has had a low past C.A.G.R. that is showing a significantly increased forward C.A.G.R. would indicate (at least to me) that further research in this area is necessary.

I particularly like applying the formula to distributions paid by MLPs, particularly the midstream MLPs, since many of these have consistently increased them on an annual basis.

The following example is provided for Enterprise Products Partners (NYSE:EPD):

Over the past five years, EPD has paid the following distributions (through July of each year):

• 2012 - \$2.50
• 2011 - \$2.38
• 2010 - \$2.26
• 2009 - \$2.14
• 2008 - \$2.01

Inputting these data to the formula results in a five-year distribution C.A.G.R. of 4.46 percent.

Similarly, we can run the C.A.G.R. for the total return on our EPD investment for the past five years using the current price, and the price for the stock for each of the past four years on this date:

• Close 9/5/2012 - \$53.05
• Close 9/2/2011 - \$41.62
• Close 9/3/2010 - \$38.45
• Close 9/4/2009 - \$26.75
• Close 9/5/2008 - \$27.81

Plugging these values into the formula yields a five-year C.A.G.R. price return of 13.79 percent.

Yahoo Finance shows EPD's forward five-year annual growth C.A.G.R. to be 6.35 percent.

Generally speaking we look for a forward C.A.G.R. of five percent or better for our portfolio stocks.

The above is but an example as to how C.A.G.R. can be used as a tool for constructing or analyzing the results of our portfolio.

Gordon Growth Model

The Gordon Growth Model (also known as the Constant Growth Rate Model), named after Myron Gordon and published in 1959, is a method of determining the value of a share of a given stock based upon dividends paid, and the growth rate of the dividend.

It is represented by the formula:

Current Stock Price = Current Annual Dividends (1 + G)/(K - G)

...where G is the expected growth rate of dividends and K is the investor's required rate of return.

The "K," or required rate of return can be estimated using the formula:

Required Rate of Return = G + Current Annual Dividend (1+G)/Current Price

There are many variations of the Gordon Growth Model, including the Dividend Discount Model, Dividend Drill Return Model (DDRM), and others. For those looking for a relatively sophisticated model to use, I suggest the DDRM, which is thoroughly explained in the book "The Ultimate Dividend Playbook," by Josh Peters. I receive no remuneration from recommending his book.

Applying the Gordon Growth Model to our previous example we first determine the required rate of return using the following data:

Current annual distribution - \$2.50

Current price - \$53.05

Constant distribution growth rate - 4.46%

Inputting these data into the formula shows that in order to sustain EPD's current yield at the present distribution growth rate will require an approximate rate of return in the realm of 9.4 percent.

If we wanted to factor in future distribution increases (retaining current growth and return rates) for the coming five years, the current distribution of \$2.50 would grow to approximately \$3.11 (at a 4.46 percent annual growth rate) by July 2017. Putting these data into the Current Stock Price Gordon Growth Model formula we would find that EPD's July 2017 stock price would be \$66.

Summary

I realize that in the small space devoted to this article that I have oversimplified how these analytical tools operate; however, my point was to illustrate how effective they can be (in combination with other fundamental evaluation tools) in evaluating stocks for inclusion in the Protected Principal Retirement portfolio.

For those of you who have enjoyed these articles, I will be back around the end of September to hopefully continue sharing with those of you who are Mid-Rangers.

Disclosure: I am long EPD. 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: The information presented herein does not constitute a recommendation to "buy" or "sell" EPD.