Portfolio: December 2018

The December Dividend Farmer update didn’t see much of a percentage weight shift relative to November.  Due to the addition of 65 shares in the Agriculture sector and 100 shares in the Energy sector, minor adjustments of one-tenth of one percent were made to the weight of a few holdings relative to the November distribution.

Aside from market news indicating a general trend toward bearishness, none of the holdings experienced events, good or bad, compelling me to alter any of the positions in a material way.  If anything, I’m taking the recent decline in the overall market as an opportunity to investigate shares that may have declined into the bargain range.  As long as new acquisitions conform to my investment selection process previously outlined, picking up a few shares during a market slide works well.

Weighted Distribution

The yield relative to current price declined from 3.82% in November to 3.75% in December due to the addition of the agriculture stock with an individual yield sufficiently below average that it moved the portfolio yield down by 7 basis points.  All dividends are automatically reinvested with no transactions fees.  Unweighted average yield on cost remained at 4.6%; nearly 1% higher than the current yield on price of 3.75%.

The average monthly dividend from this basket continues moving upward standing at nearly $1,130.  That doesn’t pay all the bills, but supplemental income is nice when needed.  The trailing 1-year CAGR bounced up from 12.6% to 14.3% primarily due to the new acquisitions.  Even if the CAGR slips back to something around 10%, it means my income stream should double in just over 7 years.  

Considering the length of time I have between now and full retirement, it’s possible I can enjoy multiple doublings as long as the portfolio continues its current trend.  Each month generates additional income growth through the power of compounding in a slow, steady manner.  The Rule of 72 post offers further detail about the power of compounding and why I’m an advocate.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

Why Yield on Cost Matters

Many dividend investing conversations revolve around the term “yield”.  Simply defined, dividend yield is the dividend payment divided by the price of the stock.  For instance, a company paying a dividend of $1 with a stock price of $20 delivers a 5% yield:  1 / 20 = .05 or 5%.

The concept is straight forward and provides a benchmark useful in comparing the quality of alternative investments or assessing the performance of a single investment across multiple points in time e.g., 1 year ago, 3 years ago, 5 years ago, and today.  The difference between yield on cost and yield on price falls primarily into the second category offering a trending viewpoint for an investment.  To an extent, it also provides an opportunity-cost perspective on switching investment positions.

Comparing Yield on Cost Across Alternatives

Assume for a moment that you bought ABC Corps. 10 years ago because it had a 5% yield.  You did so believing it was a quality company with a solid dividend.  Furthermore, you were aware that ABC’s yield was superior to rates on other investment vehicles like bonds and treasuries paying roughly 2%-3% or CDs and money markets paying less than 1%.

10 years later, you review your ABC Corps investment and discover it is still paying a 5% dividend while bonds, treasuries, and CDs have been creeping up the yield curve.  Do you abandon your ABC holding in favor of an alternative showing yield growth during that period?

Assume that over the last decade ABC has increased in price from $20 a share to $40 a share representing a compound annual growth rate of approximately 7%.  This is close to the market’s historical average.  During the decade, ABC held its yield constant at 5%.  At $40 a share the 5% yield now equals $2.00 which means dividend payment or cash flow is double what it was when you bought it.  ABC has obviously been increasing the amount of its dividend payment on a regular basis and in healthy increments.

A secondary assumption is that you made no additional purchases of stock, other than DRIP investments through your broker.  The shares you initially purchased at $20 each are now paying $2.00 in dividends delivering a yield of 10%:  (2.00 / 20 = 10%) relative to your initial cost.  Consequently, your yield on cost is significantly greater than your yield on price based upon today’s stock value, which is fantastic.  More importantly, it’s unlikely that vacating ABC in favor of a new bond or treasury investment will result in a cash flow stream anywhere near 10%.

How does this work?  It’s straight forward.  The cost of the stock your purchased 10 years ago did not change but the amount of the dividend being paid relative to it increased nicely.

Why is this important?  The price of an investment you purchase today doesn’t change over time.  This is true of real estate, stocks, bonds, gold, baseball cards, etc.  In all cases, the cost point remains constant.  On the cash flow side of the equation, only dividend stocks and rental real estate offer potential for increased cash flow across your time horizon.  See the posts on real estate for additional thoughts on that investment vehicle.  The rest of the investment world offers no opportunity for increasing cash flow without requiring additional transactions e.g., sales, purchases, calls, loans, etc.

The short story is that dividend stocks with strong payment histories, finite downside, and minimum overhead are one of the best methods of compounding your investments over time to reach your objectives.  Being aware of how yield on original cost differs from yield in current price further highlights the gulf between dividend paying stocks and alternatives.  This awareness is helpful when assessing the opportunity cost of vacating dividend paying stocks for alternatives and further demonstrates why solid dividend paying stocks should be strong considerations within any portfolio.

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and should not be considered as investment advice. The information is presented for consideration and entertainment only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional

Dividend Farming Style

A previous post highlighted an investment selection process you might consider if you’re thinking about farming dividends.  It’s helpful to understand the investing style or philosophy you want to follow before you delve into a specific process.

Below are several items for you to consider as an investor.  How you relate to each individually and in aggregate help shape your investment style which influences any process you decide to use in selecting investments.  In general, you should align these factors as much as possible before you move down the investment path.

Dividend Cash Flow

Cash Flow vs Value Appreciation:  Some investors preference consistent cash flow while others pursue value appreciation of their investment.  The former are less concerned with the size of a brokerage account than with the quantity and reliability of funds dispersed in the form of dividends (cash flow).  The latter want to see their holdings grow in value as much as possible between now and whenever they elect to sell and reap the proceeds.

Risk Tolerance:  Your propensity to tolerate risk influences your investment path.  You may wish to think otherwise, but over long investment horizons, risk tolerance misaligned with investing style isn’t sustainable.  In such situations, you can experience a level of cognitive dissonance seriously affecting investment performance.  For instance, fancying yourself an aggressive growth investor because that’s the style du jure, when you’re averse to high levels of risk, may leave you financially and emotionally exposed to losses from which you can’t recover.

Desired Return:  The rate of return you desire from your investments also influences your investing decision.  High rates of return often correlate with higher than average investment risk.  Consequently, desired return is frequently married to risk tolerance when weighing investment styles.  If you wish to double your money in 12 months, you’ll likely have to take outsized risks to do so.  If you can’t tolerate that kind of risk, your desired return of twice your original investment within a year isn’t practical and should be reevaluated.

Ability to Learn:  If you stop learning, you stop growing.  If you stop growing, you start dying.  While the universal truth of this statement may be argued, it’s often true enough of investing that you should pay heed.  Investors, whether passive, value, growth, technical, fundamental, or any other, who fail to continuously learn lock themselves into yesterday’s investing environment while today’s ecosystem quickly marches forward.  Imagine using computer technology from 1998 to run your business in 2018.  Failure to upgrade and retrain on new systems means a competitive disadvantage to your firm.  Failure to upgrade, retrain, refresh, and continually expand your investing knowledge leaves you at a decided and dangerous disadvantage.  Do you need to be aware of all the latest advances in technical analysis or high frequency trading?  No.  Should you keep abreast of economic, industry, and business trends?  Yes.  

Business Interest:  Many investors don’t consider their interest level when deciding when, where, or how to invest.  It’s just something people “do” because their parents did it, they’re required to do so through a company plan, they feel it’s necessary for social acceptability reasons, or they fear destitution in retirement.  None of these constitute the type of business interest needed to be a successful investor.  Rather, business interest means being genuinely interested in business at some level.  If you’re not, you won’t take the time to learn, even if you’re eminently capable of learning all that’s required.

Time Horizon:  The single largest determinant of investment success is time.  The more you have in which to invest, the better you’re likely to do.  Whether you’re looking at the long-term trend of stock markets or considering the strength of compound investment growth time is your friend.  As with friends, time should not be taken for granted nor its benefits wasted.  Invest as early as you can.  Continue investing regularly along the way.  Keep at it for the duration.  If you do, you can generate a substantial return over time, irrespective of your investment style.

How do these considerations fit within the Dividend Farming framework?

Cash Flow vs Value Appreciation: The Dividend Farmer focuses on cash flow.  As with agricultural farmers, it’s better to harvest crops on a regular basis while working continuously to grow the crop yield.  Having your land appreciate in value is nice, but you can’t pay the bills with appreciated land unless you borrow against it, which adds additional risk and increases your costs, or sell it, in which case it’s no longer yours.  The same holds true for dividend farming.  The goal is to be able to harvest as needed while growing the yield over time.  The best part is that if a dividend harvest isn’t needed at a particular time, the yield can be reinvested to gain more “ground” along the way compounding your return.

Risk Tolerance:  Dividend farming takes a value investing perspective, like Benjamin Graham and later Warren Buffett.  Consequently, it’s fairly risk averse.  If you can tolerate high levels of risk, particularly over extended periods of time, you may find other investing styles a better fit.

Desired Return:  Dividend farmers are concerned with steady and predictable if unspectacular rates of return.  While farmers enjoy bumper crops, they’re not enthusiastic about a bumper crop in one year followed by drought and pestilence the next.  As a result, shouldering higher than average levels of risk to obtain a significant rate of return isn’t of interest to a dividend farmer.  Instead, one should focus on the continuous compounding of the investment crop to do the work while maximally leveraging time.  Downside is minimized with the approach.  However, the possibility of enormous, newsworthy rates of return are normally given up.  Dividend farmers are ok with that.

Ability to Learn:  Farmers are always learning.  The science of farming, weather, technology, and markets never stop and neither do they.  The same goes for Dividend Farmers.  If you’re not regularly reviewing your investments and their activities, learning about markets, or trying to understand the events that influence your investments, you’re limited to serendipity for investment successful.

Business Interest: In line with ability to learn is business interest.  Nearly everyone is capable of learning.  We learn something new nearly every day.  However, business interest means channeling a portion of those learning capabilities into the investing arena.  If investors aren’t interested in learning about their investment style, their investments, or the market in general, they will not develop the knowledge base to be successful.  In such situations, throwing a dart at a board may be the best an investor can hope for unless he’s willing to put all his trust into an investment advisor.  While this is not inherently a bad thing, dividend farmers are DIY types.  If you’re not, then farming dividends may not be the path for you.

Time Horizon:  Time is the single greatest factor affecting investment success.  In total, it’s more powerful than savings, selection, or happenstance.  It offers new investors the chance to learn without causing unrecoverable investment problems.  Time allows investments to compound taking advantage of one of the greatest powers in the investment world – compound interest.  Risk mitigation through time to reach desired investment goals becomes possible.  Doubling your money in 12 months requires a great deal of risk, but doubling it in 10 years requires a 7% return which is roughly the average long-term rate of return of the stock market.  

Dividend Tree

Dividend farmers employ time to achieve their investment goals.  The best way to maximize time time is to start early.  It’s been said the best time to plant a tree is 20 years ago.  The next best time is today.  Don’t wait, plan a dividend tree today. 

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and should not be considered as investment advice. The information is presented for consideration and entertainment only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional

Dividend Growth vs Dividend Yield

Dividend Growth

There appear to be two camps in the dividend investing world.  On one side are investors who believe in putting money into firms with lower dividend payments but correspondingly low payout ratios that may be predisposed to generous dividend increases going forward.  On the flip side of the coin are investors who believe it’s fine to put money into firms with high payout ratios and higher dividend yields but limited dividend growth potential. 

In an ideal world, we would all invest in firms with respectable or above average dividend yields that also paid out a reasonably small percentage of earnings in dividends, all things being equal.  Unfortunately, this fortuitous combination doesn’t appear often.

The merit of investing in lower yield, lower payout ratio firms revolves around the possibility of future dividend increases.  For instance, if a firm delivers a 2% yield, but pays only 38% of its earnings in dividends, the argument says there’s room for healthy and frequent dividend increases since there are earnings aplenty with which to make those payments.

What’s generally left unsaid is that the firm’s management must allocate a larger percentage of those earnings to dividend increases for the forecast upside to materialize.  This doesn’t always happen.  Consequently, the prospect of better dividends and higher yields ahead can be left wanting.

Conversely, firms with higher dividend yields and high earnings payout ratios aren’t perceived as having sufficient funds to further increase dividends in the future.  As an example, a firm using 90% of its earnings to offer a dividend yield of 6% may be viewed by investors as incapable of increasing the dividend payment in the future.  Consequently, it may not be worthy of an investment as far as they are concerned.

It’s easy to see the logic behind both positions.  As a result, I thought I’d look at the math to see if one side made more sense than the other.  For this exercise I’m pitting a firm (A) paying a 6% yield, with no dividend growth, against a firm (B) paying a 4.5% yield growing its dividend by 10% annually.  Dividends are reinvested so compounding is in effect.  To keep things simple both firms have stock prices of $100 and with only 1 share of stock involved per firm.  The price holds steady through the exercise and the period is 5 years.  Below are the tables comparing the two scenarios.

Company A - High Yield, No Growth
Years     0	1	2	3	4	5
$ 100.00	$ 106.00	$ 112.36	$ 119.10	$ 126.25	$ 133.82
Divs Paid	$     6.00	$     6.36	$     6.74	$    7.15	$     7.57

In the case of Company A, the single share of stock with a 6% yield paid $41.85 in dividends during its 5-year period while holding yield and price constant.

Company B - Low Yield, High Growth
Years    0	1	2	3	4	5
$ 100.00	$104.50	$ 109.45	$114.90	$120.88	$ 127.47
Divs Paid	$    4.50	$     4.95	$    5.45	$    5.99	$      6.59

Company B, during the same 5-year period, paid only $27.47 in dividends despite growing its dividend payment by 10% year-over-year.  By the end of the 5^th year, the stock is yielding over 6.5% which exceeds the yield on Company A stock despite having paid only 65.6% of the dividends that company A did.

Extending the exercise out to the point at which Company B with its growing dividend stream has paid more in dividends than Company A with a high, but steady yield, means calculating through year 11.  In other words, Company B would have to increase its dividend by 10% per year for 11 years before it paid more in dividends than Company A does in 10 years.  Furthermore, the yield on Company B’s dividend would exceed 10% in year 11.  All this assumes, of course, that Company B’s management can maintain such a torrid dividend growth rate for more than a decade.  The probability of doing so appears remote to say the least.

Based on our exercise, I’m likely to preference solid, high dividend companies with high payout ratios over firms with low payout ratios and lower yields, all things being equal.  This despite the hope of future increases with the low payout ratio firms. 

High Dividend Yields Can Help.

It’s true a high dividend, high payout ratio company can lower its dividend, but I think it unlikely since CCC companies protect their dividend payments with enthusiasm.   

Conversely, I believe it’s even less likely that a low dividend “grower” will be able to exceed the lifetime dividend payment stream of the high yield firm even with excellent dividend growth given the length of time and level of persistence required to do so.

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and should not be considered as investment advice. The information is presented for consideration and entertainment only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional

Dividend Farming: Selecting Investments

Dividend Farmer highlighted 4 things needed to be successful:  Ground, Seed, Time, and Patience.  Explanations were given for each providing a launch point for your dividend farming operation.

Carrying the outline a step further means walking through the farming process in greater detail.  This post steps through an investment selection process you may consider.

Many would-be investors think stock selection takes great sophistication, skill, or maybe nerve.  Consequently, they’re ready to pay the trading class to make the decision for them or opt for the tried-and-true index mutual fund with little thought required.  However, these are not the only options.  A third path is possible.  Does it require diligence?  Yes.  Expert level skill and knowledge?  Not necessarily.

Below is an outline of an investment selection process I move through.

Investment Selection

Stock Screening:  

I begin with Dividend Champions, Challengers, and Contenders (CCC) from Dripinvesting.org.  Any investor starts with a screening process whether he knows it or not.  A screen might be a list of the top performing funds during the past 12 months, selecting only from a specific sector, or looking at companies with long histories of consecutive dividend payments.  The point is to take the universe of investment options and whittle it down to manageable size.  Dripinvesting.org provides a list of dividend paying firms so that’s where I start.

Since my portfolio goal is a 4% yield or better, I start looking for CCC firms paying at or close to 4%.  Depending on whether my portfolio needs more balance at the time, I may look for 4% firms in a particular industry first.  

For instance, if my portfolio seems light in manufacturing holdings, I may look for firms in that segment before any others.  If I can’t find good prospects, I’ll look at my next smallest portfolio sector to see if I might add there instead.  Should no options be available at 4% in those sectors, I’ll consider whether to add something below 4% in one of those segments if doing so helps balance my portfolio.  Case in point, I recently conducted this exercise adding an investment with a 3% yield since it was in the agriculture sector and I needed weight in that category.  If I’m not in need of rebalancing, I’m apt to seek out the highest yielding CCC firm that meets my other criteria.

Company Profiling:

After I’ve worked through my initial screen and established a short list of potential investment candidates, I profile them so I understand what they do, where, and how.  This part of the exercise usually takes me to Yahoo.finance.  

I’ll pull up each firm to read through the company summary and profile.  I’ll also peruse news articles and commentary surrounding the firm to get a feel for its operations and management team.  In doing so I’m not looking for a particular reason to invest, but for market, industry, or operational items that cause me concern and require additional analysis.  To be specific, I want to know if there are big picture concerns of which I should be aware rather than short-term, media-driven events making the news this week but which are likely to be absent from the radar in six months.  For instance, I’d like to know if my prospect might implode the way GE is currently or the way Enron did in 2001.

Financial Profiling:

Thus far, the process as outlined may not seem daunting to the DIY investor.  However, I think it’s safe to say many feel less than adequate for the task when considering the financial analysis component.  It’s at this point investors can fall prey to the siren song of “professional managers” or opt for the relative safety of index funds.  Fortunately, this binary isn’t the only option.

From a financial analysis standpoint, I start with Ben Graham’s guidance in his tome, Intelligent Investor.  He advocates that investors look for firms with the following characteristics:

1. Noteworthy, industry leader:  This isn’t too difficult for an investor to understand.  For example, is Coke foremost in its space or is Dr. Pepper?
2. Large:  Large generally means having a significant revenue stream and being well capitalized.  To put into perspective, the smallest Fortune 1000 firm in 2018 generated nearly $2B in revenue with a market cap north of $13B. 
3. Price to Earnings:  Graham stated a firm should have a P/E less than 25 and less than 20 over the preceding 12 months.  I normally look at price to trailing twelve months earnings since those are closer to fact than forecast.  Seldom do I select a firm with a P/E above 20.
4. Dividend History:  Graham likes firms with a history of paying successive dividends for 10 years or more.  I like it if they’ve done so for 25 or more (Dividend Champions).  Even better if that record includes numerous dividend increases.

Two of the first three items noted above are readily available through Yahoo.finance.  When you pull up the company name and click on the Financials link, the information is provided in an easy-to-use format.  The dividend history can be found within the CCC list.  As a result, if I start with that list, I will have addressed Graham’s item #4 before I get to the financials.

In addition to Graham’s items, I’ll also look at the following metrics:

1. Price to Book value of the firm.  Ideally, my investment will have a P / B close to 1 and certainly not greater than 2.  I’d prefer not to buy a lot of blue sky or “good will” if I can help it.  This metric is one in which Warren Buffett and Charlie Munger appear fond.  Hard to argue with their success.
2. Debt to Equity of the firm.  As with the Price-to-Book, I’m looking for something close to 1.   I don’t consider it favorable if the debt is several multiples of the equity; it’s generally a comfort level perspective on my part since I'm not a fan of big leverage.

Last, but not least, I’ll look at the 12-month price range for the stock under consideration.  In a perfect world, the metrics above will be where I’d like them to be and the stock will be closer to its 12-month low than high.  I’d rather buy what I believe to be a quality company toward the lower end of a price range if possible.

In the past, I’ve also looked at things like the quick ratio.  Although the quick ratio can be useful, it generally represents a company’s ability to immediately pay off short term debt with liquid assets.  Since my investments are predominantly large and for long duration, a short-term metric, while helpful, is not among the major decision criteria.

For dividend firms, many investors also look at the payout ratio.  This is the percentage of earnings paid as dividends.  A company with a high payout ratio is paying most of its earnings to investors as a dividend.  The argument is that companies with high payout ratios don’t have room to increase the dividend payments in the future.  However, as I’ll discuss in a future post, a high dividend, high payout ratio firm may be distinctly better than a low dividend, low payout ratio firm despite the upside of dividend increases perceived to be available with the latter.

Once I’ve screened my options, profiled the firms, and conducted basic financial analysis using the metrics provided mostly by Messrs. Graham and Buffett, I’ll complete a side-by-side matrix of the items using an excel spreadsheet. 

It’s highly unusual for a single firm to be superior to all others in every respect noted above.  However, it’s not uncommon for a firm to be superior in several categories and rank well in others.  When this happens, my process of elimination points to the option with the best overall “score” if you will.  From that point, I’ll let the analysis settle for a day or so to ensure I’m not missing anything.  After that fermentation process is complete, I’ll allocate the money I’ve saved up and make the investment or, in Dividend Farming terms, plant the seed in the ground I’ve identified then start the time and patience segment of my farming operation.

The thoughts and opinions expressed here are those of the author, who is not a financial professional, and should not be considered as investment advice. The information is presented for consideration and entertainment only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.