Dividend Cash Flow Forecasting

Forecasting Future Dividends

As a Dividend Farmer, I’m concerned less with value appreciation than I am with the cash flow I hope my farm will deliver at some point in the future.  Consequently, I pay attention to the rate at which my dividend stream is growing.  Conducting “what if” analysis to forecast where I think my dividend stream will be in the future under different assumptions is a regular activity.

For instance, I may run calculations using what I believe to be conservative assumptions e.g., 2% stock price appreciation and 3% dividend growth over a short horizon such as 8-10 years.  I’ll also do the analysis using moderate trends as well as what I think may be best case conditions.  From my perspective historical market trends are what I consider best case e.g., 3.5% price growth with 3.5% to 4% dividend to start plus moderate dividend growth annually and a time horizon beyond 15 years.

 

As a DIY dividend investor, I generally focus on the conservative case to bake in a margin of safety (thank you Mr. Graham).  Then I’ll look at the other two scenarios to gauge the upside under moderate to best case conditions.  Rarely are my exercises conducted using assumptions above historical averages.  Growth rates have a tendency to revert to the mean over time.  Variables beyond the average aren’t likely to be sustained through my investment horizon and therefore aren’t used in the models.

So what models do I use?  There are a few I like to run for cross-checking projections.  As you might expect, different models produce different outcomes since each can include variables the others don’t.

 

For instance, I start with a simple Future Value (FV) model using Excel.  This is a good one because there are only a few variables in it allowing me to run it from any handy spreadsheet.  However, the minimal variable model also means it’s tough to bake in assumptions about future dividend growth rates. 

In FV, the interest rate used may be a composite of the expected price appreciation and dividend growth rates rather than separate levers adjusted individually.  Also, FV provides a final output rather than showing the position each year between the beginning and ending years.

The next model I’ll use is the Dollar-Cost-Averaging (DCA) model from the DRIP Investing web site which publishes the list of Champions, Contenders, and Challengers.  This model is nice because it allows me to  plug in separate figures for dividend and stock price growth rates respectively.  Consequently, there are more variables to tinker with; exploring various assumptions and fine tuning the model.

Finally, I may drop my basic numbers into the Compound Growth Rate (CGR) vs Annualized Rate model found within the same tool as the DCA.  The model doesn’t allow for many variable adjustments.  However, its value lies in offering an aggregate look at possible outcomes from a valuation standpoint while providing compound and annualized rates to see how quickly (or slowly) my portfolio is growing.

The number of adjustable “knobs and dials” on each model is different meaning each produces a slightly different answer.  However, when starting with common items like beginning value, investment horizon, periodic additions, and similar growth rates, whether aggregated or broken out, the range of values across models may fall within 10% - 15% of one another.

In my latest analysis, the FV model provided the most conservative estimate.  The DCA model produced the best case outcome which was about 15% higher given similar inputs.  The CGR model fell roughly half way between the two.  As stated earlier, I generally focus on the output from the FV model since it’s the most conservative.

Once the figures are developed in the models, I’ll apply my current portfolio dividend yield to the final values to see what my expected stream of dividend payments may be at the end of my horizon.  If the forecast payment stream for the horizon in question is lower than expected I need to determine whether to add seed money to the farm, extend the horizon, modify the assumptions in the models, or some combination of the three.

Regularly checking my assumptions and reviewing future possibilities helps me keep my eye on the target.  It allows me to consider whether or not I’m retaining a sufficient margin of safety across my portfolio as I go.  Finally, I don’t aspire to be excessively rich, but would like to run a solid dividend farm, provide for my family, help others when and where I can, and enjoy a modest, comfortable retirement.  Anything beyond that is frosting on the cake.

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.