Yield on Cost Math

It’s a news flash, I know, but I’m a fan of compounding dividend payments.  More so if those payments deliver annual increases, even if small.  In previous posts, Why Yield on Cost Matters and Why Yield on Cost Matters: II, I began the discussion of the concept, then expanded it with examples of why I think it’s important for Dividend Farmers to pay attention.

Below is a table demonstrating the math behind the yield on cost principle of dividend paying stocks.

Year	Buy Price	Initial Div	Initial Yield	Div. Increase	Div	Yield on Cost
1	$40.00	$2.00	5%	%	$2.00	5.0%
2				3.0%	$2.06	5.2%
3				3.0%	$2.12	5.3%
4				5.0%	$2.23	5.6%
5				2.0%	$2.27	5.7%
6				3.0%	$2.34	5.9%
7				3.0%	$2.41	6.0%
8				1.7%	$2.45	6.1%
9				2.0%	$2.50	6.3%
10				2.4%	$2.56	6.4%

The data represent a progression from which you might benefit with a solid, dividend paying firm.

In this example, a $40.00 stock is purchased and pays an initial dividend of $2.00 annually resulting in a nice 5% initial yield or yield on cost.  In year two, the firm declares a dividend increase of 3%.  It doesn’t sound like much on a $2 dividend.  In monetary terms it represents $0.12, which may not impress the trading crowd.

Every year you hold the stock, the company rewards you with a small dividend increase that varies from year-to-year.  Sometimes it’s a little larger, others smaller.

At the end of 10 years, assuming the raises shown, the dividend on your original $40 stock will have grown, through compounding, to $2.56 resulting in a 6.4% yield on the original cost.  Again, this won’t make certain investors salivate, but the change in dividend and yield from purchase through the end of year 10 represents a 28.0% increase relative to the initial dividend and yield. 

A similar progression of small dividend increases across a 20 year holding period means your dividend payment and yield could readily increase by 70%.  It’s true you have to be disciplined and patient to hold for this length of time.  And there’s always a chance regular dividend increases may not materialize.  However, companies with lengthy histories of dividend payments and increases tend to have great inertia behind the dividend and work diligently to maintain it, improving your odds of being a successful Dividend Farmer.

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: II

Last month I wrote about why the Yield on Cost of dividend stocks matters.  The concept is sufficiently useful it bears adding detail including examples.

There are dividend paying stocks held within my portfolio for well over a decade – in some cases, more than two decades.  In other cases, stocks were purchased at fortuitous times like during the aftermath of the 2008 recession.  Most of these firms have been paying dividends regularly with some increasing payments on a consistent basis.  The combination of timely purchases, steady DRIP activity, periodic dividend increases, and a few stock splits along the way helped produce solid results.

For instance, I’ve owned National Retail Properties (NNN) for roughly a decade.  As of this writing, Yahoo.Finance shows a closing price of $48.02 with an annual dividend of $2.00 resulting in a yield of 4.16%.  I initially purchased the stock at a much lower price than today’s close.  In fact, the purchase was sufficiently in the rearview mirror that my cost basis is $22.17.  With a $2.00 dividend being paid on that basis, my yield on cost is 9%.

Altria (MO) is a stock I’ve owned continuously since the dawn of time – at least it feels like it.  Today’s closing price is $48.86 and the stock sports an annual dividend payment of $3.20 yielding 6.54%.  Like NNN, the cost basis reported by my brokerage is $22.42 providing a yield on cost of 14.2%.

Another holding is Pfizer (PFE) which closed today at $42.31 with a dividend of $1.44 annually providing a 3.36% yield on today’s price.  Given the length of time I’ve owned it my cost basis reports out at $15.67 for a yield on cost of 9.2%.

While some dividends have been reinvested at stock prices higher than the original purchase, thereby raising the average cost basis of an entire position, the fact remains that many of the shares acquired at a point close to the reported average basis provide a healthy yield given the periodic dividend increases occurring during my holding period.

What does this mean?  It means that if you buy solid dividend paying companies at good prices and hold them long enough, the dividend increases eventually drive up your yield on the original investment.  As in the cases above, it’s possible to see yields reach double digits. 

If you have such investments and are thinking about moving out of them, the challenge becomes one of finding alternatives providing better returns than the impressive yields available with your dividend stocks.  This strategy of course requires time and patience but once you’ve reached the point where you're enjoying the results, you may find it worth it.  You may also discover you’re a real Dividend Farmer.

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.

 

Dividend Farming Scorecard: General Dynamics

In the first post of this year’s blog, I looked at The Southern Company as a potential dividend investment selection for my Dividend Farm.  Since I’ve been a fan of the aviation and aerospace industry for decades, I decided to review General Dynamics (GD).  It’s got a long history of dividend payments so I thought it might be a good candidate to peruse given my portfolio is underweight in manufacturing related holdings.

The table below provides a summary of factors considered as part of the selection process based on data reviewed on January 7, 2019.  Laying out my analysis like this helps me quickly benchmark against my target metrics and compare this firm to alternatives e.g., The Southern Company.

FACTOR	TARGET METRICS	GENERAL DYNAMICS
CCC List	Champion	Champion
Current Yield	4.0%	2.4%
Company Profile	Red Flags	None
Industry Leadership	Top 10	#4
Market Cap	$10 B+	$42.7 B
P/E	< 20	15.4
P/B	< 2	3.6
Debt / Equity	< 1	2.1
Dividend History	25 Years	27 Years
12 Month Price Range	Lower Half	Bottom Quartile
Dividend Payout Ratio	< 75%	35.3%
Portfolio Weight	Under to Slightly Over	Under

The first column lists primary factors.  The middle column lists target benchmarks.  The last column highlights General Dynamics’ metrics so I can see how well they align with my benchmarks.

CCC List: The list references firms found on the DRIPinvesting.org web site in the Champions, Contenders, Challengers list.  GD is a Champion so it’s off to a great start.

Current Yield:  GD’s yield is at 2.4% which means any significant addition to the portfolio will reduce the portfolio average below my target of 4%.  With that said, DRiPInvesting.org shows GD sporting a dividend growth rate in excess of 10% for 1, 3, 5, and 10 year periods.  If the payout ratio is fairly low, that growth right might be sustainable.  The question is, how many years of high growth rate are required for it to generate a dividend return equivalent to an alternative already paying 5% or 6%?

Company Profile:  GD is an aerospace and defense contracting firm providing commercial and military aviation services, combat services, information technology services, and marine services for U.S. Navy and commercial maritime customers.  It’s been in business for nearly 70 years.  Coupled with its size, it shows no indication of decline nor are there immediately obvious red flags from a business perspective.

Industry Leadership:  Preferencing Top 10 companies within their industry means looking for established leaders.  Army-Technology.com listed GD as the 5^th largest aerospace and defense firm in the United States.  That’s a good sign.

Market Capitalization:  Yahoo Finance listed GD’s market cap at $47.7 billion which exceeds another benchmark.

Price to Earnings:  The P/E for GD is well under the maximum target figure of 20.

Price to Book:  P/B is nearly double my target metric.  That could be problematic since I’d prefer not to purchase too much “blue sky” even if it is an aerospace firm.

Debt to Equity:  D/E is more than double my target metric as well.  If a firm is pricing in blue sky along with too much debt, I begin leaning away from it.

Dividend History:  27 consecutive years of dividend payments with the aforementioned dividend growth rate is solid and appealing.

Price Range:  The price range for the stock currently is in about the bottom quartile for the preceding 12 months.  This is goodness to an extent.  However, even at that point, it’s still above $157.  As a result, if I want to add to my portfolio, I’ll have to continue adding to my powder while keeping it dry.

Payout Ratio:  The payout ratio just over 35% could be attractive.  With the healthy dividend growth rates mentioned earlier, the payout ratio indicates those rates may be sustainable for some time.  They have to be to catch alternatives currently paying above 4%, though.

Portfolio Distribution:  Acquiring GD would certainly help my portfolio balance by adding to the manufacturing sector which is light at the moment.  However, I would need to generate a fairly substantial add to move the needle on the balance meter but reduce my portfolio yield in the process.

Analysis:  GD was off to a reasonably good start.  The P/B and D/E figures give me pause as does the general price range.  I’m not convinced that building an investment pool to get more than a handful of shares is worth the blue sky and debt that come with it – particularly if doing so reduces my total yield.   

I don’t currently have a stake in GD.  Whether or not GD stacks up well to alternatives and to my pot of funds available will determine whether or not it gets added.  At the moment, GD and SO appear to be in the same boat, albeit for different reasons.  However, there are several firms to review before I pull the trigger.  Meanwhile, spring is just around the corner with preparation for farming season in full swing.

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.

Dividend Farming Scorecard: The Southern Company

In an early December post on selecting investments for my Dividend Farm, I highlighted factors I investigate when considering whether or not to add a firm to my portfolio.  It’s a new year and time to think about adding seed money to expand my crop of dividend payers.  With that in mind, I thought it might be interesting to begin analyzing possible additions.

The table below provides a summary of factors I consider as part of my selection process as applied to Southern Company on January 1, 2019.  Laying out my analysis like this helps me quickly benchmark against my target metrics and compare this firm to alternatives.

FACTOR	METRICS	THE SOUTHERN COMPANY
CCC List	Champion	Contender
Current Yield	4.0%	5.7%
Company Profile	Red Flags	Telco Svcs?
Industry Leadership	Top 10	#9
Market Cap	$10 B+	$45 B
P/E	< 20	18.3
P/B	< 2	1.8
Debt / Equity	< 1	6
Dividend History	25 Years	18 Years
12 Month Price Range	Lower Half	Yes
Dividend Payout Ratio	< 75%	98.3
Portfolio Weight	Slightly Over	Yes

The first column lists the primary factors I review.  The middle column lists the benchmarks I’m aiming for.  The last column highlights The Southern Company’s metrics so I can see how well they align with my benchmarks.

CCC List: The list is in reference to firms found on the DRIPinvesting.org web site in the Champions, Contenders, Challengers list.  SO is located in the Contenders section so it’s off to a great start.

Current Yield:  SO’s yield is a healthy 5.7% as of the CCC chart last updated on 12.1.18.  A 5.7 yield handily beats my 4% target.  SO is two-for-two.

Company Profile:  In reviewing the profile I notice that SO is not just into generation and transportation of power (electric and gas), but it’s also got a play in the telco sector.  This strikes me as being outside the firm’s circle of competence (potentially) as Warren Buffett puts it, but it’s not a show stopper.  Additionally, I take a look at recent news articles about the company to see if there are any events being reported that may have long-term, negative implications.  I didn’t locate any for SO.

Industry Leadership:  I’m interested in companies in the Top 10 of their industry.  Investopedia listed SO as the 9^th largest utility in the United States so that’s good.

Market Capitalization:  SO’s market cap is well in excess of my target for large companies in which case it’s still on track as a possible add.  I should add that I’ll reference the market cap against revenue to ensure I’m not getting tangled up in something stratospherically priced relative to income.  I consider it a cross-check to the P/E.

Price to Earnings:  The P/E ratio is below my target metric as well.  The P/E is for the trailing 12-months rather than the leading 12-months.  I’d rather base my analysis on facts vs forecasts when possible.  Also, the P/E of 20 for the trailing 12-month period is a Benjamin Graham recommendation.  SO meets the mark here as well.

Price to Book:  P/B should be less than 2 in my estimation.  Beyond 2 and I figure I’m paying for blue sky, good will, or any number of other things that don’t translate into cash flow or profit.  This metric is another of Ben Graham’s.  SO squeezes under the bar on this one so it remains in the running.

Debt to Equity:  D/E is important to me for the same reason my debt relative to my income and net worth was important to my lender when I borrowed money to buy a house.  Too much of the former and not enough of the latter generally spells trouble on the mortgage front.  Therefore, a firm that’s too far of the market on this metric must provide a significant advantage or meet a critical need elsewhere as an offset.  However, when the D/E is 3x my target, I immediately consider taking a pass.

Dividend History:  18 consecutive years of dividend payments is solid.  However, it’s not outstanding because it’s less than 75% of my target.  Although not a show stopper by itself, in tandem with the D/E figure, it may well be.

Price Range:  The price at the time of this writing was $43.92 which put in in the lower half of SO’s twelve-month price range.  I’d rather be in the bottom half of the range than the top in order to avoid over paying or potentially getting caught in the hysteria of Mr. Market.  Also, I generally don’t look long at firms with stock prices well in excess of $100 a share.  I’d prefer buying a larger number of shares than smaller for a given dollar amount.  Less is more.

Payout Ratio:  I generally like the dividend payout ratio to be under 75% in hopes there may be a little extra headroom for growth.  However, I’m not overly concerned if it rises above that point as long as the firm delivers a steady, high yield due to my preference for high yield vs high growth, all things considered.  SO has a pretty steady dividend history so a high payout ratio, particularly in a regulated industry with large capital infrastructure costs and enormous barriers to entry like those of utilities, doesn’t give me heartburn.

Portfolio Distribution:  Last, but not least, I look at what the holding would do to my portfolio distribution if I add it.  Utilities fall into my Energy segment which is the third largest bucket of the nine I break my portfolio into.  The size of the additional investment I make will affect my decision.

Taken in a vacuum, SO appears promising.  Except for the high debt to equity figure and the potential effect on my portfolio balance it actually looks attractive to a conservative Dividend Farmer.  However, I don’t normally look at firms on a stand-alone basis.  Instead, I’ll run this analysis across multiple possibilities to see if any one of them provides a better fit than SO.  If the opportunity-cost exercise is favorable, then SO could be a valuable addition to the portfolio. 

I don’t currently have a stake in SO.  How the firm stacks up relative to other options and to my pot of funds available to invest will determine whether or not it gets added.  Stay tuned.  In the meantime, spring is just around the corner.  No better time than now to think about Dividend Farming.

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.