Dividend Stocks II

It may take a little time
A lonely path, an uphill climb
Success or failure will not alter it
--Howard Jones

Previously we examined some of the major benefits and risks associated with dividend-paying stocks. Today we'll consider the implications of building dividend-paying stock portfolios for investors both young and old.

While it is common for investors to focus on capital gains possible from equity investments, studies suggest that roughly half of the returns from stocks are due to dividend payouts. Stated differently, investment strategies centered on dividends tend to be under-appreciated--and perhaps undervalued--by investors.

To see why this might be true, let's focus on the income-producing potential of dividend stocks. Although the annual dividend yield on the S&P 500 currently stands at about 1.9%, it is possible to build a diversified basket of solid dividend paying stocks that yield 3% or more. Consider, for example, the following list of stocks:

Cisco Systems Inc (CSCO) 2.5% annual yield
Dominion Energy Inc (D) 4.8%
General Mills Inc (GIS) 3.8%
Johnson & Johnson (JNJ) 2.7%
Coca-Cola Co (KO) 3.5%
Target Corp (TGT) 3.2%
Wells Fargo & Co (WFC) 3.7%
Exxon Corp (XOM) 4.0%

A portfolio invested in equal dollar amounts of these securities would currently yield a collective 3.5%. For every $1,000 in portfolio value of the above design, that's $35 in annual income. That may not seem like much, but keep adding zeros to those payouts for larger portfolios. For a $10,000 portfolio, cash payouts amount to $350 annually. For a $100,000 portfolio, $3,500 annually. For $1,000,000, the investor collects $35,000 each year at current yields.

Keep in mind that companies maintaining strong competitive positions in their industries are likely to increase their dividend payments over time. Should the above basket of dividend payers increase its payouts by 5% each year for the next 15 years, then the yield on the basket would double to 7%. You can do the math on how much that would increase annual dividend income on the various portfolio sizes mentioned above.

As noted last time, there is also the potential for share price appreciation among dividend stocks that sweetens the story even more. Personally, however, I like to view that sweetener as icing on the cake that I don't plan to eat. I like to own dividend paying stocks for their income producing potential over a lifetime. While capital gains are nice, I don't plan to sell these income producers (absent a substantial decline in their business fundamentals) because, to mix metaphors here, that would be like selling the goose that lays the golden eggs. If I sell the dividend-paying geese, then no more income eggs.

There are implications here for young and old alike. If you are a younger investor, then dividend income supplements the regular income earned from your everyday job. By taking some of your regular income and investing it in the production processes of others, you acquire additional income that essentially makes you more productive--and diversified--over time. A goal to consider: acquire as large a supplemental income stream from dividends that you can reasonably afford, and let it build over time. When you are a young, dedicated investor, the miracle of compounding works wonders for building wealth as you age.

If you are an older investor, then dividend-paying stocks offer an income replacement when your retire. Retirement essentially amounts to voluntary unemployment. Income from work disappears. Resources to fund retirement lifestyles typically come from pensions, mandatory IRA and 401(k) withdrawals, and government transfer payments such as Social Security. Dividend-paying stocks offer an additional source of regular income for retirees. Referring back to the example offered above, every $100,000 invested in the list yields $3,500 in annual income--an income that is likely to grow greater than inflation over time. A goal to consider: develop a stable of dividend-paying stocks in a taxable brokerage account that builds passive income-producing capacity for retirement. The more dividend payers that you acquire, the greater the income replacement coming from this source for retirement. This is where I am currently.

Finally, for both young and old, consider this. Capital invested in dividend-paying stocks should be patient. Don't buy dividend stocks to sell them. Buy them for keeps. Once your are done benefiting from your investment, pass it along to the next generation, and suggest that it does the same.

positions in CSCO, D, GIS, JNJ, KO, TGT, WFC, XOM

Dividend Geese

Billy Chapel: Are you saying I should retire?
Gary Wheeler: Why not? It wouldn't hurt the negotiations. And it would serve those sons of bitches right.
Billy Chapel: I, uh. I don't know. I don't know what to say.
Gary Wheeler: Well, you can't tell me that you haven't thought about it. And you've been smart with money, right?
--For Love of the Game

Until recently, dividends didn't matter much to me. Like most investors, I focused on price appreciation potential. 

A few years back my brother reacquainted me with the value of cash dividend payouts. Managing my mom's portfolio, he invested primarily in stalwart dividend paying stocks. Over time, he built an income-producing machine capable of covering a large share of monthly living expenses. Yes, the portfolio gradually increased in value as well. But so did the dividend payouts.

The capacity of a well-designed stock portfolio to generate income--particularly 'replacement' income for retirees--impressed me, perhaps in part because I'm approaching retirement myself.

In the olden days, common wisdom was that aging people in need of income replacements should invest in bonds and other fixed income instruments. Being traditionally less volatile, fixed income was seen as less prone to big capital loss. Moreover, many fixed income instruments tended to offer yields superior to stocks.

In the late 1970s/early 1980s, for example, 10 yr Treasury yields traded north of 10%. Those cash payouts were far higher than dividend yields on stocks. Of course, inflation was also flying which negated much of those cash gains.

Since then, of course, T-note yields have been in secular decline--due largely to interventionary policies of the Federal Reserve. Dividend yields on stocks have also declined as shown by the yield in the S&P 500 since 1900.

Overlaying the two trends reveals a couple of things. One is that stock dividend yields have not always been lower than bond yields. In early decades of the 1900s, stocks generally yielded more than bonds by a couple of percent. The other note is that, more recently, the offset between stock and bond yields has narrowed to the point where cash returns on stocks once again looks attractive.

Index-to-index comparisons tend to understate the superior cash-yielding capacity of stocks. For example, the yield on the S&P 500 Index currently stands at about 1.3%. However, many stocks in the SPX pay tiny or no dividends. Investors can readily assemble a portfolio of reliable dividend payers from the SPX with an overall yield north of 3%. This handily beats the current 10 yr Treasury yield of about 1.5% (and nearly all other fixed income alternatives for that matter).

If Treasury yields should rise relative to stocks then the calculus changes, of course. That said, because central banks worldwide are determined to suppress sovereign yields, large increases in bond yields seem unlikely unless policy makers lose control of the interest rate markets. While this could certainly happen, it is likely to occur in the context of Big Inflation. Big inflation jeopardizes the attractiveness of bonds. Moreover, companies may be able to navigate inflationary environments in a manner that preserves value. Dividend payouts might even increase.

Preparing for retirement, then, I view the cash-generating capacity of dividend paying stocks as central to creating 'replacement income' when the paychecks no longer roll in. Essentially, the dividend payers write the checks instead of an employer. The more I can draw on steady-to-rising dividend payments, the less I will have to cut in on the principal that generates the cash.

Stated differently, I don't want to kill the dividend-paying geese that lay the golden eggs.

Positioning for Retirement

Doing the garden
Digging the weeds
Who could ask for more?
--The Beatles

With retirement coming up fast I've been doing a few things w.r.t. personal finance. I've been saving more and spending less in order to build cash. Have also been selling some stuff on ebay and elsewhere to collect extra 'juice.' Also helps thin things out at the house--much needed.

Preparations are being made to rollover my 401(k) from work. I'm looking forward to allocating this capital among far more choices than those available thru the current fund administrator.

In both my brokerage and IRA accounts, I've been buying dividend paying stocks. Dividends are real cash that can provide a significant, and perhaps under-appreciated, income replacement in retirement.

Inflation is particularly bad for retirees as it erodes purchasing power of savings. To hedge against the prospects of Big Inflation, I've been building stock positions in the oil complex (e.g., ENB, XOM) and miners (e.g., AEM, AGI, PAAS). 

The miners appear particularly attractive. The financial strength of many in this group has perhaps never been better. Solid balance sheets and cash flows. Many are paying significant, and increasing, dividends (which helps me kill two birds with one stone). The sector has been pounded down to attractive valuation levels--particularly given the growing inflationary environment.

I've been swapping funds out of precious metal ETFs such as PHYS and into the miners to more fully express my perception of this situation--albeit at a slightly higher risk profile. 

positions in AEM, AGI, ENB, PAAS, XOM