Archive for October, 2008
Thursday, October 16th, 2008
As a dividend growth investor, I am frequently asked why I don’t invest in high growth stocks and, more importantly, why I believe investing for dividends is a more appropriate strategy.
In bear markets there are great buying opportunities for dividend growth stocks that are offering yields above their historical averages. Opportunities to buy great dividend growth stocks at above average yields is a great way to finance your retirement and increase the compounding effect of your future income from these stocks.
Here are the 3 most essential reasons that I prefer dividend investing:
1.) Dividends offer investors fantastic flexibility.
Dividends give you tremendous financial flexibility throughout your investing life. While you’ve got an income from working, you can reinvest those payments to speed the process of compounding your wealth. Once you’ve decided to retire, the cash thrown off by dividends spends just as well as any other source of money!
What is even better, a rising dividend payment can help you fight inflation by providing you more cash every single year.
2.) You can’t fake money in your pocket.
Dividends also have the added bonus of being exceptionally difficult for companies to fake. After all, it’s difficult to convince lenders to loan money to a company if that company is going to turn around and hand it over to its shareholders.
As a result, to sustainably make and increase those dividends, the business needs to generate serious cash on both a regular and repeatable basis.
3.) Dividends are paid from the company’s cash flow.
Perhaps most important, a company’s dividend payment comes from its operational success and not from the panic, hype, or analyst interpretations that influence its stock price. Throughout these rocky market periods, dividend payments allow us to make money even when the stock price moves lower.
Why Invest In Dividend Paying Stocks?
- Quicker compounding.
- Increased financial flexibility.
- Cash in your pocket without selling.
- A hedge against inflation.
- An check on the company’s accounting.
- Cash Flow in a down market.
With all of the benefits of dividends, it’s obvious why they can be an integral component of one’s portfolio.
Did I miss any benefits of dividends? If so, let me know in the comments!
Posted in Investor Education | 3 Comments »
Wednesday, October 15th, 2008
While there really is no “secret sauce” for investing in dividend growth stocks, here are some basic tips to go along with my article on How To Choose The Best Dividend Stocks.
There is no magic number to look for (or avoid, for that matter),but the article explains the power of dividends and provides a cheat sheet for choosing great dividend payers:
- Real estate investment trusts with a funds-from-operations payout ratio below 85%.
- Higher-growth common stocks that pay out less than 50% of free cash flow (FCF).
- Banks that pay out less than 60% of FCF.
- Regulated utilities that pay out less than 80% of FCF.
Posted in Investment News | No Comments »
Monday, October 13th, 2008
Why Do We Invest When We Have No Control?
Even during the most trying times for the market, it is important to understand why it is that we are investing our hard earned cash into public companies of which we have little to no control over.
It’s true. We are buying pieces of companies, in the form of common stock, that we have no control over the operations of the company.
Basically, we are saying “Here, you guys take my money to invest in your business and I will sit back and wait for you to do a good job so that I can get a return on my investment”. When we think of it this way, investing in common stock makes little sense – if any sense at all.
Many investors prefer to invest in their own businesses whereby they have control over the operations of the company, and thus, the outcomes of the business. This makes intuitive sense, but what we as dividend growth investors are trying to do is to produce constantly growing retirement income of the completely passive variety.
So What’s The Difference?
The major difference is that while we lack control of the companies that we buy stocks in, we also relieve ourselves of the responsibility of running those companies profitably. This creates a passive and growing income stream.
We all know that running a businesses takes a lot of time, skill, effort, and energy – as well as a little luck. This is time, energy and skill that most of us do not have. However, we can participate in the efforts of others by purchasing dividend growth stocks and reaping our small, but growing, dividends.
Work One Time, Get Paid Forever
Theoretically, and many times practically as well, we can input one unit of work and get paid forever. Indeed, our main goal as dividend growth investors is to work once (evaluating and purchasing a dividend growth stock) and get paid forever in continuous dividends…ideally with annual raises!
The title of this article states that our retirement income is on sale. While this is true, we do have to be very careful to do our due diligence in bear markets to pick out stocks that have been unjustly beaten down and whose dividends and future earnings are likely to increase.
Easier Diversification
While having control over one’s own business can be profitable and offers the ability to make changes to react to market conditions, it also concentrates the investment.
As much as we preach about diversification and asset allocation in our stock portfolios, it is easy to forget the need for diversification when we talk about our own businesses.
Investing in the stocks of dividend growing companies allows for the diversification of funds among several high quality companies that meet the requirements of our dividend growth model. This diversification will allow for multiple consistently growing income streams which is an ideal way to fund retirement.
Why Now?
The current market has given us dividend growth investors the opportunity to identify our favorite dividend growth stocks and purchase them (some at prices we have not seen in our lifetime).
I’m not calling a bottom for stocks here, but I am confident that we are closer to a bottom than we are to a top at this point. Regardless of the direction of the market tomorrow, there are stocks out there that have been unjustly beaten down and are offering consistent and even growing dividends.
For more on how to find these stocks, check out my article on how to choose dividend growth stocks and then stop by The Dividend Network for stock analysis from the top dividend bloggers on the internet.
Posted in Investor Education | 7 Comments »
Thursday, October 9th, 2008
In recent months there have been a significant number of companies in serious financial trouble. Given the number of companies going out of business and the number of investors who lost huge amounts of their savings, I thought it would be prudent to introduce a metric to evaluate investments based on their likelihood of bankruptcy.
What Is A Z Score?
With all of the metrics, ratios and mathematical techniques used to evaluate the worthiness of a stock, it is almost possible to come across a new measurement technique every day.
The Z-Score is a weighted combination of 5 financial ratios used to calculate the financial strength of a company. While it is a weighted measure of several financial ratios, it basically measures liquidity and the performance of invested capital.
The knock about the Z Score is its relative lack of any specific measurable outcomes.
How To Read A Z-Score
The results of the Z Score test are divided into 3 general categories:
- Bankruptcy is likely – less than 1.8
- Bankruptcy is not likely – greater than 3.0
- No certain result (unsure) – between 1.8-3.0
You are probably thinking exactly what I am thinking right now…”this doesn’t tell me anything!”
Well, we were both right and wrong.
While the Z Score doesn’t tell us much about the specific upside potential of the company, it has been accurate up to 90% in determining whether a company is likely to go bankrupt over the next year.
Therefore, using Z Score as a preliminary tool to weed out potential investments from a large group can be effective.
How to Calculate Z Score
Z = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
Where:
Z = score
A = Working Capital/Total Assets
B = Retained Earnings/Total Assets
C = Earnings Before Interest & Tax/Total Assets
D = Market Value of Equity/Total Liabilities
E = Sales/Total Assets
It seems as though calculating the Z score for a company will provide us with a vague measuring stick that allows for the determination, with some accuracy, if a company is in dire financial trouble or not.
Generally speaking, the higher the Z score the better off financially the company is. It is my contention that, like most other indicators, it has its faults when used in isolation but can be valuable when combined with other evaluation techniques.
It is interesting to note that some companies, such as Royal Bank of Canada (RY) can have Z -scores in the hundreds!
Posted in Investor Education | 4 Comments »
