Personal Finance 101

3 Reasons You Must Invest In Dividend Stocks

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! 

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Your Retirement Income Is On Sale!

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.

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Panic or Profit – You Decide

Yesterday was a difficult day for the markets with news of Lehman Brothers filing for bankruptcy, Merrill Lynch being bought and insurance giant AIG looking for funding. Central banks injected cash into the system to help with liquidity. It’s a lot to digest, whether you are in the business or are an investor.

In fact the Dow ended yesterday nearly 500 points lower – its worst point drop in more than seven years. Many investors may have been unaware of what was going on yesterday but have no doubt been made aware of it this morning.

This is a time when investors have to remember – or be reminded of – the importance of a long-term view. In the short term emotion will drive the stock market. Over the long term it’s fundamentals that drive it. There is no question that emotion is currently in control.

However as has been pointed out in the past it is time like these, as emotionally difficult as they are, when investors can buy great companies at a discount the very discount that helps power their long term returns.
  

What Can Investors Do?

Emphasize Asset Allocation.

Faced with the prospect of continued market volatility, investors should review their risk tolerance to ensure it fits with the asset mix of their portfolios. Market performance over the past several months serves to underline the fact that asset allocation and diversification remain two of the most important aspects of investing.

Continue to focus on the long term.

Benjamin Graham once said “In the short-term, the market is a voting machine. In the long-term, it is a weighing machine.”

Day-to-day market moves are driven by emotion as people react to new information. And volatile periods can continue for some time.  But investors with a long-term focus will recognize that this period of adjustment will present an opportunity to acquire great investments at attractive valuations.

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Do Financial Experts Really Help?

There’s really nothing like a poor economy and a tumbling stock market to send people’s financial plans into a tizzy! So, where can we look for guidance and assistance in these troubled financial times?

Some “experts” are now saying that this is the time to buckle down on spending with rising energy and food prices. Wow, I guess that “late breaking news” really caught us off guard – good thing there are financial experts out there to save us from this financial apocalypse.

Let’s see what the experts have to say:

The Canadian Government

Statistics Canada says gas and food prices are eating up a larger portion of our spending money, while CIBC reports household debt in Canada is rising faster than personal disposable income.

You don’t say? I guess nobody saw that one coming!

A “Smart” Canadian – The Usual Suspects

“It takes a rough patch in the economy like this for people to take a look and see where they can save money,” says Pat Foran, author of the Smart Canadian’s Guide to Building Wealth.

I’m pretty sure that this is what everyone should constantly be doing to build wealth. Always look for ways to cut spending and use that extra cash to increase your asset base.

• Foran recommends reviewing everything from your cable and cell phone bills to seeing where you can trim costs, going to the library instead of buying books, and renting movies instead of going to the theatre.
• Bringing your lunch to work a few times a week also saves money, as does cutting back on daily trips to the coffee shop for a java jolt.
• An economic slowdown is also a good excuse to cut expensive bad habits, such as smoking or overdrinking, Foran says.
• On big ticket items, he says consumers should consider used cars instead of new and putting off that vacation to Mexico when a trip closer to home might suffice.

For many families, Foran says budgets don’t work and instead recommends “forced savings,” which means setting aside a certain amount of money from each paycheque for investment.

Could Foran be any more vague? I guess we have to buy the book – good marketing strategy!

Go On A Money Diet

Patricia Lovett-Reid, author and senior vice-president at TD Waterhouse, recommends cutting back spending as if you were cutting back on calories for a diet.

Because we all know how easy it is to stick to a diet!

“There is some mindless spending going on,” she says.

“Look for ways to cut back so you don’t feel like you are on a budget.”

Hmmm…any ideas?

Another tip she has is to avoid shopping in bulk because the mass quantities that are purchased are sometimes not used and are discarded or wasted.

“If you look at what you throw out, you aren’t really further ahead … it might be better to purchase in smaller quantities.”

She also says that being an early adopter of technology is very expensive. I can concur with this as many folks purchase more computer than they need (you don’t need a $3000.00 computer to surf th enet and write e-mails) and don’t even know about half of the features of the new iPhone, for instance.

Review Your Debt

Many experts recommend refinancing your mortgage and consolidating high-interest debt through a line of credit where possible.

This makes sense if you have credit card or other high interest consumer debt.

“If you refinance and get a new mortgage you pay principle and interest on the entire amount from day one … . However, if the purpose of your refinance is to consolidate but not use all of the money at once, then set up a line of credit. You only pay interest on the amount you borrow at the time you use it,” says mortgage expert Peter Kinch.

However, he says be wary of how you used that line of credit.

“We want to make sure people don’t get into the habit of using their house as an ATM machine,” Kinch says.

Very thoughtful for a guy who just “sold” you a line of credit. Too bad this advice comes a little too late for some. For the sake of disclosure, I have a home equity line of credit that I use for investment opportunities.

What I Don’t Get

There are two major things that stick out to me in all of these expert articles and financial media mumbo jumbo.

Nobody suggests paying down debt. Everyone talks about consolidating debt and lowering interest rates, but nobody actually says (or writes) that you should pay that debt down. This is absolute craziness. In an economy like we are facing today, it should make absolute sense that people should be reducing their total debt. I recently outlined how reducing debt provides a guaranteed return on investment that is virtually unmatched.

What about the stock market? When the stock market is high all of the experts are telling us to buy stocks and that stocks are a great investment, but when the stock prices of those “great companies” are 20% lower, all of a sudden investing in the stock market is “risky” and not at all a good idea. This is absolutely counterintuitive to the basic investing tenet of buy low – sell high! In fact, one could argue that investing in the stock market now is less risky because prices are lower.

I am not claiming to be a financial expert, but the more I read the news media, the more disappointed I become. Basic financial advice changes from day to day and even the simple tenets of investing and finance are twisted or even discarded for the sake of selling a few magazines or newspapers.

At the risk of making it too simple, here are some ideas for building wealth:

1. Live within your means
2. Reduce personal debt
3. Buy assets (Stocks, Bonds, Real Estate, Precious Metals)

Of course each of these points can be fleshed out and much more detail can be added to each point. However, I find that when the articles from the “experts” start getting in my head and causing doubt, I look back to these guiding principles for direction.

Do you ever get distracted by the media?  If so, what are your strategies for dealing with the constant barrage of information?

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The Secret of the Compounding Salary

I’m sure that many of you have experienced the torture of the dreaded yearly performance review at work in the past little while.

I happened to be fortunate enough to receive the full raise that I was eligible for this year. While I’m not quite as excited about this as I am about getting a raise without doing anything, a raise in income means increased contributions to my investments and the prospect of an early retirement.

Expect The Unexpected

Because I work in the financial industry, this year has been slightly tough on the company. This means that the annual bonuses that I have been used to in recent years will not be granted this year. Not only will the company not be issuing the familiar 10-12% bonuses,  we are actually expecting nothing – 0%!

Of course, the lack of bonus pay-outs is traumatic for employees. However, people underestimate the effects of the 3% raise in salary.

The Glass Is Still Half Full

Even though it appears that I will not have my bonus money to top-up my retirement savings account, I will receive significant benefits from the small 3% raise that I did get.

1.Life Insurance – My company provides me with life insurance to the tune of 3X my gross salary. This 3% raise equates to a 9% increase in the life insurance available to my family if something should happen to me in the next year.

2.Company Pension – My company provides me with a managed pension plan for which they match 7% of my salary. This raise provides 6% more money being contributed to my pension plan for 2008.

3.Investment Account – I contribute 25% of my net salary to an account dedicated to my dividend growth investments. Obviously, this means an increase to that contribution.

It is interesting how we forget those benefits that don’t necessarily show up in our checking account when our paychecks are deposited. The power of compounding takes effect not only with our dividend stocks or in our high-interest savings account, but with our workplace benefits as well.

Understand and Use Your Company Benefits!

Of course it is our hope that we can retire early if we choose great dividend growth stocks, but we have to take advantage of all of the programs and benefits that are offered along the way. I certainly believe that investing in my company matched pension plan will speed up my retirement process.

So, the next time you hear complaints around your workplace about the lack of bonuses or a cheap 3% raise…just remind yourself of this article and make sure that you are fully utilizing all of the benefits available to you.

Posted in Investor Education | 6 Comments »

Colgate Washes Up Another Dividend

The Board of Directors of Colgate-Palmolive Company (NYSE: CL) declared quarterly cash dividends of $.40 per common share, payable on August 15, 2008, to shareholders of record on July 24, 2008.
For those of you looking for a dividend that is as close to certain as you can get, look no further as Colgate-Palmolive has paid uninterrupted dividends on its common stock since 1895.

Colgate on the Defense

With the turmoil that has been the stock markets in the past weeks and months, many investors (at least those who haven’t gone to 100% cash) are turning to defensive stocks to assist in preserving capital. With a Beta of just 0.31, Colgate (CL) is one of the least volatile dividend stocks on the market.

In addition to a healthy dividend and price stability (in relation to the market), Colgate also offers some excellent growth numbers for a company of such extreme size. Colgate boasts a Return on Assets (ROA) of 17.03 and a Return on Investment (ROI) of 29.07; both of which trump the industry numbers quite handily.

Colgate Dividend Data

With many dividend stocks struggling with earning this year, the management of the company’s dividend payout ratio is of particular importance. Colgate has a dividend payout ratio of just 43.4% of earnings, which will allow for some flexibility in earnings capacity without sacrificing the dividend rate in the short term. A dividend payout ratio of below 60% is a relatively conservative guideline for investing in dividend growth stocks.

When investing in a good dividend growth stock, one of the criteria that I use is to set a purchase price for a stock when its dividend yield is around 25-30% above the 5-year average dividend yield. Colgate’s 5-year average dividend yield is 1.88% and the current yield is 2.27% – a yield that is 20% higher than average.

Another criteria that I use is that the dividend growth rate must be greater than that of the S&P 500. Otherwise a dividend growth investor would be more prudent buying the entire index to mitigate risk. The dividend growth rate for the S&P 500 is currently at 11.0%, while Colgate features a dividend growth rate of over 14% – a healthy 3% points higher than the index.

Buy What You Know -Colgate

Unless you have been living under a rock for the past century, you will recognize Colgate-Palmolive as a leading global consumer products company. The company is very successful in its focused niche markets of Oral Care, Personal Care, Home Care and Pet Nutrition.

Colgate sells its products in over 200 countries and territories around the world under some of the world’s most recognized brand names as Colgate, Palmolive, Mennen, Softsoap, Irish Spring, Protex, Sorriso, Kolynos, Elmex, Tom’s of Maine, Ajax, Axion, Soupline, and Suavitel, as well as Hill’s Science Diet and Hill’s Prescription Diet.

Stock Summary

As investors looking at Colgate (CL), we have a stock that is quite a bit less volatile than the broader market with a beta of just 0.31, a greater than average dividend yield at 2.27% that is growing at a faster pace than the index. In addition, the company has features an excellent return on investment and wide array of well branded products that people still need to buy regardless of economic conditions.

Full Disclosure: The author does not own shares of Colgate-Palmolive at the time of writing.

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Dividend Growth Investing At Work

If one is a dividend growth investor, they are probably considered (or should be) the longest of the long-term investors.  To the absolute amazement of other investors, once the stock is purchased, the dividend growth investor may not care what the price of that stock is as long as the dividends continue to grow.

The substantial gains that are reaped by re-investing the growing dividends from our favorite stocks lies in the exponential power of compounding – which often takes years to build into a noticeable contribution to a portfolio.

Because the re-investment process can seem unproductive and the dividend growth insignificant at first, it is easy for others to dismiss dividend growth investing as “too conservative” or even unprofitable. As much as we preach that slow and steady wins the race, even the most seasoned dividend growth investor can begin to question the effectiveness of the strategy from time to time.

A Real Life Example

Many times it takes a real life example of dividend growth investing to help to keep one motivated to continue the long , often boring, journey of building a portfolio of dividend growing common stocks.

The recent bid by InBev to take over Anheuser Busch (BUD) provided this motivating real-life example that what the essence of dividend growth investing is all about.

This is what the “end-game” of our dividend growth strategy should look like – it’s beautiful!
In 1980, Sean Gorham bought his first piece of a public company: a $500 investment in Anheuser-Busch, even though he had no connection to the brewer or its St. Louis roots. He’s reinvested the dividends, or the cash payout shareholders receive, over the years.

“I’ve always admired how well the company is run. They exude a very clean image and a very American image,” said Gorham, 48, an insurance agent who lives in York, Maine, about an hour northeast of Anheuser-Busch’s Merrimack, N.H., brewery. “It’s been one of the best investments I’ve had. … The dividend I get every year is more than what I originally paid for” the stock.

Anheuser-Busch stock began being traded in 1933 in the over-the-counter market, where brokers buy and sell among themselves rather than through a stock exchange. The company first was listed on the New York Stock Exchange on April 18, 1980, making it more widely accessible to individual investors.

In the past 28 years, Anheuser-Busch’s stock has split four times. So one share bought in 1980 is now 24 shares – how’s that for creating shareholder value.

It Takes Time And Commitment

Obviously this example is one that has taken nearly 30 years to develop, but the fruits of the labor are tremendous.

Given this example, an investor who today is 30 or even 40 years old could begin to build a portfolio of dividend growing common stocks and expect to receive an excellent income in retirement that grows each year – likely at a rate higher than inflation!

When one commits to the strategy of dividend growth investing, it requires an extreme amount of patience and discipline in the first few years. It may take as many as ten years of dividend growth before the re-invested dividends make significant contribution to the growth of the portfolio.

Reaching The Tipping Point

Many financial planners will dub a person’s working years as the “accumulation phase” of one’s life. This means that during these years (roughly from age 20-65) the purpose of investing is to accumulate assets that will allow the investor to hopefully maintain their current lifestyle in retirement.

During the first decade or two, accumulating assets is the most difficult as investors tend to have other “important” expenses such as purchasing a home, raising a family, retiring student loans and consumer debt etc.

While a full blown discussion on the time value of money is not necessary in this article, one must recognize that buying assets such as dividend growth stocks during the early years of the accumulation phase will allow for the advantages of compound growth to kick in and the tipping point will be reached faster.

The tipping point is the point where the return from investments begins to grow at a greater rate than  expenses. You will notice that one does not say that investment income meets expenses because, it is known that expenses increase with inflation and (mortgage excluded) may actually have increased in retirement depending on medical needs etc.

Motivation To Follow A Proven Path

During the accumulation phase, success stories like the one above can prevent investors from straying from the proven path of investing in solid dividend growth stocks to fund a prosperous retirement.

Where do you get the motivation to stay committed to your investment strategy?

Resources: St. Louis Today

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Are Dividend Investors Idiots?

In a recent article by John Heinzl (Globe and Mail) he asks himself if, as a dividend growth investor, he and all other dividend investors are idiots? Heinzl outlines the feelings that we typically have every so often as dividend investors. That is, missing out on the “multibaggers” that everyone is talking about around the water cooler at work.

Here is a quote that sums up how us dividend investors might feel at the moment:

…Because when everyone else is doing the logical thing and shoveling money into growth stocks that are shooting to the moon, only a big fat idiot would stubbornly sit on a portfolio of boring dividend stocks that are, for the most part, doing jack squat.

It’s interesting that he mentions high flying stocks like Potash Corp. and Research in Motion as being the ones that he missed out on, while he talks about owning our favorite dividend growers – banks, insurers, pipelines and drug makers.

How Far Can You See?

When investing in dividend growth stocks , it isn’t about making a killing this week or this month.

• It is about investing for the long haul and watching your dividend income rise consistently year over year while your “investor” counterparts are searching for the next hot tip.
• It’s about holding onto that dividend paying stock and not worrying about the stock price, as long as that dividend keeps growing.
• It’s about protecting your hard-earned money from inflation and making your money work for you.
• It’s about knowing the company can’t fake a cash dividend.
• It’s about money in your pocket.

Over the long term we know (and Heinzl reiterates) that dividend growing common stock prices also out perform those stocks that pay stable or no dividends.

So What Now?

There is a famous saying from Warren Buffett that goes something like this:

“Be fearful when others are greedy, and greedy when others are fearful”

Of course this is easier said than done, otherwise we’d all be running a multi-billion dollar company like Berkshire Hathaway.

While it may take some serious resolve to start loading up on some of our favorite dividend payers, most notably banks stocks, sticking to a long term plan will make you rich in the long run.

So, to echo the words of Mr. Heinzl I’ll end with this quote:

Am I going to sell my dividend stocks to buy these high fliers now? Hell, no. If anything, I’ll be adding to my existing positions, and reinvesting the extra dividends in even more shares to take advantage of the magic of compounding.

So, don’t worry about the water cooler talk and stick to your plan. Soon enough you’ll be saying goodbye to the water cooler forever when the compounding effects of your rising dividend income begins to exceed your salary!

Here’s to your wealth!

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