Category: Dividend 101

I started thinking recently about how I would pass down stock investments to my children when I pass away. It’s one thing to just give them the stocks, but there would be little stopping them from just selling those stocks, cashing out, and blowing all of that money on cars and vacations. The real gift that I would want to pass down is my mindset for saving and investing in quality companies. I also couldn’t expect them to read everything I’ve ever written about stocks either, so I thought it would be a good challenge to try to get everything down to a single article. So this is my attempt to pass down important chunks of knowledge to accompany the portfolio.

“1 dollar every month is better than 50 dollars now”

I believe this concept to be the cornerstone to building wealth and living a secure and enjoyable life. A set amount of money being paid or received is only ever going to be that amount of money, but money moving at a regular rate has the potential to become far more over a long enough timeline. If I receive 1 dollar every month for 5 years, I’ve received a total of 60 dollars, and will keep making more every month. This also means that something that costs me $1 per month will exceed the cost of a $50 one time payment after 4 years and 2 months.

Another way to look at this concept is renting versus owning. If you plan on owning something long enough that the cost of renting exceeds the one time cost of ownership, then it is a better choice to own it. The best thing you can do is own an asset that other people want to rent, so you pay once, and they keep paying you forever.

“The value of stocks is not the price they can be sold for, but the income they produce”

This goes back to concept #1. Owning dividend paying stocks gives you free money for the rest of your life, with no limit. In fact, the amount of money you receive from the stocks you own will probably increase each year. The best companies increase their dividend payments every year. Selling a stock for a one time payout is basically robbing yourself of all the future dividend payments you would otherwise receive. The only time a stock should be sold is if this income is going to be lower this year, than it was last year (disregarding any special 1 time dividends or splits).

“If you can’t explain a company’s business in 2 sentences, you probably don’t understand it and probably shouldn’t buy it”

One of the biggest mistakes an investor can make is buying shares of a company without any knowledge of how that company makes money. This doesn’t mean knowing all of the details of Coca-Cola’s distribution channels. It means knowing the products or services that a company sells and knowing the general demand for that product or service. People everywhere drink Coca-cola soft drinks, and they probably will continue to do so for the foreseeable future.

“Buying a stock in the hopes that its price will increase over any period of time shorter than 2 years is gambling. Don’t gamble your money”

This is pretty self-explanatory. Gambling is not a reliable way to build wealth, and buying a stock with the intention of selling it later is gambling. Instead, focus on buying shares of companies that are going to keep growing their business and profits and share those profits with investors. This is the difference between buying some apples with the intent of selling them tomorrow and buying them to plant trees that will provide you with apples for life.

Without getting into the highly technical concepts with which I use to evaluate my investments, I think these values could help set someone along a path to financial wisdom.

And of course, my favorite phrase: “Buy Smart, Never Sell”

Why you need to be financially literate.

The retirement plans offered by employers have evolved from pensions to 401k’s at the end of the last century. What this means is that the responsibility for saving for retirement has shifted from the employer to you. This is great for investing nerds like myself, but not as good for today’s average young professional.

Let’s role play for a second. You’re a level 1 professional with a full time job making $35,000 per year. Your employer offers you a 401k with a match up to 2%. You’ve been told by your parents that the match is free money, so you enroll and put away 2% of your paycheck each month which your employer will match.

The next step is tricky, it’s time to pick out funds. Having never looked at anything like this before, it looks like something out of the Matrix or written on the wall of an ancient pyramid. You’ve got to pick something, so you just randomly pick 10 funds that sound “cool” or “profitable.” As a result, you end up with high expense ratios, low yielding bonds, and shares of companies you know nothing about. Let’s say this works out well enough and your funds manage to produce an average of 5% compound growth per year.

Assuming the average yield, salary, and contributions remain the same for 20 years, you’ll come out with a 401k valued at about $48,000. To a novice, this might sound like a lot, but anyone that’s tried to plan for retirement knows how little of your expenses this would actually cover at a 4% withdrawal rate. Now, you’re in your 40’s and really not even close to retirement.

Because our schools don’t teach students how to create a budget, evaluate funds, or analyze a company’s EPS or payout ratio, The young professionals of the world have no clue how to approach investing for their retirement. Social Security is most likely not going to be a major contributing factor for Millennials in their retirement, and without pensions offering a “hands-off” way to invest, the burden is entirely on the individual to figure it out.

Many are not even aware of this burden. Discussing money has become taboo in the U.S., and if nobody is talking about it, how are young people going to find out?

Unless you want to work until you’re 75, you need to educate yourself on investment. Unless you want your kids to work until they’re 75, teach your kids about money, budgeting, and investing. I’ve been adding posts to a Dividend 101 category for you to get started and learn how to be a dividend growth investor. There’s no shame in starting out, but there is shame in having the ability to act and doing nothing.

George Santayana once said “Those that who cannot learn from history are doomed to repeat it.” When it comes to dividends and dividend growth, those who DO learn from history are blessed to repeat it.

You can learn a lot from a company’s dividend history. Before I get into why it’s important, you need to know where to find a company’s dividend history. First, you can use this site, Enter the stock ticker into the search bar at the top of the page and it will take you to a page that includes the past 10 years of dividend payments (and lots of other useful info). You can also use Google finance or dividata.com to find the history.

Reviewing the dividend history for a stock will reveal their stance on rewarding shareholders. A company that increases their dividend payment each year is dedicated to providing value to you for owning shares of their business. The history will reveal stagnant dividend growth or any past dividend cuts. Those kinds of companies are the ones you want to avoid.

It’s important to note that a dividend may appear to be reduced if the company had a stock split and the history has not been adjusted. A stock split is when a company believes the price per share is too high and grants extra shares to all shareholders and reduces the price. For instance, Coca Cola (KO) had a 2:1 price split in 2012 where the price went from around $80 to around $40, and all shareholders ended up with twice as many shares.

Looking at the history of a stock will also give you insight on how long the company has been increasing their dividend. This is how we know where they fall in the Dividend Hierarchy.

If you get used to reviewing the dividend history for a stock, you should be far from doomed.

One of the most confusing concepts of dividend investing is understanding how and when you get paid a dividend. If you’re new to dividend investing, you may have no idea of even where to look. You might think you just get paid a dividend for owning the stock right away, like a gunshot in Call of Duty. In reality, it’s more like Angry Birds, there’s a delay before you get your payout.

So first, let’s start with the vocab lesson.

The 4 terms you will see on these sites are the “Declared Date,” “Exdividend Date” (or Ex Date), “Record Date,” and “Pay Date.” The most important ones to know are the Ex dividend Date and the Pay Date. It’s very simple: if you own a stock when the opening bell rings on it’s Exdividend Date, you will be paid the dividends for each share you own on the dividend Pay Date. So if MCD has an Exdividend Date of 2/27/2014, for you to “Capture the dividend,” you must buy shares on 2/26/2014 or earlier. Then, on their Pay Date, 3/17/2014, you will receive dividends for each share you owned on 2/27/2014.

It should be noted, that for a dividend to be “qualified,” and thus taxed at a lower rate, you must own that stock for 60 days before and after the Exdividend Date.

The “Record Date” is usually a day or so after the Exdividend Date, and this is when the company looks at their records from the Exdividend Date and determines who is eligible to receive a dividend payment. The “Declared Date” is the day the company announces its next dividend. For the most part, these dates are not really relevant to the standard dividend investor, and can thus be ignored.

When I need to find out when a specific stock pays a dividend, I look on either dividend.com or dividata.com. These sites also have features that will let you search for stocks that have upcoming Exdividend Dates.

There is an investing strategy called “Capture the Dividend.” Where an investor purchases the stock the day before the Exdividend Date and then sells afterwards. This allows them to receive the dividend payment and potentially reallocate their cash elsewhere, maybe to capture another dividend. The problem is that on the Exdividend Date, the stock price usually “gaps down” by the amount of the dividend payment. For our example of McDonalds, if their dividend payment is $0.81 per share, and the closing price on the night before the Exdividend Date is $95.00, the opening price will be $94.19 the next morning.

This is not considered a safe or reliable strategy because there’s no guarantee that the price will move back up to or above the price you bought it at before receiving the dividend. Additionally, since this dividend is not “qualified,” you will pay taxes on it as capital gains (which is a higher rate). The most tried and true strategy for quality dividend stocks is “Buy and Hold.”

Well, hopefully you have a much better understanding of what you’re looking at when analyzing a stock.

The most common problem for novice investors is they have no idea how to interpret all of the stats they can see for a particular stock. Imagine trying to play your Diablo 3 Barbarian and not knowing how Strength and Vitality affected your character. In Diablo 3, there are well over 50 different stat bonuses you can find on items, but really, there’s about 5 you should care about. The same is true for stocks. The most important valuation stats for dividend stocks are Growth History, Annual Yield, P/E Ratio, and Payout Ratio. These are the most important statistics to dividend investors like myself. Here is how I used them.

Growth History: Quality companies that distribute dividends regularly tend to raise their dividends consistently. I try to find stocks that have at least 10 years of dividend growth history. Meaning they have raised their dividend payment each year for the past 10 years or more. More than 10 years is an added bonus as I explained in the Hierarchy of Dividend Growth.

Annual Yield: The annual dividend yield is a percentage of the current price that is paid out each year in dividends. Really, the dividend payment is set, so the yield varies based on price. In the end, you’re always looking for a high yield when investing. I look for stocks with an annual dividend yield over 2% and below 7%. Stocks with yields over 7% are most likely failing one of the following guidelines, or are the result of a very strong downward trend and may continue to lose value.

P/E Ratio: This is the ratio of Price to Earnings Per Share (or EPS). Many people use the EPS to determine what a fair price is for a stock. I consider stocks with a P/E Ratio below 20 to be a good enough value to invest in. Stocks with high P/E Ratios are most likely overvalued.

Payout Ratio: This is the ratio of Dividends paid per share and Earnings Per Share (EPS). If a company earns 5 million dollars and pays out 2 million dollars in dividends each year, their payout ratio is 2/5 or 40%. I aim for stocks that have a payout ratio under 65%. Stocks with too high of a payout ratio, may not be able to afford raising their dividends each year, and may even need to cut their dividend payment. A dividend cut is like the mark of death for a dividend stock. Despite the name of this blog, you should absolutely sell a dividend stock that reduces its dividend payment.

I hope this helps shed some light on the way I value stocks and the important statistics for you to keep track of. How about you, how do you evaluate good stocks?

Debt comes in many flavors: student loans, mortgages, credit card debt, car loans, etc. I talk a lot about how to invest when you’re debt free like me, but the reality is that I’m extremely lucky and a minority in modern day financial culture. I like to think of money like water; it can allow you to float, but you can also drown in it. When you are overloaded by debt, it can be easy to feel like you’re drowning and completely out of control. I’d like to provide whatever advice I can to help you start treading water, and someday even build a boat to float on.

First of all, debt is not a magical entity. It’s money you owe so you can have something you haven’t earned yet financially. That may sound condescending, and when it comes to a college education or a reasonable car (Camry = reasonable, Bentley = unreasonable), it’s not meant to be, you need those things to survive in our modern culture. The reason why I say it’s not magical is because there are very logical and real ways to make your way out of debt. So, here we go.

Don’t be too proud

Before you can get to work on your debt, you need to understand if your current lifestyle is sustainable. To do this, you’ll need to do a cash flow analysis on your monthly income and expenses. If you’re making more money than you’re spending, jump to the next step. If you’re losing money, it’s time to find some help. If you were drowning, would you be too proud to grab the hand of someone sitting in their cozy boat? You need to accept that your lifestyle is more lavish than you financially deserve. Stop eating out as much and learn to cook. Consider moving in with roommates or even your parents. The first step is to get your cash flow into positive territory.

Build a cushion

Before you start paying anything off, you’ll want to save about $1000 so that you have a cushion for your expenses each month. You can also do this as part of your budgeting exercise in the previous step. This step will help remove some of the paycheck to paycheck stress that might cloud your judgement.

The Debt Snowball

Credit for this technique belongs to Dave Ramsey. How this works is you find out which of your debts has the lowest balance. You will make the minimum payment on all of your debts except for that one. All of your extra cash each month should go towards paying off the debt with the lowest balance. Once you have that first one paid off, you can use the money that would have gone towards that account to pay off the next lowest balance. With each debt you pay off, you build momentum like a snowball falling down a hill.

Interest Rate Balancing

If you’re most interested in just getting out of debt, you can stick with the snowball method until you’re debt free. However, I believe there are some cases where debt is ok. I spend a lot of time building javascript calculators to answer my own financial questions of what the best strategies will be. I’ve found that if your investments are capable of yielding a greater return than the interest percentage on your debt, then you’re better off investing instead of paying off your debt early. For credit card debt, your interest rate is probably in the double digits, and that is going to be hard to beat, so definitely pay those off. For mortgages or student loans (most of the time) the interest rates on those debts are so low, that you can easily outperform them in quality dividend stocks.

Here’s an example. You owe $200,000 for a mortgage with a 4% APR on a 30 year term. You have $1000 each month with which you pay your mortgage minimum payment, and with the remainder you can either invest at an average yearly return of 7%, or use to pay off your mortgage faster. After 30 years, either way you will have your mortgage paid off, however, if you paid it off more quickly, and then invested all of the extra money afterwards, you’d have an investment balance of $31,681. If instead, you invested the extra money, making only the minimum payments, you’d end up with $55,426. So by investing early, you end up with $23,745 more than by paying off your mortgage faster.

Additionally, money you invest is more liquid than money that goes towards debt. Even though this strategy may seem controversial, it may be in your best interest. If you’re new to investing and aren’t confident that you can get a good enough return, don’t risk it. You should always consider your personal situation before adopting a financial plan from someone else.

How about you, are you underwater or floating? What’s your take on paying off debt early or investing extra capital?

Anyone who’s played an MMO knows how important titles are. Having a specific title for a character’s achievement shows what you’ve accomplished, and other players will recognize that as a sign of your quality as a player. Dividend stocks have titles of their own. There is a hierarchy of 3 levels to show the achievements of a dividend stock.

A “Dividend Achiever” has raised its dividend for 10 consecutive years. A “Dividend Aristocrat” has raised its dividend each year for 25 years. Finally, the most prestigious of dividend titles, a “Dividend King” has risen its dividend for 50 consecutive years. This title is as epic as it sounds, fifty years is a really long time and crosses through a couple of recessions. A company that has maintained this kind of record is going to try pretty hard not to break the streak.

Now, just because a dividend stock has earned one of these titles, it does not mean that it is a must buy. There are still factors to take into consideration regarding its valuation. For instance, stocks of this caliber may be overvalued in the current market, and you should wait to make your purchase. Usually, checking the P/E Ratio can help you determine this. A P/E ratio over 20 means the stock may be overvalued. Another risk factor to consider is the payout ratio. A payout ratio higher than 60% means the company may not be able to afford to keep raising its dividend.

Think of it this way, if you were to pay a player with a nice title to join your party for a dungeon. The dungeon might go easier, but if the the cost is too high, you might end up worse off after the dungeon than before you started. Personally, I try to buy stocks on these lists because it’s a good sign that the dividend will continue to increase. However, if a dividend achiever has a more attractive yield, P/E ratio, and payout ratio than a dividend king, I will buy the achiever.

How about you, do these titles impress you?