Category: Valuation

To achieve my goal of investing $15,000 this year, I’ll need to invest at least $1250 each month (on average). So let’s start this year with a bang! I was able to invest $2000 for January. The 3 stocks I was considering were IBM, MMM, and WFC. So I thought I’d share with you my decision making process for this process.

First of all, These 3 companies each match my basic criteria of a solid history of dividend growth, a PE ratio under 20, a payout ratio under 60%, and a yield over 2.5%. All three are also in short term dips (or long term in the case of IBM).

Next, let’s look at past performance and dividend growth history. 10 years ago, $1000 invested in IBM would be worth $2334 today, in MMM would be worth $3288, and in WFC would be worth $2925. IBM’s dividend grew 18% last year, and on average it grows 23% per year. MMM’s dividend grew 19% last year, and on average grows 9% per year. WFC’s dividend grew 7% last year, and on average it grows 4% per year.

In terms of price growth, they each have grown an average of about 8 to 10% each year in the past. However, the price of MMM and IBM went down 7% last year, where WFC grew 4%. Price trends usually don’t affect my long term investment decisions, but it’s interesting to note the similarities.

Right now, the thing that appeals to me most is the dividend growth potential. So I went with IBM and MMM.

I bought 7 shares of IBM at $135.29 adding $36.40 to my yearly dividend income
and 7 shares of MMM at $144.35 adding $28.70 to my yearly dividend income.

This puts me at $485.94/$600.00 for my annual passive income goal for 2016, and $40.50/$100.00 for my average monthly passive income long term goal.

I’m excited to be doing some serious damage on my goals at the start of the year.

The dividend growth investor loves to see high quality businesses trading at a discount. The problem is that the “good deals” are hard to find these days. The overall market is up, real estate is recovering, and nobody seems to be flailing their arms and desperately selling their shares. Times are good, but that means opportunity is limited.

If we turn the clock back to 2011 or 2008, great deals on dividend stocks were easy to find because there was panic in the streets. Stock prices were falling, which created more panicked selling which lead to even lower prices. If you weren’t viewing stocks as dividend engines, you’d be freaking out that your portfolio was plummeting. These were huge opportunities for dividend investors to pick up some great deals.

I had not found my strategy yet when those price dips came around. So now, I’m hoping for another chance to get in on the ground floor. I’m hoping, people panic.

I can’t see the future. It’s a bummer, I know. If I could see the future, I would have bought Tesla stock back when it was valued around $35. Believe me, I considered it too, but I had no true way to value the company so I decided to avoid the risk. That may sounds stupid now since it took off like a rocket ship and is now up over 500%. However, would you buy Tesla stock now? probably not, because it seems like it’s at the top and all the growing is done, but if it goes up to $1000 per share next year, we’ll all feel dumb again.

The fear of investing in a company like Tesla at a time like now is what I call “Pinnacle Mentality.” This is the belief that prices are too high to grow any more based on past performance. In the case of Tesla, there are other risks that should also be taken into account, but it serves best as an example here. This belief is what propagates all of the market doomsayers that are always telling you that market is just about to crash.

In 2011, I watched a popular documentary-style film called Zeitgeist. After seeing that, when the country was about to hit the Fiscal Cliff (for the millionth time), I was positive that the market was going to plummet and I should sell off my stocks. The Dow did fall that year, but the Dow has also risen ~30% from it’s highest valuation in 2011, does that sound like the “End of the World?”

My point is that even though you may think prices are at their highest, it’s only ever true relative to the past. In World of Warcraft, a long time ago, when I got my Lightning Bolt to deal over 6000 damage in PVP by using a clever combination of talents and buffs, I thought that was going to be the highest damage I would manage to do. Now, after a couple expansions, a shaman’s Lightning Bolt easily can hit for over 12,000. I thought I had peaked when in reality, numbers were just going to go up in the future.

Another reason this mindset is so common is that we’ve been trained to look for “bubbles.” After hearing all of the horror stories of the “tech bubble” or the “real estate bubble,” any time it looks like a price is rising exponentially, fear kicks in. A fun way to realize that it’s all an illusion is to look at chart (preferably on Google Finance) of the S&P 500. First look at the last 10 years, notice the dip for 2008 (which had real underlying infrastructure causes), but otherwise prices look like they’re rising pretty rapidly. Then push it back to going from 1994 to 2004, you’ll see another dip, and more prices rising at a similar rate. Finally push it back to 1984 through 1994, and you’ll notice that prices always look like they’re rising really fast and there’s a minor dip in one year. Unless, you’re at the bottom of a dip, the prices are ALWAYS going to look like they’re at the top or in a bubble. Also note that the best way to protect yourself from those dips is to just not sell and Tough it Out.

Warren Buffet has said that one thing he really believes in is the ability for businesses in the United States to continue growing. Even though when we look at stock charts we see the present date as a cliff, in a couple years, it will just be a bump on the way to new heights. So, don’t let yourself be fooled by a Pinnacle Mentality, buy smart, never sell.

The red and yellow titan of fast food, McDonalds is a brand that no American is unaware of. McDonalds (MCD) is also a dividend growth stock that has been increasing its dividend payout every year for over 35 years, making it a Dividend Aristocrat. The reason they are so successful is not the quality of food, but the systems they have in place to run like a well oiled machine. You can get a better hamburger at several places I personally enjoy, but when a manager quits at those establishments, the efficiency of recovery is nowhere near what McDonalds is prepared for. Additionally, their marketing has established not only a loyal customer base, but a brand that is known the world over.

I just bought 10 shares of MCD at $95.90 per share.

Let’s talk numbers. First of all, the dividend yield is great right now at 3.38% yield on cost. Over the past 10 years, the dividend has grown about 4.4% per year. Which isn’t all that impressive, but the price has also grown by an average of 18% per year over the same time frame. This means, that despite the solid yield, they are still making use of the rest of their capital to grow the business. The payout ratio is sitting at 56%, which is under the level I consider to be too high, and given their growth, I would say there is little risk in this regard. According to Google, their PE Ratio is 17.25, which is safely below 20. If you invested $1000 in this stock 10 years ago and reinvested all dividends, you would now have about 62.67 shares worth $6013.81 paying out $195.53 dividends each year.

When you look at these numbers, it begs the question “Why wouldn’t every dividend investor want to own this company?” Well, in my opinion, they should. However, given the unhealthy nature of the majority of their menu, McDonalds can get a lot of bad press. On the moral scale, MCD comes in a little heavy, but honestly not as much as a tobacco stock or oil stock in terms of damage to people and the planet.

So the next time you see a news story float around about how unhealthy McDonalds is, check the stock price. Because you might be able to pick up an outstanding stock at a discount due to some short term price noise.

The final stock I’ll be analyzing before making my next stock investment in early February is The Coca-Cola Company (KO). I currently already have a position of KO in my personal portfolio, and it has made little headway outside of dividends since I made my entry. When I consider the history of this stock, I won’t just be talking about the past 2 years I’ve owned it.

The Coca-Cola Company has had an amazing history, with 51 years of dividend increases, it is a Dividend King.

Their dividend distributions have risen over 9% in the past year, and about 9.3% per year for the past 10 years on average. Right now, entry yield is 3.01% and they’re just about due for another dividend raise in the middle of February.

The current EPS is $1.93 putting the PE ratio at 19.26 which is just below my threshold of 20. I think this stock is set to take off over the next year, making now the ideal time to buy.

KO’s payout ratio is currently 53.6% which gives them space to increase distributions and is below my threshold of 65%.

If you invested $1000 in The Coca-Cola Company 10 years ago and reinvested all dividends, you would now have about 71.36 shares worth $2654.59 paying out $79.92 dividends each year.

The Coca-Cola Company also has a significant economic moat as the provider of both the #1 and #2 top soft drinks. Source

This concludes my analysis of stocks for this next purchase. Today Target fell into the $55 range, and it did so a little sooner than I thought it would, so I intend to stand by until after whatever damages result from their quarterly earnings report. Right now, KO is my favorite, so I’ll probably be purchasing 25 shares of KO. MSFT is my second favorite right now, so if I can swing it, I’d like to buy 13 shares of MSFT as well.

One of the Dogs of Dow this year that caught my eye is the software giant, Microsoft (MSFT). Microsoft, has its hand in everything: mobile, search advertising, video games, operating systems, office products. I’m personally not a big fan of their individual products, but that’s mostly because I was raised in an Apple household. However, Microsoft has Apple beat in dividend history. It is soon to become a Dividend Achiever.

Microsoft has been raising its dividend since 2007, and has increased its payout by an average of over 14% each year, and with a payout ratio of 36%, it shouldn’t have any trouble continuing the trend.

The entry dividend yield is pretty attractive at 3.11%, and the P/E ratio is only 13.32. So it meets all of my usual criteria for valuation. From what I can gather, it’s EPS has also grown an average of 6% each year for the past 5 years.

If you invested $1000 in this stock 10 years ago and reinvested all dividends, you would now have about 68.60 shares worth $2485.03 paying out $66.54 dividends each year.

Now, despite this writer’s opinion of Microsoft’s products, the company does have a significant share in every industry it competes in. Google is obviously the #1 search advertiser at 65%, but Microsoft’s bing takes up 30 of the remaining 35%. The xbox one had a very successful launch as they shipped 3.9 million systems last year. As more games are released, that number is surely going to skyrocket. Windows phones are not nearly as widespread as the iPhone or Android, but their share is steadily growing as well.

I would argue that Microsoft’s strength is not in the individual products, but in the company’s willingness to take chances and expand. With a brand that has been around long enough to have customers’ loyalty and trust, Microsoft will always have buyers.

You may remember from my post about Target that I was waiting for the price to drop to the mid-50’s. It’s looking like I was right on that, so my next purchase will probably be either TGT or MSFT.

What do you think? would you buy TGT or MSFT?

I’ve had some time to think about how we evaluate dividend stocks. First we’ll make some assumptions.

A healthy dividend paying company should have a payout ratio that does not exceed 60%. Which means annual dividends should not be more than 0.6 times the company’s earnings per share. According to common belief, the lower the payout ratio, the greater the potential for dividend growth.

Traditionally, if a company’s PE ratio is greater than 20, it is considered to be overvalued. So a company priced at 20 times EPS is accurately valued.

This last assumption is not up for debate since it’s just straight math. Yield percentage is equal to the annual dividends per share divided by share price.

So an average healthy dividend stock will pay a dividend of 0.6 times EPS and be priced at 20 times EPS. This works out to an average dividend yield of 3% (0.6/20). Which means for a stock to have a better yield, it either needs to be undervalued so the PE ratio is lower than 20, or have a higher payout ratio, which is not considered healthy. This is why finding bargains is so essential to dividend investors.

If you own nothing but healthy dividend stocks, the yields are all going to be roughly the same if the company’s are healthy. So what sets apart the big winners? Growth

As dividend investors, we typically search for companies with a solid history of dividend growth dating back 10 years or more, such as Dividend Achiever. The trailing dividend growth rate shows that the company will reward shareholders. But if the dividends per share were a function of the EPS, the ability to grow that EPS would be a stronger indicator of future dividend growth.

A company can most effectively grow its earnings potential through either innovation or expansion. By this, I mean releasing newer better products, building new storefronts, or selling in different markets. If a company has a lower payout ratio, it’s safe to assume it has more revenue with which to reinvest in these areas, thus growing EPS.

This is why most naysayers of dividend investing believe the strategy to be foolish, since mathematically, everything comes back to EPS. However, there is must to be said for a company that is able to payout a solid dividend yield and still grow revenue each year.

In a market where everyone with a paycheck has the potential to be an active trader, stock prices tend to auto-correct themselves for minor mistakes in valuation. For instance, if a company is overvalued by 5%, it is likely that after a month, it will be corrected at some point to its average EPS multiple. So, the only way to take advantage of massive dips in price is when a company has fallen on hard times due to a lawsuit or a bad quarter, but has the branding and strength to recover as a business. If the company looks statistically bad in the short term, but has the capability to recover and come back stronger, there is some serious growth potential there.

The company that comes to mind for me right now is Target (TGT). They have faced difficulties with their expansion into Canada as well as the recent security issues. As a result, the price has dropped over 17% from the 52 week high in July, 2013. TGT currently has a payout ratio of 46% and a PE ratio of 16.30. This results in a dividend yield of 2.83%. This is all based on an EPS of $3.73, which is almost 20% lower than 1 year ago.

Considering the PE ratio of Target was about 13-14 a year ago, I believe Target still has a little a little further to fall (probably mid-50’s). After that, the company has the brand and leadership to recover rapidly and return some substantial rewards to investors. I currently have a small position in Target (16 shares), and am looking to possibly double that, but I think it can wait another month to get a really attractive entry price.

I should also mention that Target has been growing its dividend for 46 years, making it just 4 years away from being a Dividend King. It’s dividend growth rate has been outstanding over the past 10 years, averaging over 20% annual growth. If you invested $1000 in this stock 10 years ago and reinvested all dividends, you would now have about 35.00 shares worth $2126.60 paying out $55.30 dividends each year. This is a little less impressive than Clorox, so that makes my decision even tougher.

What are your thoughts on Target?

I will be able to make a new investment at the beginning of February, so over the next few days I will be analyzing a few stocks I have my eye on for this investment. It’s important to do proper research and analysis before you commit to buying a stock. All valuation metrics will be at the time of writing, so they may no longer be entirely accurate by the time you read this.

The first of the stocks I’ve wanted to take a position in is The Clorox Co. (CLX)

The Clorox Company (Clorox) is a manufacturer and marketer of consumer and professional products. It’s products are sold by merchandisers, grocery stores, other retail outlets, distributors and medical supply providers. The company owns brands that you will most likely see in every household such as Pine-Sol cleaners, Fresh Step cat litter, Glad bags, Kingsford charcoal, Hidden Valley and K C Masterpiece dressings and sauces, Brita water filters, and even Burt’s Bees Wax. I was personally surprised to see this much variety from the company, but that kind of diversification is great to see as an investor.

Clorox has raised its dividend every year for 36 years, making it a Dividend Aristocrat. Over the past 10 years, the company has increased its dividend payment by an average of 10.94%. So in terms of growth, it meets all of my criteria.

The dividend Yield for Clorox is fantastic at 3.16%. I typically aim for at least 2%, so Clorox definitely wins here. If you had invested $1000 in CLX 10 years ago and reinvested all dividends, you would now have about 37.16 shares worth $3336.22 paying out $100.33 dividends each year. So after 10 years, the dividend yield on cost is about 10%.

Clorox’s Earnings Per Share (EPS) is $4.34. So, with an annual dividend payout of $2.84, it’s Payout Ratio is 65.4%, which is just barely over my cut off criteria. Additionally, the Price to Earnings (P/E) Ratio is 20.69. For my investments, I like to make my entry when a stock’s P/E Ratio is below 20.

While I love the dividend yield and growth for this company, I think there may be better values to find in the market. Stay tuned for the other stocks I’m looking at.

How about you? Is Clorox on your radar? What other stocks are you watching?

I decided a fun little Christmas present to myself and my wife would be an income generating asset. We by no means are living a glamorous life for middle class Americans, but at the same time, more “stuff” does not seem all that appealing. So, what better gift than a dividend paying position.

I added 14 shares of Realty Income Corp. (O) to our joint portfolio.

This investment will payout $2.52 every month. Most dividend stocks pay their dividends quarterly. However, it’s not uncommon for Real Estate Investment Trusts (or REITs) to distribute dividends monthly.

REITs can be difficult to value since you can’t follow the usual stats for a good picture of their business. A REIT essentially owns several┬árental properties, and is required to pay out over 90% of the net profit to investors. As such, it would look like the payout ratio and EPS are outrageous in terms of standard valuation. Instead you need to find the Funds From Operation (or FFO) and compare that to the price to get a more accurate representation of EPS. In the case of Realty Income Corp. It is currently at about 15.8 Price/FFO, which is an attractive entry price.

Additionally, it has a dividend yield of over 5.8% with a history of 19 years of dividend increases averaging over 4% per year. Most analysts are predicting that the growth may slow down with changes to interest rates and the FFO to dividend ratio is getting tighter. However, I am optimistic, and having shares of a REIT is like owning a tiny far more liquid rental property.

Anyways, money is going to be tight in January, so this may be the last investment I get to make for the next several weeks.

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?