Category: Commentary

A while back I got Josh Peters’ The Ultimate Dividend Playbook: Income, Insight and Independence for Today’s Investor. It came out in 2008, and I read it just a few years ago. Here are some notes that I took on it. I am going to post them mostly verbatim.

He says to focus on cash flow more than price. Cash flow is the ultimate indicator. If a private equity firm want to take a company private, their offer price will be based on the company’s cash flow (page 31). Also: During the Great Recession, many dividend paying stocks went down in price 30% but still had cash flow and still increased their dividends.

Look into his dividend drill return model.

This book was written in 2007 or 2008. His dividend builder portfolio has a lot of bank stocks, no oil companies, and few utilities. Granted, now in 2016, oil companies do not look like such a great bet either.

He says dividends can be a signal. An article in the Motley Fool [URL not saved] points out that US firms pay consistent amounts. It may leave less to invest. True. One commenter asked why would anyone buy GM if it had a payout of 8%? Yes, a high dividend like that is a warning, and I think dividends are more likely to send a warning signal if a company pays out a consistent amount.

Intersting to note: I think all DJIA stocks pay dividends. For a long time MSFT did not.

Peters says chemical firms do not have a moat. The book has a section on the tax complexities of MLPs, and appendices on different industries.

Personally, I plan on avoiding MLPs. Kinder Morgan bought two MLPs for which it was the general partner: Kinder Morgan Energy Partners and El Paso Pipeline Partners. I think Richard Kinder helped invent MLPs. If he thinks they are no longer a good idea, who am I to argue?

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I saw an article on Yahoo Finance that I thought had some good advice, and some really bad advice.

The title of the article is “Top 3 Dividend Stocks Offering Stability to your Portfolio in 2016”.

The things the article said that I agree with are:

• to look at dividend stocks,
• a reminder that the advantage of dividends is that you can get income even while the price is flat (or even declining),
• a reminder that dividends are not guaranteed,
• and to do some research on a stock before buying.

The bad advice is to buy Frontier Communications Corporation (FTR) because its yield is 9.6%. A yield that high is usually a red flag, and in this case I think it is. The author looked at price-to-book and price-to-sales. But the PE ratio and payout ratio are basically 0, because they have been losing money for about a year. FTR’s long-term debt and interest expenses went up a lot in 2015. The long-term debt seemed to double, and their interest expenses went up by about a third.

As far as FTR’s dividend, they started paying a dividend in 2004, and kept it constant 25 cents a share until 2010. Then they cut it to 18.8 cents a share. Then in 2010 they cut it again to 10 cents a share. Then in 2015 they raised it to 10.5 cents a share. So they are raising their dividend while they are losing money. How sustainable is that?

At some point, I will write a post on my dividend investment criteria. I admit, I think I am still working it out. But I think my criteria are similar to a lot of dividend growth investors (or DGI). Under these criteria, FTR would not be looked at by many DGIs.

The details are different for different investors, but the basic pattern is as follows:

1. A history of dividend increases. Some people want at least 5 years of increases. Other people want at least 10, 15, or more. The longer your time horizon, the stronger the company, but then you have fewer companies to invest in.
2. P/E Ratio (or just “P/E”). The historical P/E ratio of the US market is about 16.5. From what I have read, periods of low interest rates have higher P/E ratios, so I am willing to buy a stock with a P/E under 20. It seems like some stocks with lower P/E ratios (like Deere, Caterpillar, the big oil companies) are not looking too good these days. If a company is losing money, Yahoo Finance will list its P/E as “N/A.”
3. Dividend yield. Many investors want a company to have a yield of at least 2%. Some want at least 3%. The upper limit depends on the industry. Financial firms, utilities and telecoms have higher yields than other industries, but anything above 6% is a red flag. 9.6% is a blinking red flag that just caught fire.
4. Payout ratio. The payout ratio is the percentage of their post-expense cash a company is paying out as dividends. This threshold is also different for different people. I am willing to go as high as 75%, others want it to be under 50%. If a company is losing money, Yahoo Finance will list its payout ratio as “N/A.”

The only criteria for selling that the DGI community agrees on is to sell if a company cuts or eliminates its dividend. Dividend freezes is a point of disagreement. Also, some DGIs sell if a stock’s P/E gets too high.

So maybe FTR has a high dividend. But how long can it last if the company is losing money and is taking on debt? I plan on holding my stocks for the rest of my life and eventually living off the dividends and not selling any shares. That will probably not happen with all of the stocks I own, but there is no way I see it happening with FTR any time in the near future.

The author does recommend Bank of Montreal, which looks a lot more solid. He used a proprietary screening tool to pick these stocks. FTR is such a bad pick I did not bother to look at the third.

Not to brag, but when I started, all I did was spend a little time looking at the financial stocks for all of the then-Dividend Arisocrats on Yahoo Finance. I passed on a couple of stocks that wound up cutting their dividends (Diebold, and Integrys, which is now being bought by Wisconsin Energy).

I think people would be better off learning how to value companies themselves and sticking to dividend growth stocks.

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I am thinking about shifting the investments in my taxable account from individual stocks to dividend ETFs.

The original plan for this account was to buy enough shares in individual stocks such that each dividend payout would be enough to buy an entire share. I needed to have enough to get a better commission rate, and I wanted to have some diversification. That meant I could only get about a dozen stocks, and spend $5,000 or so on each. There are not many stocks that fit the criteria.

There are some disadvantages to using dividend ETFs. There might be some overlap in my holdings. They only rebalance a few times a year, so they might hold a stock after it cuts its dividend. They are passive, so they will not sell a stock even though there are signs the dividend might be cut. They might also invest in stocks that I would not touch with a ten-foot pole. One of the ETFs I am looking at has shares in IBM. It’s only about 2% of the stock, but as far as I am concerned, anything more than no IBM is too much. Whenever I read an article stating that buybacks are bad (which they are) and profiling companies that make all or most of their money from financial engineering versus their nominal function, IBM is usually mentioned. It used to mean “International Business Machines”. Now it seems to mean “Incompetent Banking Manipulation”.

There are disadvantages for me for making this change. It would result in a lot of churning, which is bad. The point of dividend growth investing is to buy and hold for as long as possible, preferably forever. I would have to sell the stocks I bought in my taxable account, and in some cases buy the same stocks that I sold in my IRA.

There are some advantages to dividend ETFs. They can give people diversification that otherwise would be out of reach. It takes a hundred (or several hundred) shares of a stock to get a payout that will buy an entire share.

But the advantage might be to reduce long-term churn. There have been a few events that have caused me to reconsider the goal of this account. Duke is buying Piedmont Natural Gas. Norfolk Southern is fending off a merger offer from Canadian Pacific, and Berkshire Hathaway’s BNSF might look into buying another rail company. Baxter split. Verizon said it’s open to the possibility of buying Yahoo (that was a real WTHBTU? announcement). And the big deal is that Dow Chemical will merge with DuPont, and then they will split into three companies.

I want this account to be simpler. I will have to pay taxes on holdings in this account every year. If companies are buying and selling to each other, that will make my life more complicated. I am not a lawyer or an accountant, but I think that an ETF will shield me from some of that complexity.

Image from Wikipedia, assumed allowed under Fair Use. WTHBTU: What the heck brought that up?

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As I had mentioned previously, I opened a taxable brokerage account to buy more stocks.

The plan is to put in some money, and buy enough shares of each such that each dividend payment will be enough to buy an entire share. At first I thought I would buy shares of additional companies. Now I am thinking of replacing shares of companies in my tax-advantaged account as well.

Granted, if I did that, I would lose the tax advantages for those shares. But it would free up money in my retirement accounts to buy additional shares of the companies I would still own in those accounts. It has taken three years to buy an additional share of 3M. Perhaps I could finally buy more and reduce that time.

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I am thinking about re-buying shares in Deere.

They increased their dividend a few weeks ago by about 17%. It was one quarter late, but I think it still counts towards their streak.

I know I keep saying I should stick to my rules, but I am still trying to work out what my rules are. How strict should I be? I held on to Intel after they had gone 8 quarters without a dividend raise. Deere raised theirs after five quarters. They have a nice P/E ratio, and they are still making money.

Plus they are in the agriculture business. Sort of. I think along with energy that food and water will be huge issues (and huge money makers) in the next decades. I think Deere is a good way to play that. Plus they are based in Illinois.

I bought Kellogg recently. I read an article that pointed out that most things we buy at the grocery store come from a handful of companies. Kellogg is on the list. I will start looking at some other companies listed in the article: Kraft, General Mills, JM Smucker, even Pepsico (even though we are a Coke family).

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Lately I have been thinking about going with a different broker.

One reason is security. So far there have been no problems, but you can never be too careful. There have been a lot of articles about security after the discovery of the Heartbleed bug. I read a article/comment/post from someone who said the passwords for one of his financial providers was case-insensitive. Some do not allow non-alphanumeric characters for passwords. Some have low character limits.

I also found out that Scottrade has what they call FRIP, Flexible Reinvestment Program. It is sort of like a DRIP. With a DRIP, dividends from a stock are re-invested in that stock. With a FRIP, you can re-invest dividends commission-free in upto five stocks. It does not have to be the same stock that paid the dividend.

When I was looking at brokers, I did not go with Scottrade because they did not allow you to buy fractional shares. If they had the FRIP back then, I probably would have gone with Scottrade.

I am currently reinvesting all the dividends from the stocks I own back into themselves. I think with a FRIP, I could reach my goal of getting some of my stocks up to 100 shares a bit more quickly; have all the stocks feed into one, then when it gets to 100 shares, pick another. I might be buying high if the market keeps rising, but if I keep doing what I am doing I will be buying high anyway. Plus now that I am looking at the FRIP, the idea of fractional shares seems unnecessarily complicated.

The downside is that I would pay a lot in commissions to sell at my current broker, and buy at Scottrade. Another broker offered 50 free trades for new accounts, but I did not see that at Scottrade. I have read comments on other dividend sites that they might offer it if you ask. Plus I would be giving up some dividend income for a couple of weeks. We shall see.

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A few of the dividend sites that I visit (like Dividend Growth Investor  and Dividend Growth Stocks) will frequently post lists of stocks: stocks they have recently bought, stocks they are looking at, and stocks that have recently increased their dividends.

Sometimes these stocks will include companies that are master limited partnerships. An MLP is a different legal structure for a company. Unlike a corporation, its members share some liability.

My issue is that many of these sites (and lots of articles around the web) will mention MLPs without really explaining some of the differences from regular stocks. One example is here.

One of their main features is they do not pay income taxes at the company level. For this reason, they are sometimes called “pass-through entities“. They must send a certain amount of their profits to their investors. Investors buy and hold “units” instead of shares, and they get “distributions” instead of dividends. (I think some REITs are also pass-through entities.)

They tend to be in the energy industry, and have “LP” at the end of their name. A couple of the bigger, more famous ones are Kinder Morgan Energy Partners, L.P. (KMP) and Enterprise Products Partners L.P. (EPD).

Because they are taxed differently, you get a different tax form called a K-1. I have heard it is a beast to deal with.

My impression is since they are pass-through entities they should only be held in taxable accounts. You could pay tax on the MLP income even if you hold it in a Roth IRA. I think there are a lot of people in the USA for whom the $5500 they put in their Roth IRA is the entirety of their retirement savings. Right now, I am one of those people. If you want to go with an MLP, I think an ETF would be the best bet.

Dividend investors need to be aware of the different tax treatment. And some of us who have been doing this for a while need to let beginners know that there are a few gotchas with MLPs. I think most people should avoid investing in them directly and just go with an MPL ETF.

Another point about MLPs is that they tend to have higher percentage yields than most stocks. Many of them have yields above 6%. Many dividend investors would consider anything above 6% yield for a corporation to be a serious red flag if not a reason for elimination. But for MLPs it is not necessarily a cause for concern. When I was first looking into dividend investing I found this a bit confusing until I learned a bit more about MLPs. One week a writer would say I should avoid a stock with a yield of 7% since yields that high are considered a sign a company is having trouble. But then the next week the same writer would say that some other stock (an MLP in this case) was a good investment because it had a 7% yield. If you do not know the distinction between a corporation and an MLP, those mixed signals can be a bit confusing.

They also may have higher payout ratios than stocks. I have neither a degree nor any experience in accounting, but from what I have gathered MLPs track things differently. So a higher payout ratio is not a cause for concern.

Once again, I think for most people an ETF is the best way to invest in MLPs.

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I have been thinking a lot about my stock portfolio. As I stated before, I started out buying $1000 worth of shares of stocks. I quickly dropped that, and went for 50 shares of each stock, although I still have less than 50 of some of them. I am now starting to go for 100 shares of each stock, as well as getting a few more stocks. The market has been going up a lot lately, so I might wait a few more months. For a long time the best time to buy stocks for the long term was between May and October. That pattern was disrupted during the Great Recession, but I think we are getting back to it again.

I found this site called Buy Upside with some great tables on it. One is the Dividend Map: Dividend Aristocrats Annualized Dividend Growth Rates and Dividend Yields  You can find Dividend Aristocrats that have decent yields and fairly high yield growth. A few that look good to me are KMB, PG, BMS, ADP, APD, CLX, COP

There is also a concept called the Dividend Kings. It is the group of stocks that have been increasing their dividend for at least 50 years. This list seems more colloquial than the Achievers, Aristocrats or Champions. There does not seem to be one person or group that keeps track of this list. Granted, that might be unnecessary, since there are not that many stocks that meet the criteria.

There is a site called Dividend Kings, but it seems like a general investing blog. I have only glanced at it, but some of the posts mention companies that I do not see on other dividend sites. Plus it is not updated too often.

One site that has listed the Kings is Dividend Growth Investor.
Here are the stocks on the list that I have: AWR, DOV, NWN, EMR, PG, MMM, VVC, KO, JNJ, LOW
Here are the stocks on the list that I do not have: GPC, PH (low yield)
In a couple of years, there will be a couple of more socks added, both of which I own: CL, ITW

Dividend Aristocrats is a probably a trademark of S&P. Dividend Achievers is probably a trademark of Indxis. This site has a disclaimer.