Dividend Increases in January

Several Dividend Aristocrats have increased their dividends in January. The companies are:
New Old Change
AFLAC Inc – Ticker AFL 0.96 0.82 17.07%
Comerica Inc – Ticker CMA 2.64 2.56 3.13%
Consolidated Edison – Ticker ED 2.34 2.32 0.86%
Family Dollar Stores– Ticker FDO 0.50 0.46 8.70%
McGraw-Hill Companies– Ticker MHP 0.88 0.82 7.32%

From this list, the only company that fits my fundamental criteria is MHP, which has a one year dividend growth rate of 7.32%. In terms of changes within the index I expect that SNV might be removed from the dividend aristocrats list. The reason is that its shareholders have received shares in TSYS, which was completely spun off from Synovus in the transaction at the beginning of 2008. On paper the dividend will be cut, but in reality this reflects a spin off and I guess the dividend aristocrats committee does not take into consideration the cash that stockholders received. I believe that SNV would keep increasing its dividends over time. The same thing happened with Altria group after the spin-off of KFT. Even though the dividend fell from 0.82 to 0.69, it’s crawling back up at the time of this writing and would soon exceed the pre-spin-off levels.

Expected dividend increases in February

Based off historical information from this spreadsheet, I would expect that the following companies increase their dividend in February: MMM ABT ADM CINF KO KMB NUE PBI SHW SIAL WWY. Those dividend aristocrats have increased their dividends during every month of February over the past 4 years. Upon a closer examination of the dividend growth behavior of the 60 dividend aristocrats, it seems that every month there is at least one company that raises its dividend. It’s nice to get a pay raise every month. The only company that has increased its dividend twice in one year is STT- State Street.

A comparison of investing in high-yield, low dividend growth stock versus investing in a low-yield, high dividend growth stock without capital gains

I was asked before about the reasoning behind my statement that I would buy a stock whose dividend is increasing even by one percentage point per year, if it has a high yield, rather than invest in stocks which increase their dividend payment by at least 10% per year. To answer this question, lets me walk you through my calculations:

Let’s say that you have 2 stocks- A and B in each of which we invest $100,000. We assume that both stocks will always trade at $10 for simplicity sake. Stock A is yielding 5% per year (50 cents per share), while Stock B is yielding 2% (20 cents per share). The dividend growth in Stock A is a meager 1%, while Stock B’s dividend is growing at 5% annually. We will look at two outputs – total return and changes in annual income. It would take stock B 24 years to reach the same annual income level as stock A. In addition, it would take stock B around 40 years to achieve the same total dollar return as stock A. If however we had a growth stock C, which was yielding .5 % at the start of the experiment, and whose dividend was growing at 10% annually, it would take the annual income around 27 years to reach Stock A’s dividend income. It would also take around 42 years for the total dollar return of Stock C to reach the total dollar return of Stock A. I have also included a $100,000 investment in bonds, which yield 6% every year.

The return from the invested capital though, would have been increasing substantially over time assuming that we didn’t reinvest our dividends back into our stocks. After 10 years the yield on cost for Stock A is 5.5%, Stock B is 3.3% and Stock C is 1.3%. After 10 more years stocks A, B and C are yielding 6.1%, 5.3% and 3.4%. An investor, who simply purchased bonds, would have been making the same 6% over and over. I am attaching my spreadsheet below. This file is for informational purposes only; I just tried to make my point that you have to not only buy a stock which has a high dividend growth rate, but also a one which has a pretty decent yield. A major limitation of this analysis was that I assumed that stocks would not realize anycapital gains over the period; that’s why the long-term results of Stocks A, B and C are almost identical to long-term results for Bonds. However it shows you that if you reinvest dividends, stocks achieve a higher compounding power than bonds.
You can see the file here or here.

Leveraged Investments

I have always been intrigued by the power of leverage. Using leverage means borrowing money to invest in something for the purpose of magnifying your profit potential.
When you are right, leverage works in your favor. When you are wrong though, leverage could result in disastrous results and bankruptcy.
An interesting leveraged instrument is SSO, which generates double the daily return of the S&P 500 through investments in stock index futures. If the S&P 500 rises by 1 %, SSO will increase by about 2%. The changes are never EXACTLY twice the rate of change for S&P 500 due to tracking errors.
I gathered daily data for S&P 500 going back to 1950. I then calculated the returns for the 58 year period for twice the daily changes in the index. I didn’t account for taxes, commissions, dividends and interest for simplicity purposes. The results are truly astonishing.
Investors who could have stomached the extra volatility from the increased exposure to the S&P 500 could have enjoyed average annual returns of almost 14.33% annually. The worst drawdown in annualreturns occurred from 1972-1974 -68.60%, and 69.50% during the 2000 - 2003 bear markets. In addition to that, investors who bought the back tested index at the end of 1999 are still underwater by 37%.Here are the results per decade:

Year $1 invested at the beginning of the decade grows to: at the end of the decade
1950's $ 11.32
1960's $ 2.13
1970's $ 1.14
1980's $ 7.77
1990's $ 14.14
2000's $ 0.78

For example if you invested $1 in the SSO at the end of 1980, your investment would have grown to $55 by the end of 2007. On the other hand, the same $1 investment in an S&P index fund would have grown to $22.50.
So how should investors incorporate leverage in their portfolios? I believe that a 5% to 10% of ones portfolio could be invested in a leveraged instrument like SSO as a long-term investment. Over time this investment should boost your profitability overall.

Why dividends?

I believe that creating a passive income stream through dividends is an achievable, intriguing and stimulating way to decrease my dependency on the salary income, which is over 95% of my income at the moment. The remaining 5% comes from interest income from CD's and my interest checking account at Schwab, credit card rewards and signing up for offers online. After doing some research, i have found that putting your money in bonds, cds and money market funds will only be enough to meet inflation and over long periods of time exceed it by a couple percentage points on average. Stocks on the other hand offer you the best possible investment opportunity out there. Over 30-35% of stocks performance over the past 50 years has been attributed to dividends; the rest comes from capital gains. If you take a look at the S&P 500 from 1957- 2005, the dividends have grown on average of 5.3% per year for the index. A $1000 investment in the S&P500 in early 1957 would have provided you with an annual dividend income of about $40. In 2005 your dividend income would have grown to $610, assuming that you spent all your income. Furthermore your investment would have been worth over $32,000 by the end of 2007. With inflation assumed to be averaging around 3 - 4% per year, your investment in dividend paying stocks would provide you with an income that keeps its purchasing power year over year, which unlike fixed income securities, can also provide you with capital gains.
My strategy involves saving around half of my paycheck and investing it in the dividend achievers and high yield dividend achievers that show consistent increases in dividends over time and the ability to cover those dividends in the future. I will have my screening method and my goals for passive income on my next posts. I would also try to describe my current net worth, and how it is invested. I hope that this blog will serve as an inspiration for people and that it would change their financial lives for the better.