Look for Safe Dividends for your Income Portfolio

Summary

  • low payout ratio does not suggest lots of room for dividend growth
  • companies with wide economic moats are more likely to continue to grow dividends
  • companies with strong balance sheet strength are more likely to continue to grow dividends

Low Payout Ratio does not suggest there’s plenty of room for Dividend Growth

The payout ratio is the amount of earnings paid out in dividends to shareholders. Just because a company has a low payout ratio does not imply that it will continue growing its dividends. Businesses in stable industries tend to have higher payout ratios. For example, it is normal for industries like consumer staples, tobacco, and utilities to have relatively higher payout ratios of 60-70%. Companies such as Coca-cola (NYSE:KO), Philip Morris (NYSE:PM), and Wisconsin Energy Corporation (NYSE:WEC) come to my mind. On the other hand, if a company had higher earnings variability, it would need a higher cushion for the dividend in periods when the company’s profitability is challenged. That is, such a company would have a lower payout ratio. Thus, the payout ratio is just one of the metrics which help determine if the dividend is safe and has potential to grow.

A good way to tell if a company is meant to have a low payout ratio or not is to simply compare its payout ratio to its peers’ payout ratio. Since they’re in the same industry, they’d want to have a similar amount of cushion for their dividends. For instance, Ross Stores (NASDAQ:ROST) and TJX Companies (NYSE:TJX) are both in the cyclical business of apparel retails. Ross has a payout ratio of 16.5, while TJX’s is 13.7. If both companies decide to keep the payout ratio in the teens, the only way they can grow the dividend is to rely on earnings growth. So, estimating the earnings growth of a company becomes a good exercise to help determine the safety of a company’s dividend and its growth.

Of course, a company can choose to grow its dividend at a faster rate than its earnings growth. In this respect, other than with the “help” of earnings growth, the company must raise its payout ratio. An example that I noticed is Qualcomm (NASDAQ:QCOM). It recently grew its dividend by 20% from an annual payout of $1.40 to $1.68, while this year its earnings growth estimation is around 15%.

Companies With Wide Economic Moats are Likely to Continue to Grow Dividends

Companies with economic moats have one or more competitive advantages over peers, and that a wider economic moat protects dividends over long periods of time. Matthew Coffina, from Morningstar, talks about Building a Moat in your Portfolio (pdf link to his slides) from March’s Individual Investor Conference. He lists the 5 sources of a moat:

  • Network Effect – the value of a company’s service increases as more people use it
  • Intangible Assets – patents, brands or regulatory licenses which protect excess returns
  • Cost Advantage – economies of scale, access to a unique asset
  • Switching Costs – it’s too expensive for customers to stop using a product
  • Efficient Scale – a niche market is effectively served by one or a small handful of firms

A company with a wide moat has multiple competitive advantages over its competitors. For example, I think that Coca-Cola’s moat comes from having intangible assets, cost advantage, and possibly efficient scale, as Coca-Cola is a world-renowned brand, and selling its products in more than 200 countries through its distribution system, and the only other big player is Pepsi (NYSE:PEP).

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Oversold or Overbought? Relative Strength Indicator Examples

When to Use the Relative Strength Indicator?

In my book, fundamental analysis always trumps over technical analysis. That said, using both hand-in-hand is useful. After deciding that I like a company’s fundamentals, and that it can be bought at proper valuations, I like using technical analysis to help determine whether it is a good time to buy. Looking at the relative strength indicator or the RSI is a simple way to tell whether a stock is currently overbought or oversold. Investopedia defines RSI as “A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.” When the RSI reaches 30 or under, the stock is considered oversold. When the RSI reaches 70, the stock is considered overbought.

RSI Example with Bed, Bath & Beyond

Just because the stock price reaches RSI 30, it could still keep going down. At the top of the Bed, Bath & Beyond (NYSE:BBBY) daily chart below, we see the RSI, indicating oversold for as long as month!

Bed, Bath & Beyond Daily Chart

Source: Stockcharts.com

RSI Example with Union Pacific

On the contrary, a fundamentally strong company might seldom hit the RSI 30 area. Even when Union Pacific (NYSE:UNP) hit RSI 70 (became overbought), the price didn’t go down much, and only traded sideways for awhile. The sideways trading led the RSI to get back to 50, before the price went higher again.

Union Pacific Weekly Chart

Source: Stockcharts.com


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Dividend Stocks to Buy: February 2014 Watchlist

With the recent dip in the market, it is time to shop for some blue chip companies for good yields and growing income.

For this month, I came up with these dividend payers.

Blue Chip Dividend Stocks

These are companies which have grown their dividends for over 15 years. Most generate revenue from different parts of the world.

  • Chevron (NYSE:CVX) – yield: 3.57% (next expected dividend raise: Q2 2014)
  • Coca-Cola (NYSE:KO) – yield: 2.95% (next expected dividend raise: Q1 2014)
  • International Business Machines (NYSE:IBM) – yield: 2.14% (next expected dividend raise: Q2 2014)
  • Procter & Gamble (NYSE:PG) – yield: 3.11% (next expected dividend raise: Q2 2014)

Chevron

Chevron logoChevron is a big oil company, which pays an attractive dividend of over 3.5%, higher than its 5-year average of 3.3%. It’s paying out 31% of its earnings for its dividends, indicating there’s room for it to grow. Furthermore, Morningstar gives it 4-stars, meaning the shares are currently undervalued. I usually try to get some Chevron starting at the 3.5% yield, and that’s what I did recently. Furthermore, if history is telling, then, having raised dividends for 26 years in a row, CVX will be increasing its dividend in Q2 of 2014, which is very soon!

Coca-cola

Coca-cola logoCoca-cola should be a familiar brand name for all who lives in a first world country. It sells non-alcoholic beverages via its wide-reaching global distribution system to over 200 countries. Its recent 10% acquisition of Green Mountain Coffee Roasters, and long-term relationship with the company will help add a kicker to Coca-cola’s growth. It is now selling at 18% discount according to Morningstar. Value Line projects KO’s price to be in the range of $50 to $60 by 2016-18. That is an upside of 31.8% to 58%, while starting with a yield over 3%, as Coca-cola is expected to raise its dividends in Q1 2014. See Value Line’s full report on KO (pdf).
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Get Your Credit Card to Work for You

When using a credit card, it can feel you aren’t using real money, and as a result you might spend more than you intended to. So, some people opt out of using credit cards altogether. However, the more important thing is to stay in control of your spending. Distinguish between needs and wants and never spend more than you earn. This way, you would never run out of money, and be able to save some and invest some.

If you will only use your credit cards to buy what you need most of the time and occasionally buy a Starbucks coffee, you should be fine. Just remember to pay in full every month. This way, you don’t lose out on the interests. I don’t know about you, but my credit card charges 21% on the interest! The market returns an average of just 10% a year.

If you’re afraid you’ll miss the payment to your credit card, you can set up an auto-payment to ensure your bill is paid automatically from your chequing account.

Using credit cards help in building your credit history. If you have a good solid history, it’ll be easier and may get better rates when you do need to get a loan (perhaps a mortgage?). You shouldn’t apply for tonnes of credit cards either. Only apply one when you need one.

Factors which Influence your Credit Score

  • payment history: 35%
  • amount of outstanding debt: 30%
  • length of credit history: 15%
  • new credit: 10%
  • types of credit used: 10%

Credit Score Rating Scale

300-559 560-659 660-724 745-759 760-900
Poor Fair Good Very good Excellent

Reference: local metro paper – 2013 issue

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Sold some Rogers Communications Shares to Add to 2 Core Holdings

Last week, I sold most of my shares in Rogers Communications (TSE:RCI.B) to add to my Enbridge (NYSE:ENB) and Union Pacific (NYSE:UNP). I sold Rogers at a little over breakeven. This reduces my exposure to the Canadian telecom sector which the Canadian government has obvious interest in increasing competition in. I’m still holding positions in all 3 telecoms: Rogers Communications, BCE (TSE:BCE), and Telus (TSE:T), with my biggest position in Telus. This sector makes up about 6.4% of my portfolio, and I’m comfortable with that. If the sector drops again, I will probably add to my Telus position because it is the most dividend investor friendly as I’ve mentioned in my previous article, Identifying Core Holdings in my Whistler Income Portfolio.

Why I Chose to Add to Enbridge

Adding shares in Enbridge helps diversify my portfolio and dividend income from the Oil and Gas Industry. My only other core holding in this industry is Chevron (NYSE:CVX).

Here are some other reasons to support my choice of adding to Enbridge:

1) Financially Strong with a S&P rating of A-

2) Good Dividend Yield and Dividend Growth

Enbridge’s yield of 3.1% is higher than 2.8% (1.5x the SPY’s yield of 1.87%).

Enbridge’s dividend yield and its growth pass the Chowder Rule, which states adding yield to dividend growth rate [DGR] is expected to be 12% or higher. 3.1 + 13.8 = 16.9%

yield: 3.1% (at $41.45 per share)

3-year DGR: 14%

5-year DGR: 13.8%

3) Valuation

Morningstar.com gives Enbridge 4 stars, indicating it’s undervalued, and gives it a fair value estimation of $53. That is a 14% discount if you’re buying on the Toronto Stock Exchange with Jan 29, 2014 closing price of $46.35. That is a 27% discount if you’re buying on the New York Stock Exchange with Jan 29, 2014 closing price of $41.45.

However, Value Line doesn’t expect Enbridge to have much upside for the next 2 years. It estimates Enbridge to return 1-3% annually for the 2016 – 2018 projection. For further insight, you maybe able to visit your local library to access the December 6, 2013 Value Line report.

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Identifying Core Holdings in my Whistler Income and Growth Portfolio: Reflection on Seeking Alpha article commentary

Finally, I made my income and growth portfolio public (on the Seeking Alpha website). To do this in an easy to understand manner for myself, I decided to label my holdings as core, non-core, and speculative. I thought my core holdings would make up a big part of my portfolio, but instead, it was only 63%. To add to that, currently, 13% is in the Canadian banks (Royal Bank, and Scotiabank), and 11% is in Canadian telecoms (Bell, Telus, and Rogers).

Here’s a glimpse of my core holdings:
income and growth portfolio core holdings

Other than identifying the core holdings in my portfolio, I also decided to label them for income, for growth, or for both. This helps me in determining whether I’m buying a stock for capital gain or income. If it’s one for income, then, I shouldn’t be selling the stock as long as the income keeps coming, better yet, to keep growing by way of annual dividend increases of course. If a holding is for growth, then, my intention was to sell for a capital gain eventually. These growth holdings may also pay a dividend while I wait. However, I hope to continue holding my core holdings for as long as fundamentals stay strong. I just need to focus on buying at the right valuation.

I hope in identifying my cores and non-cores that I will trade less. I notice in Q4 2013, I traded 29 times. That is $290. And that eats into my returns.

The commentary that followed in my article was very informative for me as a Canadian indeed. Some suggested Canadian stocks I could look at (other than the common big 5 banks and the 3 big telecoms). Suggestions include some Canadian REITs. To my surprise, I also learned that some Canadians are holding US REITs in their RRSP account and there’s NO WITHHOLDING TAX on the distributions. Those US REITs include MPW, OHI, ARCP, and O. Further, Kinder Morgan (NYSE:KMI), if held in the RRSP is also mentioned to have no withholding tax on the distribution.

Someone pointed out that I maybe over-diversifying by holding the 3 telecoms. With possible competition entering the Canadian telecom market, I might as well be holding 3 Canadian banks instead of 3 telecoms. I think what I’ll do is to see how much the dividend is raised in Q1 2014 for Rogers, and decide from there, as Rogers is my biggest holding out of the 3 telecoms. I might just switch out of (at least some) Rogers for more Telus shares. I was just looking at the 3 telecoms’ dividend policies, and Telus seems to be the most dividend-friendly. It already has is dividend dates laid out for 2014 and it expects to have the semi-annual dividend increases until 2016, with intended 10% annual increases. (The above given the board approves at the time.)

In my opinion, the most intelligent comment I made in the whole comment stream, was
“I wish I were more defensive from day 1 [of investing]. Preservation of capital is the utmost important. And then, comes to maintaining purchasing power. Third would be thinking about income and growth.”
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Canadian Stocks Long Ideas – December 2013

The US Dollar has been rising and rising against the Canadian. So, I’ve been looking to buy some Canadian stocks instead, although the following 2 stocks are also available for purchase on the NYSE.

Silver Wheaton

TSE:SLW $21.37 | Yield: 1.78% | Morningstar fair value estimate: $33

Silver Wheaton (SLW) signs long-term purchase agreements with mining companies. So, it is able to buy silver at the fixed cost outlined in the agreements, without having to worry about the cost and risk of running mines. Its earnings per share has still continued to increase even though the price of silver (SLV) has fallen 35% year-to-date. That’s because it has signed more agreements. Its revenue mainly comes from the sale of silver, although they sell some gold as well. Both precious metals are at their 3-year low. Analysts estimate the next 5-years of earnings growth is 20% for SLW. The demand for silver mostly comes from industrial usage, jewelry creation, and coin creation, totally accounting for 72% of demand. Other areas of demand include government purchases, producer de-hedging, and investment. If you believe the demand of silver will increase, and thus, believe its price will increase, now maybe a good time to start a position as it is bouncing off its 400-day moving average. Morningstar has a fair value estimate of $33. That is a margin of safety of 54%. Silver Wheaton serves as a capital gains play in my portfolio. I buy small positions at a time, and may sell slots of positions at resistance levels.

Enbridge

TSE:ENB $43.26 | Yield: 3.24% | Morningstar fair value estimate: $54

Enbridge (ENB) transports and distributes energy across Canada and the United States. It operates a crude oil and liquids transportation system. It just increased its payout by 11% (from $0.315 to $0.35 per quarter) which is inline with its recent year increases between 10 and 15%. Morningstar has a fair value estimate of $54. That’s a margin of safety of 24.8%. I believe there will be higher demand for energy in the future, and thus, I plan on holding Enbridge for the long-term for dividend and capital growth. I believe it’s a good buy around the $45 area.

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Dividend Stocks to Buy: November 2013 Watchlist

The October Dividend Watchlist consisted of the following dividend growth companies: Wal-Mart (NYSE:WMT), Target (NYSE: TGT), Exxon Mobil (NYSE:XOM), and Coca-cola (NYSE: KO). They are still at good value according to Morningstar.com although they have gone up a little in price since last month.

For this month, I came up with these dividend payers.

  • McDonald’s (NYSE:MCD) – $97.41
  • Microsoft (NASDAQ: MSFT) – $36.64
  • International Business Machines (NYSE:IBM) – $177.85
  • Baxter International (NYSE: BAX) – $65.13

McDonald’s

McDonald’s has over 34,000 restaurants around the globe in 118 countries. McDonald’s serves 69 million people everyday! It currently pays a yield of 3.3% which is slightly higher than its 5-yr average yield of 3.2%. Further more, Morningstar gives it 4-stars, meaning the shares are currently undervalued. I usually try to get some McDonald’s close to the 3.5% yield.

Microsoft

Although Microsoft had a recent run-up in price, its yield of 3.06% is still much higher than its 5-year average yield of 2.4%. This is partly due to its impressive dividend growth in recent years. Its 3-yr dividend growth is 21% while its 5-yr dividend growth is 16%. That said, its dividend payout ratio is still only at 34%, so there’s still room to grow that dividend. Though, we’ll have to wait a year because Microsoft already recently increased its dividend from $0.23 per share to $0.28 per share. The dividend is paid out quarterly. Any pullback in Microsoft can be seen as an opportunity to scoop up some shares.

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Replace A Loser With A Dividend Growth Blue Chip

I made the mistake of buying Teck Resources (TSE:TCK.B) as one of my first investing experience. The mistake is 2 folds. First, Teck Resources has volatile earnings, as the company’s earning’s power is determined by economic demands and the price of the basic materials. Second, I did not know about valuations at the time. Understanding valuations is one of the fundamental ideas of value investing. In my opinion, value investing combined with dividend growth investing leads to success. Holding a company which pays a growing dividends also helps with controlling emotions.

I managed to sell out on my Teck position on one of its “up” days. Still, I posted a 30% loss. To add to the pain, the transactions occurred in my Tax-Free Savings Account. So, I’m unable to report a capital loss to offset some of my taxes. I remember I bought Teck in the TFSA because I intended for it to be a capital gains play. Obviously, that didn’t happen. Do all your initial investing experiments in the taxable account (so you could report a capital loss if the worst happens). After you’ve done “enough” learning, then, invest properly in your TFSA and RRSP.

On the same day that I sold my Teck position, I used some of the capital to buy International Business Machines (IBM), and the rest to buy Union Pacific (UNP). Yes, I bought US positions in my Canadian currency TFSA. Generally, there’s a 15% withholding tax on US companies. Because these companies have low yields, the 15% deduction is not that painful. However, if I bought them in my taxable account, I would be paying my marginal tax rate on those dividends, which is higher than the 15%. Of course, I could have bought these shares in my RRSP so that I don’t get the tax withholding. (There’s a tax treaty between the United States and Canada.) Thinking deeper though, it makes more sense to hold higher yielding US companies in my RRSP. Generally, I try to buy high quality companies with yields closer to 3% (or higher) in there.

To read further about my decision of selling Teck Resources and buying some shares in IBM and UNP, please visit my Seeking Alpha article.

Disclosure: I am long IBM and UNP at the time of writing.

Disclaimer: I am not a certified financial adviser. This article expresses my own opinions, and doesn't constitute as financial advise. Please use this article as initial research, and perform due diligence before making any investment decisions.

Dividend Stocks to Buy: October 2013 Watchlist

There has been a small market pullback of ~5% since mid-September. From my watchlist, and picked out some dividend growth companies that are worth further investigation. Of course, you as your own portfolio manager should determine whether these companies are a right fit to your portfolio based on diversification and allocation needs.

I have shortlisted my watchlist for the month of October. This list is for do-it-yourself investors who are looking for income growth and steady price appreciation for their long-term portfolio. Here is the shortlist:

  • Wal-Mart (NYSE:WMT) – $72.9
  • Target (NYSE: TGT) – $62.13
  • Exxon Mobil (NYSE:XOM) – $85.51
  • Coca-cola (NYSE: KO) – $37.28
  • International Business Machines (NYSE:IBM) – $178.72
  • Qualcomm (NYSE: QCOM) – $66.35

Exxon Mobil and Coca-cola are repeats from my August Watchlist. In fact, they have gotten cheaper! Realty Income (O) was removed from this list although its price remained essentially the same. It is because I believe 15% of the distribution is still withheld for REITs for a Canadian even if the REIT stock shares were bought in the retirement account. In addition, there are many other companies which grow their dividend faster than Realty Income. That said, Realty Income gives a high yield for US investors, so it may serve the purpose of immediate income. Also, because it pays its dividend monthly, it may serve well for a long-term portfolio by reinvesting its dividends automatically. I also took out Yamana Gold as this month’s list focuses on dividend growth payers. (I still hold my shares of Yamana Gold.)

Wal-Mart and Target

Both Wal-Mart and Target are mega-stores which have been paying a growing dividend for over 38 years! I like both companies, although Wal-Mart has a higher S&P rating, and has more stable earnings. Wal-Mart’s 5-year average dividend growth rate is 14%, while Target’s is 21%. With their current yields of 2.5+%, it’s not a bad time to buy some shares.

Exxon Mobil

With its yield close to 3%, it isn’t a bad time to initiate a position in this blue chip. For the long-term, I think Exxon Mobil is a good investment.

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