US Dividend Growth Stock for Retirement Account – Sept 2013

I’m looking for US dividend growth stocks to add to my RRSP. I expect to hold for the long term with a 5-year outlook. Since I plan to place it in my retirement account, this company must be of high quality, and it should help diversify my current portfolio by stock or sector. I must be comfortable holding this stock, so I shouldn’t be buying this stock because a respectable investor is buying it. Because I’m more comfortable diversifying my holdings, it’s unlikely I’ll be able to automatically reinvest my dividends, which means high growth of yield is preferred so that yield on cost increases at a faster rate.

US High Dividend Stocks in the RRSP

As I understand, US dividends received in the Canadian RRSP account will not have a withholding tax. However, the tax issue is more complicated for US REITs and MLPs. There is still at least 15% withholding tax for US REITs. Generally, for US dividend stocks which aren’t REITs or MLPs, it makes more sense to hold these foreign high yielders in the RRSP, so that you’re deferring the tax for your investments until retirement. As a result, you can compound the returns of your investments.

Foreign Exchange Rate is a Big Deal

I started my investing hobby in my Tax-Free Savings Account and my non-registered (taxable) account when the exchange rate between the Canadian Dollar (CDN) and the US Dollar (USD) was around parity. If I had known about the tax withholding on the US dividends, I would have bought my high dividend US companies in the RRSP instead. Anyway, on Friday August 31st, 2013, from the bank I use as my investing platform, the foreign exchange is $1.072 CDN for $1 USD for any transactions under $5000. That is, the US stocks are actually 7.2% costlier than the price shown on the stock exchange! As a result, to determine which stock to buy, I had to calculate the expected total return from the price of the security AFTER I applied the exchange rate.

Doing a Total Return Overview of Possible Buys

To determine a possible buy, I looked at a list of US dividend payers. Many of these are considered blue chips. I picked a price that occurred on August 31, 2013 for each stock. I applied the exchange rate of 1.072 to calculate the actual cost of 1 share. Then, I checked Morningstar for the companies’ fair value to see if there are discounts on the companies or not. After that, I used the FAST Graphs to look at the historical normalized P/E, and apply a slight margin of safety whenever applicable. Then, I overlay that P/E on the FAST Graphs return estimation for the next 5 years and come to a conclusion of annualized returns. These are all estimations. However, they help me filter my list to a smaller one for possible buy opportunities.

The blue chips that came to my mind are randomly listed below. Notice that some have historically commanded a higher P/E (higher than 15). That premium indicates the company may have a sustainable moat. There were a couple of oil companies, namely Chevron (CVX) and Exxon Mobil (XOM) that I excluded from this list. This is because their price didn’t follow their historical normalized P/E closely, so there’s no good estimation of what their P/E might be 5 years from now. Thus, I couldn’t possibly come up with a fair target price estimation in 5 years.

McDonald’s annualized return graph with an overlay P/E of 17 – FAST Graphs

McDonald’s annualized return graph with an overlay P/E of 17 – FAST Graphs

This is the result of my findings. Companies on this list are General Electric (GE), Coca-Cola (KO), Pepsi (PEP), Target (TGT), Walmart (WMT), CSX, IBM, Lorillard (LO), General Dynamics (GD), Lockheed Martin (LMT), Procter & Gamble (PG), Colgate-Palmolive (CL), Microsoft (MSFT), Johnson & Johnson (JNJ), and McDonald’s (MCD).

Estimations By 2018
Ticker 1Price (USD) Price (CDN) Morningstar Fair Value Discount from Fair Value 2Yield P/E Target Price 3Annualized Return
GE $23.18 $25 $27 8% 3.04% 15 $39.6 9.64%
KO $38.12 $41 $45 9.7% 2.73% 19 $58 7.18%
PEP $80 $85.76 $88 2.6% 2.64% 18 $39.6 9.64%
TGT $63.3 $67.86 $64 -5.6% 2.53% 16 $120 12.08%
WMT $73 $78.26 $74 -5.7% 2.4% 16 $128.5 10.43%
CSX $24.65 $26.43 $30 13.5% 2.27% 15 $48.05 12.7%
IBM $182.5 $195.64 $208 6.3% 1.94% 14.8 $404.6 15.64%
LO $42.3 $45.35 $43 -3% 4.85% 12.6 $69.29 8.85%
GD $83.14 $89.13 $90 1% 2.51% 13.5 $118.64 5.89%
LMT $122.25 $131.05 $94 -39% 3.5% 13.5 $160.8 4.18%
PG $77.72 $83.32 $87 4.4% 2.88% 17.5 $110.1 5.73%
CL $57.6 $61.75 $57 -8.3% 2.2% 19 $81.47 5.7%
MSFT $33.4 $35.81 $35 -2.3% 2.57% 13.6 $55.85 9.3%
JNJ $86.13 $92.33 $90 -2.6% 2.86% 15 $110.25 3.61%
MCD $94.28 $101.07 $105 3.88% 3.04% 17 $146 9.14%

1 Price of August 31, 2013
2 Yield based on Cost in Canadian Dollars (column 3)
3 Annualized return from price appreciation alone

Retirees focus on Dividend Income

For do-it-yourself Canadian investors who are retirees or close to retirement, they might want to buy companies with higher yields versus a higher total return. These investors might be less worried about the total return. Instead, they care about their current income so they can pay the bills. These retirees then must be prepared for a volatile ride since prices going up and down is in the inherent nature of stocks. Sometimes this volatility does not correlate to how well the business is doing.

Younger Investors focus on Higher Dividend Growth and Total Return

As a younger investor in my late twenties, I like an acceptable current income from dividends. Before completing the list above, I was hoping to buy a US company at least yielding 3% and with at least moderate dividend growth of 6+%. However, after completing the list, I realize that it maybe more realistic to set for 2.5% starting yield. Since I have less of a focus on current income, I will focus more on the growth of the dividend and the total return. Therefore, I’ve included an annualized return column.

Consider Diversification vs. Concentration

Depending on your temperament, whether you have many years until retirement or not, you might want to concentrate your funds in certain stocks or diversify your holdings. Generally, it helps to control emotions if I had diversified my holdings. So, any big moves either up or down wouldn’t affect me as much.

I initially wanted to reinvest my dividends automatically in the RRSP as well, as it’s unlikely I’d have much money to contribute to it throughout the year. However, I realize that’s also unrealistic because I only have about $1k to invest in it each time I do so. In addition, my bank only allows synthetic dividend reinvest. This means I can only buy full shares if I turn the dividend reinvestment on. Dividends generated from $1k of shares definitely is not enough to buy a full share.

Of course, I could wait until I have more funds to invest so that I could automatically reinvest the dividends. However, my holdings wouldn’t be as diversified, and I’m not sure I’ll be very confident holding lots of shares in a few companies, especially in the case of a downturn. Further, it would take a long time for me to accumulate over $5k. Waiting for that long in cash doesn’t allow my money to work for me with the current low interest rate.

Conclusion for My Portfolio

For my portfolio, there are 3 possible companies to add.

  • CSX – I have no shares in any railroad companies, so this will further diversify my portfolio. It is currently undervalued, and the estimated total return is above the average return of 10%. Morningstar also recently marked the railroad companies with wide moat.
  • MCD – I have a small position in my taxable account. With a higher yield, and a not bad annualized return, I might add a small position in my RRSP. Though, this company shows as fully valued in FAST Graphs.
  • TGT – One could argue Target is at fair value or slightly overvalued for a Canadian. However, if one expects it to grow its dividends in the double digits as it has in the past 10 years, then it maybe a good investment in the retirement account.

I do not know what you hold in your portfolio, and I don’t know your goals. So feel free to use my above analysis/estimations to help make your own decisions in what fits into your portfolio.

Beware

  1. I didn’t take into account the 2018 target price AFTER currency exchange, since there’s no way of knowing the foreign exchange rate of the future.
  2. There’s currency risk in the US dividends I receive. The US dividends I receive from the RRSP account will automatically be converted to Canadian dollars. The conversion could work for or against me. However, in the long-run, the effect is averaged out if you’re thinking in terms of receiving dividends every quarter for the next 40 years for example.
  3. The annualized return column in the table does not include the return of the dividends, as I haven’t quite figured out how to apply that to the return. If I expect about 3% dividend from McDonald’s every year, is it as simple as adding 3% to the estimated 9.14% return?

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Disclosure: At the time of writing, I am long KO, TGT, IBM, MSFT, MCD, and CVX.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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