Are you looking for income to complement your job’s income? Do you have money and time to spare? If you answered “yes” to both questions, you should consider dividend investing.
When you invest in dividend stocks, you can boost your income. However, there are several things you should keep in mind: quality, value, growth, time, and the intention to hold for the long term.
Intention to hold for the long term
I deliberately didn’t say “long-term investment horizon” because some investors have a long-term investment horizon but trade in and out of stocks.
I’m not saying investors shouldn’t do that but perhaps for specific stocks, they should think twice or thrice before they part with them.
Specifically, quality companies that become profitable over time should be held for a long time to maximize your wealth.
Think about Warren Buffett’s yield on cost on Coca-Cola (NYSE:KO). He bought the shares in 1988. His cost basis is now US$3.25 per share, and his yield on cost has grown to 43%!
Since Coca-Cola pays out a quarterly dividend of $0.35 per share, it means Mr. Buffett gets a return of almost 10.8% of his original investment back every quarter. His investment has paid back itself many times over by now!
Comparatively, if you bought Coca-Cola shares at the start of 2016 at US$43 per share, your yield on cost would be almost 3.26% ($0.35 * 4 / $43 ).
What makes a quality company? It should provide a needed product or service.
Coca-Cola’s slogan is “refreshing the world, one story at a time”. It surely does that by offering non-alcoholic beverages including juices, teas, water beverages, coffee drinks, carbonated soft drinks, sports drinks, etc. If people don’t drink, they’ll die of thirst.
Of course, one can argue that people don’t have to drink Coca-Cola products. This brings out the second point. Coca-Cola’s brand is an intangible asset. Its umbrella of brands is trustworthy worldwide, including Coca-Cola, Diet Coke, Sprite Fanta, Minute Maid, Dasani, Powerade, etc.
Coca-Cola also has other competitive advantages such as a strong distribution network. As well, being a top beverage manufacturer, Coca-Cola can save costs by an increased level of production.
Coca-Cola is also a dividend champion. It has increased its dividend for 54 consecutive years! It last increased it in the first quarter at a rate of 6%, which is lower than its three-, five-, and 10-year dividend growth rates of 9%, 8.4, and 9%, respectively.
Slower growth is a concern.
With slower expected growth from lower sales from soft drinks as consumers become more health conscious, consensus analyst estimates Coca-Cola to grow its earnings per share (EPS) by about 5% in the next three to five years, and its EPS is expected to decline 3% in the fiscal year 2016.
That said, a 5% medium-term growth is still phenomenal for Coca-Cola’s size. It has a market cap of $195 billion!
However, at the same time growth slows, Coca-Cola will also have to slow down its dividend growth.
Coca-Cola’s payout ratio based on its 2015’s EPS is 70%, which is the highest it has ever been in the last 18 years. This is further evidence that Coca-Cola’s dividend growth is likely to be slower in the next few years compared to the last decade.
Your investment grows as time passes (because businesses take time to create value and generate growing profits.
At the same time, as a stock investor, investors should devote time to understand and keep up-to-date with the businesses they own.
Portfolio management also takes time. For example, you might set a rule for your stock portfolio to allocate as much as 25% to any sector or to allocate 20% to growth-oriented stocks and 80% to income-focus stocks.
If investors buy shares when they’re expensive, they’ll be reducing their income and total returns. So, investors should try to never overpay for any company, even the best ones.
However, for a quality company such as Coca-Cola, a reasonable multiple might make sense.
At about US$45 per share, Coca-Cola trades at a multiple of 22.9, which is expensive based on its long-term normal multiple.
In the recent past, Coca-Cola traded at a multiple of roughly 18.3 on dips. Using that as a guideline, it’d be a reasonable multiple to pay for its shares. Using the 2015 EPS and 2016 EPS estimate, the price range is $35.50 to $36.60 per share for a starting yield of 3.82-3.94%.
If you’re looking to boost your income, consider quality dividend companies that are reasonably priced and have growing earnings.
Coca-Cola has all the above except that its shares are too expensive today. That said, its 3.1% yield is still safe if your focus is income and not total return.
In the next article, I will cover a quality dividend company you can consider as a long-term investment.
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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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