World Dominating Dividend Growers
This interview is about one of the greatest income investment ideas in the world. It's the ultimate idea for the time-strapped, risk averse investor. And it can build an incredible amount of wealth over the long term.
The strategy is a favorite of our resident income expert Dan Ferris, editor of Extreme Value. We sat down with Dan to learn more about what makes this idea so valuable and the best ways to take advantage of it.
Stansberry & Associates: Dan, you're a huge proponent of buying a class of dividend paying stocks you've termed "World Dominating Dividend Growers." Can you define this idea for us... and tell us why these stocks are such a great idea?
Dan Ferris: I've coined the term "World Dominating Dividend Growers" to describe a small group of elite businesses that dominate their industries. They use their dominant positions to pay their shareholders safe and ever-increasing dividends.
The main thing that separates them from all other stocks is they're the No. 1 company in their industry... the biggest and the best. And they tend to have much better businesses than all their competitors.
A great example of this is Intel. It's got a much better business than AMD – its closest competitor. It's much, much more profitable, and its balance sheet tends to be a lot better. Their products sell a lot more. They dominate 80% of the global semiconductor market... meaning they're four times bigger than the entire rest of the industry.
They've proven their ability to deliver time and time again, more so than any other company in the industry... And consequently, they've had consistently thick profit margins and huge free cash flow generation.
Intel's dividend has also grown consistently since 2004. These are the kind of characteristics you find with a World Dominating Dividend Grower.
Another characteristic of these stocks is they don't just pay a solid dividend... they pay a solid dividend that relentlessly grows every year for years, often several decades.
S&A: What makes them such great places to put money, compared to the average dividend stock?
Ferris: They're great because they're more predictable.
By that I mean you don't have to worry too much about what a company like Wal-Mart is going to look like in five or even 10 years. You don't wonder what Procter & Gamble will be doing in 10 years. I think they'll both be bigger, and doing almost exactly what they're doing now. That predictability is really, really valuable.
It can often be very difficult to figure out the value of many stocks. The value today is technically worth all the future cash you're going to get out of the business. If you're looking at a mining company, an oil and gas company, or even an insurance company, you don't know what they're going to be charging five or 10 years from now for the product they sell... and it's largely out of their control. They can't just raise prices to keep pace with inflation when their costs rise.
On the other hand, Coca-Cola can raise the price of a soda another nickel or dime and nobody cares. Pricing power is just one aspect of the predictability, but it's a significant part of it.
It's also fairly predictable that they're going to be in excellent financial condition this year, next year, and five or 10 years from now. They're going to have great balance sheets, and they're generally going to take good care of the money they make for shareholders.
That predictability translates into less risk. Less risk is really important... much more important than trying to get a higher return.
The fact is, successful investors don't tend to be people who swing for the fences and try to make 50%, 60%, 100% a year. They're people who avoid risk over a long period of time.
S&A: What else makes World Dominators such great stocks to own?
Ferris: These stocks are also one of the greatest compounding vehicles in the world today. And compounding is the surest way to build a great deal of wealth.
The best example of compounding I've ever heard can be illustrated with a simple question: If you start with a penny and double it every day, how long until you have $1 million? Many people will guess several months... I've even heard someone say a year or two. But the answer is just 28 days.
That's an extreme example, obviously no one's going to make 100% per day, but it's a great example. The second day you only go up by one penny, then by four cents, and before you know it you pass a million bucks. That's the way compounding works. In the beginning you don't see it so much, but over time you see it a lot.
Another well-known example is Warren Buffett's position in Coca-Cola. Buffett bought Coke back in 1988, and he's now getting 50% of his purchase price back every year in dividends. He's compounding his money at an enormously high rate. Why would he ever sell an investment like that?
Imagine an investment where you get 50% of your original purchase price back every year. It's an investor's dream. And the surest, safest way to get that is to buy a World Dominating Dividend Grower at a good price and just wait. That's all it takes, but people rarely do it – most people simply don't have the patience.
Over the last 81 years, dividends accounted for about 44% of the total return of the S&P 500. As of 2011, reinvesting all dividends produced eight times the return as the S&P without dividends.
S&A: You mentioned buying these stocks at the right price... How do you determine a great price for a World Dominating Dividend Grower?
Ferris: Almost any stock can be a good investment if you get it cheap enough. But when you can get a World Dominator that's been growing dividends for 50 years cheap enough, that's one of the greatest opportunities in the investment world.
"Cheap enough" for these stocks is pretty easy to figure out. These stocks are all huge cash-gushers. In most circumstances, they have so much cash you have to assume quite a bit of it is redundant and unnecessary and should be paid out to shareholders. So you want to subtract that cash from the market capitalization. That gives you a price for the actual business.
When it comes to World Dominating Dividend Growers, any time the price for that actual business is under 15 times the company's cash flow, it's really attractive. Sometimes, you can buy them at 12 or 13 times cash flow. It's amazing.
Anytime these valuations get down to the low double-digits or even single-digits – which is absurdly cheap for these companies – you know you've got a fantastic buy.
It doesn't matter that most of these companies will never be taken over by a private company... It matters that it is earning an enormous return on shareholder equity. That's where your return comes from when you hold a stock over time.
S&A: Do you recommend a specific buying strategy or position sizing for these stocks?
Ferris: For any stock you plan to hold as an investment, legging into it over a period of weeks or even a couple months is usually smart. That's my preferred method for World Dominating Dividend Growers.
As far as position sizing – meaning what percentage of your portfolio you put into any one stock – you can safely buy a little more than you might typically. I generally suggest anywhere from 3%-5% of your assets, or even more if you're really confident and really up to speed on a company.
S&A: You've mentioned the ultimate goal with these stocks is to buy them when they're cheap, reinvest the dividends, and compound your wealth by holding for a long period of time. Under what circumstances would you sell them?
Ferris: Well, no company is perfect forever. Most companies lose their competitive advantage over time, or at least weaken and succumb to competition. Maybe bad management will take over.
There are many reasons why a company might eventually stop performing. And when I say performing, I'm talking about the business, not the stock. That's true of World Dominators, like it is for any other stock. It's relatively rare, but they're not immune.
We always assume the stock will eventually reflect the performance of the business. So if that happens, that's when you need to start thinking about selling.
Another time you might consider selling is when a stock gets expensive. When a stock gets expensive, it's delivering years of return up front. In many cases, it's wise to take it off the table. When the market says, "You don't have to wait, I'm going to pay you now," you should let it do that. That's been a hard lesson for me to learn, but in many cases I think it makes good sense and can greatly increase your returns. And you can always buy the stock back once it returns to a more reasonable valuation, assuming nothing else about the business has changed.
Of course, there's a case to be made for holding as well. Coke was trading at 88 times earnings in 2000 and Buffett never sold. Now he's making 50% a year in dividends. When you buy a great stock at a great price, you can afford to hold through ups and downs.
S&A: Great point. Thanks for talking with us, Dan.
Ferris: My pleasure.
|About S&A Investment Research||About S&A Investment Research|