Buy WDDGs and wait... Altria boosts its dividend again... How to beat inflation... Record bond issuance...
We spend a lot of time in the Digest discussing the merits of buying and holding world-class businesses that regularly increase their dividends. That's partly due to the specialty of my Digest co-editor Dan Ferris, who writes our income-focused 12% Letter... Buying these companies, which he's dubbed World Dominating Dividend Growers (WDDGs), has become a religion of sorts to him.
The other reason we spend so much time writing about these stocks is because buying and holding WDDGs is the safest and best way to get rich in the stock market. But it's boring... And most investors don't have the patience to simply buy a stock like Coca-Cola and do nothing (other than reinvest the dividends) for 20 years.
It's too bad, though. Legendary investor Warren Buffett bought Coca-Cola stock 24 years ago. And his investment pays him $100 million each quarter in dividends. Buffett says in 10 years, the annual dividends from his Coca-Cola stock will exceed what he originally paid for his position. We wrote about this phenomenon here.
Yes, Buffett is putting much more capital to work than you and I are... But we can still achieve the same investment result on a smaller scale. It simply takes careful stock selection and patience.
Take one of our favorite, dividend-paying stalwarts – Altria Group... Last Friday, the company raised its quarterly dividend from $0.41 to $0.44 – a 7.3% increase. After the dividend hike, the stock yields 5.2%.
This was Altria's 46th dividend increase in the last 43 years. The company says it aims to achieve an 80% dividend payout ratio... You calculate the payout ratio by dividing what the company spends on its dividend by earnings. Based on Altria's current earnings and $0.44 quarterly dividend, the company has a payout ratio of 74%.
To achieve its goal of an 80% payout ratio, Altria would have to boost its quarterly payout to $0.48 – a 9% increase from today (assuming earnings stay constant).
And if history is any indicator, Altria will reach its goal.
I asked Dan Ferris to comment on Altria's dividend boost. His response is below...
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Altria consistently generates higher returns than anybody expects. It has outperformed the S&P 500 every year from 2000 through 2011 (and is on track to do the same again this year). Everyone is afraid of getting into the cigarette business, because cigarette smoking is on the decline in Altria's market (the U.S.). So the stock price stays relatively cheap, and the dividend yield remains relatively high. With the new dividend hike, it's yielding more than 5%, compared with the S&P 500's yield of around 2%. |
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But it keeps making money because it owns the U.S. cigarette market like no other company. Its top brand – Marlboro – is by far the No. 1 brand in the market, with a 42% market share. Altria has about half the U.S. tobacco market when you add its other brands into the mix. |
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So... people keep smoking. And Altria keeps selling them more tobacco than any other company, making huge profits (more than $6 billion last year), and it keeps generating huge amounts of cash and paying out most of it to its shareholders in dividends. |
Altria has been in The 12% Letter's model portfolio since November 2008. Since then, subscribers have made 147% on the recommendation. That includes $6.70 in dividend payments per share. Based on an initial purchase price of $16.50, subscribers have made 40% in dividends alone. In other words, without the dividend, you'd only be up 107% on your Altria position.
Dan recommended Altria to his Extreme Value subscribers in March of that year. Accounting for the spinoff of Philip Morris International – which occurred later that month – Extreme Value subscribers are up about 92% on the total position.
You may think Altria is an extreme example... The company relentlessly raises its dividend. And it regularly outperforms the market. But it's not so extreme... In the April 3 Digest, we discussed research from Standard & Poor's showing just how important dividends are for investors:
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According to Standard & Poor's senior index analyst Howard Silverblatt, if you go back to the end of 1989, a $10,000 investment in the S&P 500 would be worth $40,154 in capital gains... and reinvested dividends would add another $24,396, for a total value of $64,550 today. So reinvested dividends made the difference between a 302% gain and a 546% gain. (Nothing like an extra 244 percentage points to get your attention.) |
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In the 1980s and 1990s, dividends went out of style. During the '90s, dividends generated less than 20% of stock market returns. When a bull market is raging, capital gains become more important and dividend yields fall. Also, the tech companies that contributed the most to the '90s-era frenzy were less inclined to pay out dividends. It was believed they'd do better by retaining capital and reinvesting in their businesses. All of that convinced investors that dividends were not important anymore. |
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But historically, dividends have been very important. Going back to 1926, dividends have provided about 41.85% of the total returns from stocks, Silverblatt reported. The pendulum has been swinging back in the direction of dividends for more than a decade now, and I expect it'll continue to do so for another decade... |
Let me reiterate... For almost the past 100 years, dividends have provided investors with nearly 42% of their total return from stocks. If that single fact isn't enough to convince you to buy WDDGs, nothing likely will... But we'll still try.
We know the current interest-rate environment and inflation are two major worries for our readers. With the federal-funds rate (the benchmark rate at which banks lend to each other) at zero percent, traditional income-producing vehicles like bank accounts and government bonds are yielding next to nothing.
And inflation is eating away at the little income these vehicles do pay you. Let's say inflation is running at 4%, but you're only earning 2% in interest. You're losing 2% a year in purchasing power. That's called a negative real rate of interest.
As Dan regularly explains to his subscribers... buying a WDDG is one way to beat inflation. The below excerpt comes from the 12% Letter update on March 28...
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If inflation destroys a 3% bond yield, why isn't it equally bad to own a 2.8% current dividend yield?" |
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The bottom line is this: Inflation is a rate of change. You can't compare current yields to inflation. You must compare rates of change. The best way to do that is to look at what happens to $1 of income from bonds and $1 of income from WDDGs when faced with inflation... |
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Consider that $1 of income you receive from a bond now will buy you $1 worth of stuff this year. But next year, after 3% inflation, that same $1 will only buy you $0.97 worth of stuff. |
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So as long as you own that bond – and inflation stays at 3% per year – your income falls in value year after year. After 10 years, your $1 of bond income will only buy you about $0.74 worth of stuff... |
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Now consider $1 of dividend income from a WDDG. The WDDG stocks we hold in The 12% Letter raised dividends at an average rate of about 11.5% over the past year. Using that dividend growth rate, you could look at it like this: Last year, they paid you $1 of income... And this year, they'll pay you $1.115 of income. But if you factor in 3% inflation, that $1.115 is only worth about $1.08 ($0.97 dollar value post inflation X $1.115 dividend payout = $1.08 in buying power). |
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After 10 years of 11.5% dividend growth and 3% inflation, $1 of WDDG income will grow in value to more than double its current level. And remember... that's adjusted for inflation. |
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So after 10 years of 3% inflation, you can wind up with $1 that's only worth $0.74 with a bond... or $1 that's more than doubled with WDDG stocks. As a long-term investment proposition, bonds don't come anywhere near WDDG stocks... |
WDDGs also produce higher-than-average returns on tangible assets without having to invest a lot of money to continue operations. These companies can generally earn excess returns without requiring excess capital. Porter calls this "capital efficiency." He wrote an essay about it here.
Capital-efficient businesses often fall into the WDDG category... These businesses have nothing better to do with their money than pay them out as dividends or buy back stock.
So you can buy a bond today and almost be guaranteed a loss due to inflation... Or you can buy a WDDG and compound your returns with a dividend that grows at a higher pace than inflation. The answer seems obvious... Still, investors prefer bonds over stocks today.
According to Dr. David "Doc" Eifrig, who writes our Retirement Millionaire newsletter, about $210 billion has flowed out of stocks since 2007. And more than $1.25 trillion has flowed into bonds.
Global corporate bond issuance in August has been the highest on record... Companies have issued nearly $120 billion of bonds this month to date, according to data provider Dealogic. That's the highest figure since records began in 1995. And more than double the $58 billion average.
And that's after July 2012 set a record as the busiest July for investment-grade corporate bond issuance in U.S. history. As Doc said in his August issue...
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If you are invested in low-yielding U.S. government paper... please get out as soon as you can... There's no reason to accept less than 2% from the federal government, when successful companies and state and local governments will pay you 4%-8% for the same sorts of risks. |
If you're looking for the highest-quality, highest-yielding stocks to put money into today, we'd advise you to try a subscription to The 12% Letter. You can stock your portfolio with WDDGs and watch your dividends increase and your gains compound over the years...
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New 52-week highs (as of 8/24/12): Guggenheim BulletShares 2015 High Yield Corporate Bond Fund (BSJF), iShares High Yield Corporate Bond Fund (HYG), iShares Dow Jones U.S. Home Construction Fund (ITB), Constellation Brands (STZ), and Royal Gold (RGLD).
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"I've been investing for over 40 years (and am recently retired now). Over that span, I've subscribed to dozens of newsletters, so I admit I've become a bit jaded. However, your 'End of America' piece was recommended to me by a friend who sent a link to it in an e-mail. So I thought I would give it a listen. At worst, it would waste 20 minutes or so of my time, I figured. What I heard shook me out of my complacency, and I immediately signed up for a 2-year subscription. It's the best newsletter investment I ever made.
"After almost 39 years as an engineer in the chemical industry, I retired as a Senior Scientist with a nice six figure income. Since I started my career so long ago, I now get a decent pension from a blue-chip company, but it's still only about half my pre-retirement salary. Therefore, I set a personal goal to 'make up the difference' by becoming a more active investor. Thanks to Stansberry's Investment Advisory (and a few associated newsletters that I signed up to get for free via email), I'm happy to report that I'm on track to achieve that goal and then some, all with just a few hours a week. I say this not to brag, but to thank you and your colleagues for the various strategies you teach.
"I feel God has blessed me, so I want to share that the most effective strategy (for me) has been selling puts. I've traded a lot of options over the years, mostly calls (covered calls to generate income and long calls to speculate on stocks that I felt bullish about). I haven't kept a tally of all the hundreds of long calls I've purchased over the past four decades, but I'm pretty sure the total sum was a net loss. It's just so difficult to be right about both the direction and timing of a stock move.
"I finally swore off speculation with long calls in favor of getting paid up front by selling puts short on stocks that I feel bullish about. I was pleased to learn that I could employ this strategy in my IRA accounts also, as long as I had cash on deposit to cover any put assignments. I soon transferred money from my 401k to an IRA to augment the capital available for selling puts.
"There are so many interesting companies that are recommended by your family of newsletters that it has been no problem to find candidates for put sales. The problem was too many candidates, so I built an Excel spreadsheet to calculate the annualized returns available on various options. I was excited to find that these annualized returns can sometimes exceed 100% on stocks that are a bit more volatile. I want to stay diversified, so I don't overdo it on those trades, but overall, I have found it's easy to find trades with annualized returns better than 30%.
"Of course, the time to expiration is usually a month or less, so it's a challenge to keep the capital fully deployed with the turnover each month at options expiration. I also learned to pay more attention to the overall market, no matter how good an individual company looks. In the first quarter of this year when the market was fairly positive, most of my puts expired worthless, and I was happy to keep the premium and create a new position. Things got a little rockier for the market in the second quarter, and I ended up getting a lot of puts assigned.
"Not that I'm worried long-term about the stocks I was forced to buy (they are all companies that I liked), but it does tie up that capital for a while. I've since unwound many of those assignments by selling covered calls (generating more income and restoring capital for new put sales). However, that experience has created a stronger bias in me to focus on companies that pay a good dividend, since that yield can further soften the impact of any put assignments. I know, I know, you guys preach all the time about dividends, and it's finally sinking in! Thanks again, and keep up the good work." – Paid-up subscriber Harold J.
Regards,
Sean Goldsmith
New York, New York
August 27, 2012