Dividend Growth Investment Strategy

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Dividend Growth Investment Strategy

Post by JWR1945 » Thu Jul 15, 2004 11:59 am

I have just read The Dividend Growth Investment Strategy by RoxAnn Klugman. This is part of my ongoing investigation into dividend based strategies. This book focuses on the accumulation stage.

The author recommends buying low-yielding stocks with a long history of rapidly increasing dividend amounts. The reason for starting out at low yields is to reduce taxes during accumulation. Fast dividend growth translates to a high-income stream at retirement when it is needed. Another reason for focusing on dividends and dividend growth is to keep investors in the market as prices vary wildly. Thinking in terms of streams of income relative to one's initial cost is not only soothing psychologically, but it is also in the proper form for retirement planning.

The book is very good for those just starting out although I strongly prefer strategies that depend less on growth. The book itself takes only the first 120 pages. I would recommend that readers of these boards jump immediately to Appendix 1 and go on from there. It has the details of the strategy along with the author's recommended stocks (and some other stocks that are not recommended but included for contrast).

The book has a 2001 copyright. Its examples are from 1983 though 2000. That was a great time for growth stocks and it extends right to the bubble's peak.

Here is the distribution of the price to earnings ratios P/E of the thirty highly recommended stocks.

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P/E = 0 to 10,    none.
P/E = 11 to 15, 1 out of 30.
P/E = 16 to 20, 6 out of 30.
P/E = 21 to 25, 3 out of 30.
P/E = 26 to 30, 4 out of 30.
P/E = 31 to 35, 4 out of 30.
P/E = 36 to 40, 5 out of 30.
P/E above 40,   7 out of 30.

Here is the distribution of the dividend yields of the thirty highly recommended stocks.

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Yield = 0.0 to 0.5%, 8 out of 30.
Yield = 0.6 to 1.0%, 5 out of 30.
Yield = 1.1 to 1.5%, 8 out of 30.
Yield = 1.6 to 2.0%, 3 out of 30.
Yield = 2.1 to 2.5%, 0 out of 30.
Yield = 2.6 to 3.0%, 2 out of 30.
Yield = 3.1 to 3.5%, 3 out of 30.
Yield = 3.6 to 4.0%, 0 out of 30.
Yield above 4.0%,    1 out of 30.

The author has 16 additional recommendations. Their valuations are not quite so high.
Here is the distribution of the price to earnings ratios P/E of the sixteen additional stocks.

Code: Select all

P/E = 0 to 10,  1 out of 16.
P/E = 11 to 15, 5 out of 16.
P/E = 16 to 20, 3 out of 16.
P/E = 21 to 25, 1 out of 16.
P/E = 26 to 30, 3 out of 16.
P/E above 30,   3 out of 16.

Here is the distribution of the dividend yields of the sixteen additional stocks.

Code: Select all

Yield = 0.0 to 0.5%, 1 out of 16.
Yield = 0.6 to 1.0%, 2 out of 16.
Yield = 1.1 to 1.5%, 2 out of 16.
Yield = 1.6 to 2.0%, 3 out of 16.
Yield = 2.1 to 2.5%, 2 out of 16.
Yield = 2.6 to 3.0%, 1 out of 16.
Yield = 3.1 to 3.5%, 2 out of 16.
Yield = 3.6 to 4.0%, 2 out of 16.
Yield above 4.0%,    1 out of 16.

I am currently reading another book, The Single Best Investment by Lowell Miller, that looks at the trade off between starting yield and growth rate much differently. From page 58:

Let's say that you have a Single Best Investment pick that yields 4% today and shows a projected growth in yield at 10%. Compare that to a growth company with a 1% current yield and a projected growth of yield of 20%. In three and a half years, the second stock will have a yield on original investment of 2%. In seven years, it will be 4%. In a little more than 10 years, it will be 8%. But our SBI [Single Best Investment] turtle, with income growing at half the rate, will be at 8% in seven years, and at 12% in about ten years.

Lowell Miller goes on to mention that growth usually slows down as companies mature. He recommends starting with dividend yields of twice (and never less than 1.5 times) that of the market overall.

Readers of these boards will recognize the Gordon Equation in its most basic form:
Growth Rate = Dividend Yield + Dividend Growth Rate. In alternative forms, the Dividend Growth Rate is replaced with the Earnings Growth Rate and a Speculative term is added as Price to Earnings multiples expand and contract.

You can get growth in the investment value of a security (as distinguished from the speculative value) with any combination of dividend yield and dividend growth. For those who are interested in generating a perpetual income stream (or, at least, long enough to last their lifetimes), a dividend based strategy makes a lot of sense. It is based upon the same theoretical foundation, the Gordon Model, as stocks in general.

RoxAnn Klugman emphasizes growth for an immediate tax deferral. Lowell Miller emphasizes having the assurance of reaching one's goals. In his example, the 20% rabbit would have been a better choice if you really could depend upon its growth lasting more than a decade into the future.

Have fun.

John R.

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Post by Shakespeare » Thu Jul 15, 2004 12:36 pm

Buy low(er) dividend/high growth in accumulation. Starting about 5 years before retirement, begin investing in higher dividend/lower growth stocks. Transition the portfolio in the five years after retirement, taking some profits from low-dividend equities (as long as they can be taken in the lowest tax brackets) and investing in higher-dividend equities or REITS. If you are picking individual stocks rather than ETFs, individual opportunities come along every so often. Be patient. Keep a cash reserve so that a great group buying opportunity like the one two years ago can be jumped on. But never buy everything all at once; buy your allotment for one stock in three or four tranches. Keep individual stocks below 5% (if your conservative), and preferably below 3%, of your portfolio. And be careful with your sector weights; financials and utilities tend to predominate. Keep sector weights to 15% maximum.

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Post by unclemick » Thu Jul 15, 2004 2:48 pm

I just do it - last year taxable dividends/dividend stocks were 40% percent of income (no SS or IRA takeout) - yet. I'm messy enough to perhaps not label it a strategy - although I did take some good humored flak under the topic 'dividend stock ladders' on another forum.

Basically I buy DRIPs via Moneypaper, and use The Handbook of Dividend Achievers(since 94) and Ben Graham type screens to pick. Sent for one share of AT&T this week. (37 stocks - a lot of one/few shares waiting on better prices to to hundreds of shares of keepers).

Short term trader - if after 7-10 years the stock hasn't returned 10% counting reinvested dividends - it's a sell candidate - depending on my tax situation. Net effect - I once had the temerity to label laddering. Also - given mergers, spin offs, and plain old cash buy outs - it can get messy along the way. 2000 wiped out three of my four water stocks with cash buyouts - took a cap gain I didn't want.

Been dinking around since 1989, has helped ER since 1993, and will probably keep it up to nurse the income stream - even after SS kicks in and we start to take IRA. Expect div's to come in at around 20-25% of taxable income. (non-cola pension, divs., SS and IRA). Pension will fade due to inflation over time.

Like I said messy - JWR ran some numbers on the other forum - reasonable, not outstanding and you have to stay on top of it.

BTY - I don't worry about sectors, diversification, or market fluctuation. The last little interest rate flutter in 2000 - my Con ED went from 40 something to 25 so I bought a bunch more instead of of spreading across different sectors. After ten years - got a few with divs compounding on divs in the 12-20% range on original $ (Con Ed, Bank of America-orig. BankBoston, Eli Lilly, New Plan Reality) and some so-so Exxon, Excelon-orig. Commonwealth ED, and so on. And a reasonable number which went down in flames - that I haven't yet sold for tax reasons - Aetna, Union Pacific, Flowers Foods - sometimes when they cut divs, the stock price shoots up incurring potential cap gains. But I've had enough buy high, sell low stocks over the years to bring my overall average down and not get hosed too much on taxes.

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