Category Archives: Dividends

The Dogs of the Dow

The “Dogs” are the ten stocks in the Dow Jones Industrial Average (DJIA) that have the highest dividend yield. They are referred to as Dogs because the stocks with the highest yields are often those that are out of favor with investors and whose prices have declined significantly.

The Dow is made up of 30 stocks that are leaders in their industry.  They are generally though of as “Blue Chips.”  All of the stocks in the DJIA pay a dividend. Their yield is determined by dividing their annual dividend by the stock price. For example, as of December 31, 2014, AT&T was one of the 30 stocks in the DJIA. At that time it had an annual dividend of $1.84 and was priced at $33.59. Dividing $1.88 by $33.59 gives us a dividend yield of 5.48%, making it the highest yielding stock in the DJIA.

One of the reasons for the high yield is that AT&T declined in price by about 4.5% in 2014 while keeping its dividend level.  70%  of the other Dogs of 2015 also declined in price while keeping dividends level. In fact, seven out of the ten actually raised their dividends even as their prices declined.

This price drop coincided with an over-all market increase of over 10%.  For the smart investor this provides an opportunity for bargain hunting.

The market moves in cycles. Some companies run into company specific problems that cause their stocks to decline. Still others lose favor because of the industry they are in. Whatever the reason, it becomes a top management priority to fix the problem and get the stock moving back up. Their bonus depends on it.

The Dow Dogs of 2015 were AT&T, Verizon, Chevron, McDonald’s, Pfizer, General Electric, Merck, Caterpillar, ExxonMobil and Coca Cola.

Keeping in mind the old maxim that the way to make money in the stock market is to buy low and sell high.  Buying the Dogs provides an opportunity for investors who are looking for a simple way of buying high quality stocks when they go “on sale.”  While there is no guarantee that these stocks will turn around and go back up, the chances are fairly good that some will and that will lead to a positive over-all return.

As an added advantage, investors who buy the Dogs get an above-average income from a steady stream of dividends that these stocks produce. There is even a tax bonus since dividends from these stocks are considered “qualified dividends” for tax purposes and are taxed at a lower rate than ordinary income.

The investor who follows the Dogs strategy strictly will review his portfolio annually and sell those stocks that are no longer the highest yielding. They will be replaced by the new Dogs. By doing this the investor if forced to sell his biggest winners and replace them with the new, lower priced, Dogs.  While selling our winners and buying stocks that are out of favor goes against human nature, it is a time tested strategy that has worked well over long periods of time for the disciplined investor.

The person most responsible for popularizing the Dogs of the Dow Strategy was Michael O’Higgins who wrote a book “Beating the Dow” in 1991. The strategy worked well for a number of years but fell out of favor at the end of the decade when the boom became the new rage. It’s making a come-back now.

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Are Retirees Focused on the Wrong Thing in Their Portfolios?

According to a recent study, a middle class couple aged 65 has a 43% chance that one of them will live to age 95. The challenge for this couple is to continue to enjoy their lifestyle and have enough money to live worry-free. Once you stop working you are dependent on income sources like pensions, annuities, social security payments and withdrawals from the savings you have accumulated over the years.

Most of these retirement income sources are fixed once we retire and are out of our control. It’s the retirement savings component that has people concerned. Most retirees don’t want to run out of money before they run out of time. For many they, themselves, are the income source that makes the difference between just getting by and enjoying life. Many retirees focus on the dividends and interest that their portfolios create. That may not be the best answer. Let’s examine the problems associated with this approach.

For the last five years the interest rate on high quality bonds (and CDs) has been close to zero. People who have chosen the “safety” of U.S. Treasury bonds or CDs have actually lost purchasing power after you take inflation and taxes into consideration. The same holds true for owners of tax-free municipal bonds. Those who bought bonds 10, 15, even 20 year ago when interest rates were higher have realized that bonds eventually come due. And when bonds mature, new bonds pay whatever the current interest rate is. That has meant a huge drop in income for many people who depend largely on interest payments.

Dividend payments are also subject to disruption. The financial crisis of 2008 was devastating for many investors. Those who owned bank stocks were particularly impacted. Bank stocks were a favorite for many income investors at that time because they produced lots of dividend income. Most banks slashed or eliminated their dividends, and some went out of business completely. Even companies that were not considered banks, like General Electric, were forced to cut their dividends. Dividends are nice income sources, especially in a low interest rate environment, but they are not guaranteed and you have to be careful about having too much of your portfolio concentrated in any one stock or industry.

The preferred method of planning for withdrawals from retirement savings is to take a “total return” approach. Total return refers to the growth in value of a portfolio from all sources, not just dividends and interest but also capital appreciation. In many cases, capital appreciation provides more return than either dividends or interest.

So how does one go about taking an income from a total return portfolio? Many advisors use 4% as a good starting point for withdrawals. That means for every $100,000 in your portfolio you withdraw $4,000 (4%) per year to live on while investing the rest. The goal is to invest the portfolio is such a way that over the long term, the growth offsets the withdrawals you are taking. It’s like a farmer harvesting a crop, leaving enough so that your portfolio has the chance to actually grow a little over time.

Of course, as we age other factors enter into our lives and the retirement equation, often headlined by medical problems related to aging. We will deal with these issues in another essay.

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“Will a Stock Market Drop Affect My Dividend Payments?”

We got this question from a client of ours earlier this week in response to the stock market’s wild market ride.  It is a great question!

The quick and easy answer is “No, it shouldn’t.”  And we could pretty much stop right there.  But if you know us, you know we love to get into the explanation!  So here it goes…

Let’s go back to the very start, with “What is a dividend?”  A dividend is a payment of a portion of a company’s earnings distributed to the company’s shareholders.  Dividends typically are paid in cash, and the company’s board of directors decides the amount distributed.

Now the next question would be, “What causes a company to raise or lower their dividend?”  The answer is cash flow.  It all comes down to earnings and profitability and how much money the company has remaining after paying for all the things that keep it running, such as salaries, research and development, marketing, etc.  After those expenses and the dividend payment, the remaining profits go back into the company.

When a company pays a dividend, their board is essentially deciding that reinvesting all of the company’s profits to achieve further growth will not offer the shareholders as high a return as a dividend distribution.  That said, companies offer a dividend as extra enticement for investors to buy their stock.  Moreover, a steadily increasing dividend payout is an indication of a successful company.

Therefore, it stands to reason that a company’s steady or increasing profitability will typically lead to steady or increasing dividend rates, and a decline in profitability will lead to that company reducing or eliminating their dividends.  Most U.S. companies are loathe to reduce their dividend rates because it signals to investors that their profits are lagging, which results in their stock price getting pummeled.  And that is not a good thing for their company’s board or management.

The final long-winded answer: You will often see companies cut their dividends when there is a severe economic crash, but not in reaction to a market correction.  Since dividends are not a function of stock price, market fluctuations and stock price fluctuations on their own do not affect a company’s dividend payments.

If you have a question, feel free to send it our way!

(Here is an interesting tidbit: the term “dividend” comes from the Latin word dividendum, which means “thing to be divided.”  With a dividend, companies are dividing their profits up among shareholders.)

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How do you get income with interest rates as low as they are?

I was reminded recently how low interest rates were when I downloaded my investment account activity into Quicken. Each account with a money market balance received a few pennies worth of interest, not enough to buy a cup of coffee. Certainly not enough to buy a Happy Meal. The average money market fund yields 0.02%. Every $1,000 investment will give you 20 cents in a year. And that’s before taxes. You could make more money collecting bottles at the side of the road.

There are some alternatives. One way is to invest for growth and forget about income. You can always spend some of the growth when you need the money.

But for those who want to see income flowing into their accounts, there’s always the “Dogs of the Dow.” The “Dogs” are members of the 30 Dow Jones industrial average with the highest dividend yields. This may be the result of a drop in prices, hence the name. For example, two of the highest yielding stocks in the DJIA are oil stocks which have declined in price even as they increased their dividends.

The current yield on the “Dogs” portfolio is over 3.5% and last year the total return (dividends plus capital appreciation) was over 10%. For more information on this strategy, contact us.

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What’s the Wall Street View of GE?

The Street is falling out of love with GE.  About 40% of analysts give GE a Market Perform – a “Gentleman’s C” – with an equal number above and below that ranking.  Since there’s little reason to buy a stock rated average by the street (buy an index fund instead and get the same resutl with less risk) GE is treading water.

Paraphrasing JP Morgan at Barron’s

Try as it might, General Electric (GE) just can’t get anything going. Don’t expect that to change in 2015, say the folks at JPMorgan.

We began our investment career working with GE employees and retirees.  We once worked for GE.  We remember how well the stock did under the leadership of Jack Welch.

We also have a well-founded skepticism of Wall Street analysis.  That said, we are not better than anyone else in predicting the future.  We don’t know when (or if) GE will regain its footing and begin to grow at a rate that will make it more attractive.  In the meantime, the main thing GE has going for it is a dividend yield over 3.5%.

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General Electric (GE) dividend increase disappoints

General Electric announced a 4 cent increase in its annual dividend, from $0.88 ($0.22/per quarter) to $0.92 ($0.23/quarter). The x-dividend date is December 18th and the pay date is January 26, 2015.

A number of analysts were looking for a bigger increase. The smaller-than-expected rise in the dividend is attributed to the drop in oil prices. GE has made a big bet in energy infrastructure including wind, as well as in more energy efficient transportation such as fuel efficient jet engines and locomotives. Lower oil prices make investments in these items less compelling.

It looks as if it will be some time before GE gets back to the $1.24 annual dividend it paid prior to 2009.

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Living on a fixed income has gotten a lot harder

At one time, living on a fixed income meant you were retired, received a pension and social security, and got some extra income from your savings. For our parents and grandparents, certificates of deposit, otherwise known as “CDs” were a guaranteed source of no-risk income. Back in 1981 you could put your savings in the bank and get nearly 18%. That was a period of high inflation when prices were also going up. But CDs and bonds paid investors high enough rates so that retirees were comfortable with putting their money into CDs or bonds.

But interest rates have been on a downward path since then. CD rates have dropped from about 11% in 1984 to 1% or less today.

CD rates history


Today, CDs and bonds, once the go-to choice of the thrifty retiree, pay a small fraction of what they once did, and provide very little income to supplement their other retirement income sources.
The Federal Reserve has been keeping rates close to zero for years to try to jump-start the economy, with limited success. But while it’s been good for businesses and home buyers who have have been able to borrow money at rates that we have not seen since the 1950s, the traditional saver has seen their income dry up, collateral damage of Federal Reserve policy.

Charles Schwab, in an article published in the Wall Street Journal states that:

U.S. households lost billions in interest income during the Fed’s near-zero interest rate experiment. Because they are often reliant on income from savings, seniors were hit the hardest. Households headed by seniors 65-74 years old lost on average $1,900 in annual income over the past six years, according to a November 2013 McKinsey Global Institute report. For households headed by seniors 75 and older, the loss was $2,700 annually.
With a median income for senior households in the U.S. of roughly $25,000, these are significant losses. In total, according to my company’s calculations, approximately $58 billion in annual income has been lost by America’s seniors since 2008.
Retirees depend on income from their savings for basic living expenses. Without that income, many seniors have taken on greater risk to increase the potential yield on their savings, or simply spent down their nest eggs. After decades of playing by the rules, putting off spending and socking away money, seniors have taken it on the chin. This strikes a blow at the core American principles of self-reliance, individual responsibility and fairness.

What’s a retiree to do? Let’s look at some of the alternatives that people on fixed incomes are being offered and what to watch out for. All of them involve risk that may not be readily apparent. There are traps for the unwary.

Continue reading

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Income from “Total Return”

When thinking about income from an investment portfolio many people focus on interest and dividend income. That can lead to problems. In times like these where interest rates are low, the desire to get income from bonds and high dividend paying stocks can be hazardous.

Bonds that pay high yields may be low grade “junk” bonds that are riskier than high grade bonds. Or they can be long-term bonds that will lose value when interest rates rise.

Stocks with unusually high dividends may actually be paying more in dividends that they earn. How long can that go on? Focus too much on dividend income and you could be like those who, in 2008, owned lots of bank stocks that were paying some of the highest dividends. Some of these banks failed and shareholders lost all their money. The survivors cut their dividends to – or near –zero.

Don’t misunderstand; getting income from bonds and stocks is not bad. But “reaching” to get income from these sources can be hazardous.

There is another way of getting income from an investment portfolio that does not focus on just interest or dividends. It’s called the “Total Return” system.

Total Return introduces a third factor into the income mix: growth.

Let’s use a stock as an example.

Imaging that we buy XYZ company stock at $100. It pays a dividend of $3. That gives us a dividend yield of 3%. But let’s assume we chose XYZ stock not just because of the dividend but because we believed it would grow. A year later, XYZ stock is now selling for $110. The “Total Return” on XYZ is the sum of the dividend and the growth in value.

Dividend:                    $3.00 (3%)
Growth in value :     $10.00 (10%)
Total Return:           $13.00 (13%)

Under these circumstances, we could take the dividend plus part of the increased value of the stock, spend it, and still have more wealth than we had before. Viewed from the Total Return principle, we could spend up to $13 and be wealthier than before.

This example is easier to accomplish using mutual funds, and it’s one of the strategies that we employ for those who are retired and those who are still building their retirement portfolio.
If you want to know more about the Total Return way of investing, contact us.

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Fundamental Sources of Retirement Income

Traditional sources for retirement income—such as Social Security and defined benefit plans—are less certain to satisfy retirement needs than they were in the past. The rising cost of living, a diminishing number of defined benefit plans and a social security system that requires reform in order to pay benefits for younger workers in the distant future are worrisome. As a result, it’s increasingly more important for investors to work closely with their advisors to create a comprehensive plan that will enable them to meet their income needs during retirement.

The traditional sources of retirement income include:

  • Employee sponsored retirement accounts
  • Pension plans
  • Social Security
  • Employment
  • IRAs
  • Fixed income securities
  • Dividends
  • Annuities

How much is enough?

Running out of money in retirement is a concern for many investors. It’s a challenge to calculate exactly how much they’ll need, given that many factors—from investment returns, healthcare costs and inflation to Social Security’s future and individual life spans—are nearly impossible to predict.  What is certain is that individuals are living longer. In fact, at least one member of a 65-year-old couple has a high probability of living into his or her 90s, 35 years beyond what has historically been considered a “normal” retirement age in the United States.

Experts often estimate retirees will need 75 to 85% of their pre-tax, pre-retirement income.  But often there will be no reduction at all in the cost of living in retirement due to medical bills and the desire and the time for travel.

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Two Views of GE

General Electric is one of the most widely owned stocks in the world.  And as a GE alumnus we are often asked about it.  At present there are two main schools of thought about GE and it’s outlook over the next year.

The bullish case argues that General Electric still has many growth opportunities, especially considering its $223B order backlog. Six out of seven of General Electric’s business segments posted earnings growth in Q2 compared to last year, with three seeing double-digit growth.  In addition, GE is one of the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), with a dividend yield of over 3%.

The neutral case is made Goldman Sachs:

“Our view is based on limited upside to 2013/2014 EPS coupled with a balanced risk/reward at this time. Specifically, we believe the 2013 margin targets are aggressive and a lower asset base at Capital will weigh on 2014 growth. Over the long term, we like GE’s position in attractive markets, simplification efforts and actions since the global financial crisis to make Capital stronger/safer. However, while GE appears well on its way to achieving its ENI reduction targets, we believe more can be done to improve its returns/ growth profile, making it a more attractive investment longer-term,”

With a P/E ratio of over 17, our view is that GE has limited upside potential.  We see the likelihood of an announcement of a dividend increase in the 4th quarter.  GE still has a lot of restructuring in its future as it sheds more of its GE Capital businesses.  This stock is not for the impatient.

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