Dividend Growth Provides For Inflation

Inflation is the silent killer for many retirement portfolios. Over time, prices tend to increase. If you rely solely on a portfolio of long-term fixed income securities, you will lose purchasing power each year as inflation robs your portfolio. Dividend growth rates on traditional high-yield stocks (e.g. utilities, REITs, etc.) are often less than inflation. However, most blue-chip dividend growth stocks grow their dividends well in excess of the annual inflation rate.

Dividend Growth Often Provides For Higher Value

The combination of a good starting yield and respectable dividend growth will often provide the investor with greater long-term value when compared to alternatives with higher current yields and lower growth dividend rates. The only way to know for sure is to run the numbers using a model such as my D4L-PreScreen.xls.

Compound Dividend Growth Is Powerful

Compound interest is what occurs when interest previously earned is added to the principle and is considered when calculating future interest – i.e. earning interest on interest. Compound dividends are like compound interest on steroids. Like compound interest, dividends are being reinvested. However, these dividends are growing which provides and added boost.

Conservative View Of Dividend Growth

The dividend growth rate is a key metric in many calculations. As such, I use a conservative estimate as follows: The minimum dividend growth rate of the 1, 3, 5, 7, 10 year compound annual growth rate or 15%, if dividends grew on average in excess of 15% for each consecutive 4 year periods, within the last 10 years of history.

10 Stocks With a 10%+ Dividend Growth Rate

General Dynamics Corp. (GD) | Yield: 2.5% | Growth: 10.1%
General Dynamics is the world’s fifth largest military contractor and also one of the world’s biggest makers of corporate jets. GD is a member of the S&P 500 a member of the Broad Dividend Achievers™ Index. The company has paid a cash dividend to shareholders every year since 1979 and has increased its dividend payments for 19 consecutive years.

Hormel Foods Corp. (HRL) | Yield: 1.9% | Growth: 10.6%
Hormel Foods Corp. company is a leading processor of branded, convenience meat products (primarily pork) for the consumer market. HRL is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index and a Dividend Champion. The company has paid a cash dividend to shareholders every year since 1928 and has increased its dividend payments for 45 consecutive years.

Wal-Mart Stores Inc. (WMT) | Yield: 2.8% | Growth: 11.0%
Wal-Mart Stores, Inc. is the largest retailer in North America, WMT operates a chain of discount department stores, wholesale clubs, and combination discount stores and supermarkets. WMT is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index and a Dividend Champion. The company has paid a cash dividend to shareholders every year since 1973 and has increased its dividend payments for 36 consecutive years.

Colgate-Palmolive Co. (CL) | Yield: 2.9% | Growth: 12.5%
Colgate-Palmolive Company (Colgate) is a major consumer products company that markets oral, personal and household care, and pet nutrition products in more than 200 countries and territories. CL is a member of the S&P 500 and a member of the Broad Dividend Achievers™ Index and a Dividend Champion. The company has paid a cash dividend to shareholders every year since 1895 and has increased its dividend payments for 47 consecutive years.

Owens & Minor Inc. (OMI) | Yield: 2.6% | Growth: 13.2%
Owens & Minor Inc. is a leading domestic distributor of medical and surgical supplies to the acute care market, a health care supply chain management company, and a direct-to-consumer (DTC) supplier of testing and monitoring supplies for diabetes. OMI is a member of the Broad Dividend Achievers™ Index. The company has paid a cash dividend to shareholders every year since 1926 and has increased its dividend payments for 13 consecutive years.

ConocoPhillips (COP) | Yield: 3.3% | Growth: 13.2%
ConocoPhillips Co. is the fourth largest integrated oil company in the world. COP is a member of the S&P 500 a member of the Broad Dividend Achievers™ Index. The company has paid a cash dividend to shareholders every year since 1934 and has increased its dividend payments for 10 consecutive years.

Target Corp. (TGT) | Yield: 2.0% | Growth: 15.5%
Target Corp. operates about 1,500 Target and 250 SuperTarget general merchandise stores across the U.S. TGT is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index and a Dividend Champion. The company has paid a cash dividend to shareholders every year since 1965 and has increased its dividend payments for 43 consecutive years.

Southside Bancshares Inc. (SBSI) | Yield: 3.2% | Growth: 16.6%
Southside Bancshares Inc. primarily provides financial services to individuals, businesses, municipal entities, and non-profit organizations. SBSI is a member of the Broad Dividend Achievers™ Index. The company has paid a cash dividend to shareholders every year since 1969 and has increased its dividend payments for 12 consecutive years.

Walgreen Co. (WAG) | Yield: 1.7% | Growth: 18.5%
Walgreen Co is the largest U.S. retail drug chain in terms of revenues, this company operates more than 8,000 drug stores throughout the U.S. and Puerto Rico. WAG is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index and a Dividend Champion. The company has paid a cash dividend to shareholders every year since 1933 and has increased its dividend payments for 36 consecutive years.

Casey’s General Stores Inc. (CASY) | Yield: 1.4% | Growth: 19.8%
Casey’s General Stores Inc. has over 1,500 convenience stores in the Midwest, selling food, beverage, health and automotive products. CASY is a member of the Broad Dividend Achievers™ Index. The company has paid a cash dividend to shareholders every year since 1990 and has increased its dividend payments for 10 consecutive years.

Conclusion

If time is on your side, you should investigate if certain lower yielding stocks with a dividend growth rate fits into your long-term investment strategy. When making this evaluation, it is important to note that the sustainability of the dividend growth rate must be evaluated on a go-forward basis. Like high-yield stocks, there is increasing risk as the dividend growth rises.

Full Disclosure: Long GD, WMT, CL, OMI, COP. See a list of all my income holdings here.

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Listed below are select companies that have recently elected to raise their payout and yield by increasing their cash dividends to shareholders:

Wal-Mart Stores, Inc. (WMT) serves customers and members more than 200 million times per week at 8,970 retail units under 60 different banners in 15 countries. March 3nd the company increased its quarterly dividend 21 percent increase to $0.3650/share. The dividend is payable on April 4, 2011 to shareholders of record on March 11, 2011. The yield based on the new payout is 2.8%.

WGL Holdings, Inc. (WGL) engages in the delivery and sale of natural gas, and provides energy-related products and services in the District of Columbia, Maryland, Virginia, and Delaware. March 3nd the company increased its quarterly dividend 2.6% to $0.3875/share. This annual increase is the 35th consecutive year that WGL Holdings, Inc. has increased the cash dividend on its common stock. The new quarterly dividend is payable May 1, 2011, to shareholders of record on April 8, 2011. The yield based on the new payout is 4.0%.

General Dynamics (GD) is a market leader in business aviation; land and expeditionary combat systems, armaments and munitions; shipbuilding and marine systems; and information systems and technologies. March 2nd the company increased its quarterly dividend 12% to $0.47/share. The dividend is payable May 6, 2011, to shareholders of record on April 8. The yield based on the new payout is 2.5%.

Fred’s, Inc. (FRED) operates 676 discount general merchandise stores, including 24 franchised Fred’s stores, in the southeastern United States. March 2nd the company increased its quarterly dividend 25% to $0.05/share. The dividend is payable on March 15, 2011, to shareholders of record as of March 10, 2011. The yield based on the new payout is 1.5%.

Waste Management, Inc. (WM) is the leading provider of comprehensive waste management services in North America. March 1st the company increased its quarterly dividend 7.9% to $0.34/share. The dividend is payable March 25, 2011 to stockholders of record on March 11, 2011. The yield based on the new payout is 3.7%.

National Interstate Corporation (NATL) is the holding company for a specialty property-casualty insurance group which differentiates itself by offering products and services designed to meet the unique needs of niche markets. March 1st the company increased its quarterly dividend 12.5% to $0.09/share. The dividend is payable on March 18, 2011 to shareholders of record of the Company’s common stock as of the close of business on March 9, 2011. The yield based on the new payout is 1.7%.

The Hanover Insurance Group, Inc. (THG) offers a wide range of property and casualty products and services to individuals, families and businesses through an extensive network of independent agents. March 1st the company increased its quarterly dividend 10% to $0.275/share. The dividend is payable March 29, 2011, to shareholders of record at the close of business on March 15, 2011. The yield based on the new payout is 2.4%.

UniSource Energy Corporation (UNS), through its subsidiaries, operates as an electric utility in Arizona. February 28th the company increased its quarterly dividend 7.7% to $0.42/share. The dividend is payable on March 23, 2011 to common shareholders of record as of March 11, 2011. In 2010. The yield based on the new payout is 4.6%.

CBL & Associates Properties, Inc. (CBL) is one of the largest and most active owners and developers of malls and shopping centers in the United States. February 28th the company increased its quarterly dividend 5% to $0.21/share. The dividend is payable on April 15, 2011, to shareholders of record as of March 30, 2011. The yield based on the new payout is 4.7%.

Weingarten Realty (WRI) is a commercial real estate owner, manager and developer. February 28th the company increased its quarterly dividend 5.8% to $0.275/share. The dividend is payable in cash on March 15, 2011 to shareholders of record on March 8, 2011. The yield based on the new payout is 4.3%.

Selecting stocks with increasing dividends is critical for an income growth strategy. The above list contains stocks that recently raised their dividends; it is not a list of recommend buys. As always, due diligence should be performed before buying or selling any stock. For a list of stocks with a long string of consecutive cash dividend increases, see this list.

Full Disclosure: Long GD, WMT. See a list of all my income holdings here.

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Industrial Materials Attributes

The Industrial Materials Sector consists of companies that manufacture products or otherwise harvest a product, such as a mining company. The products are most often inputs or raw materials into another manufacturing process, such as steel producer. Many of these companies are often referred to as members of the “smokestack industry” and are classified as cyclical stocks – a stock that rises and falls in step with the economy.

Timing is important when buying an industrial stock. If you buy when business is booming you will likely pay too much, which means a very low yield. Most stocks in this sector are currently overpriced. The average yield on Industrial Sector stocks that I follow is only 1.7%. This includes only 3 stocks yielding in the 3% range., with all the others sub-3%.  Several of these sub-3% companies were yielding in excess of 4% in 2008 when the world looked bleak for Industrial stocks.

Industrial Materials Companies

Below are several leading Industrial Materials companies that I follow. The companies selected have a dividend yield of 2.00%, or higher, and have raised their dividends for at least 15 years.

RPM International Inc. (RPM)
Yield: 3.5% | Growth:2.5 % | Years: 38
RPM International Inc. makes specialty coatings and products for the structural waterproofing and corrosion control markets, as well as products for the consumer, do-it-yourself, and hobby markets.

MDU Resources Group Inc. (MDU)
Yield: 3.0% | Growth: 1.9% | Years: 20
MDU Resources Group Inc. is involved in electric and natural gas distribution, natural gas storage, gathering and transmission, construction materials and mining, and oil and natural gas production.

Nucor Corporation (NUE)
Yield: 3.0% | Growth: 0.8% | Years: 37
Nucor Corporation is the largest minimill steelmaker in the U.S., Nucor has one of the most diverse product lines of any steelmaker in the Americas.

PPG Industries, Inc. (PPG)
Yield: 2.5% | Growth: 1.9% | Years: 37
PPG is a leading manufacturer of coatings and resins, flat and fiber glass, and industrial and specialty chemicals.

Illinois Tool Works Inc. (ITW)
Yield: 2.3% | Growth: 4.8% | Years: 47
Illinois Tool Works Inc. is a diversified manufacturer that operates a portfolio of about 840 industrial and consumer businesses throughout the world.

3M Company (MMM)
Yield: 2.3% | Growth: 2.5% | Years: 52
3M Co. provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives, and other chemical additives.

Harsco Corporation (HSC)
Yield: 2.3% | Growth: 1.9% | Years: 20
Harsco Corp. is a global industrial service provider and manufacturer has operations in steel mill services and access services, as well as construction.

Emerson Electric Co. (EMR)
Yield: 2.2% | Growth: 2.2% | Years: 55
Emerson Electric Co. designs and supplies product technology, and delivers engineering services and solutions to a wide range of industrial, commercial, and consumer markets around the world.

Air Products And Chemicals Inc. (APD)
Yield: 2.2% | Growth: 2.1% | Years: 29
Air Products and Chemicals Inc. is a major producer of industrial gases and electronics and specialty chemicals and also has interests in environmental and energy-related businesses.

General Dynamics (GD)
Yield: 2.1% | Growth: 10.1% | Years: 19
General Dynamics is the world’s fifth largest military contractor and also one of the world’s biggest makers of corporate jets.

United Technologies Corp. (UTX)
Yield: 2.0% | Growth: 10.4% | Years: 18
United Technologies Corp. portfolio includes Pratt & Whitney jet engines, Sikorsky helicopters, Otis elevators and Carrier air conditioners, among other products.

Pentair, Inc. (PNR)
Yield: 2.0% | Growth: 5.6% | Years: 34
Pentair Inc. makes and markets water and fluid control devices, and electrical and electronic enclosures.

Conclusion

The Industrial Materials Sector is the largest sector in my database of dividend stocks. Of the 198 stocks that I track, it currently is represented by 34 stocks (17%). As noted above, this is not a sector I am in a position to buy often, but when the time is right, I plan on taking full advantage of the opportunity. Two of my largest annualized returns (IRR) come from industrial stocks: 3M (MMM) at 46.5% and Emerson Electric Co. (EMR) at 49.7%. I wouldn’t buy them at their current valuation, but based on where they were when I purchased them, I am enjoying a healthy yield-on-cost.

Full Disclosure: Long NUE, ITW, MMM, EMR, GD, UTX. See a list of all my income holdings here.

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This expectation does not change even when the economy turns down and earnings decline; dividend growth investors still require annual dividend growth. The companies that are able to accomplish this are those with a operating model that generates strong free cash flows with room to pay out a higher percentage as dividends. Below are several companies with a low free cash flow payout (below 40%):

An interesting twist to the above is a 2006 study conducted by Credit Suisse that found high dividend yield stocks generally
outperformed those with lower yields. However, the best returns did not come from those with the highest yields, but those with higher yields coupled with low payout ratios. The study found that high yield, low payout stocks that produced the better returns were priced at low ratios of price-to-earnings, and as a corollary, at high ratios of earnings-to-price; i.e., earnings yield. Put another way, the stocks prices were depressed, thus creating the higher yield and a value play. Below are several dividend growth stocks with a higher yields (around 4%+) and low free cash flow payouts (50% and below):

At some point we will all want to retire, but that is not to say we want our portfolio to stop working for us. A good dividend growth stock portfolio will not only provide us income in our retirement, but provide us more income each year than the one before.

Full Disclosure: Long GD, MDT, ADP, PG, INTC, ABT, GPC, TEG, CINF, LLY, HGIC. See a list of all my income holdings here.

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Have A Plan

If you suddenly found yourself unemployed and were unable to immediately replace the lost income, do you know what you would do? I suspect there are few families that have given a lot of thought to this. It is like buying a cemetery plot – it is not high on the list to things to consider. The drive home after receiving a pink slip is too late to start planning; at this point you should be in a position to start executing your plan.

Prepare to Execute Your Plan

Schools and businesses have fire drills for a reason. We all know we need to get out of a burning building, but do we really know how until we practice. Recently, my employer had a fire drill and too many people were going down the stairs on one side of the building and this created a traffic jam. If it had been a real fire many would have lost their lives.

In the same regard, it would make sense to take your plan and play “what if I lost my job today. ” You need to understand the answers to these questions: How long can I go without finding a replacement job? Will my plan permanently damage my financial position? What adverse effect will this have on my family (kids’ college, braces, house payments, etc.)? What is the worse case scenario? How will we fare in the worse case scenario?

Develop Alternative Income Streams

One of the best ways to ensure financial success is to develop alternative income steams. If one stream dries up, you have others to fall back on. We all have things we are good at, most can be packaged in a way to provide alternative income. Again, this is not something you can quickly develop the day you are terminated.

Dividend Growth Stocks

One of the best alternative income sources are dividend growth stocks. Just like a regular job they can provide you a steady AND growing income. With advance planning, your income portfolio can become the foundation of your contingency plan. Here are several dividend stalwarts to consider when building your income portfolio:

General Dynamics (GD) is the world’s fifth largest military contractor and also one of the world’s biggest makers of corporate jets. The company has paid dividends since 1979 and has increased them the last 19 years. Current yield: 2.61%

Colgate-Palmolive Company (CL) is a consumer products company, whose products are marketed throughout the world. Colgate’s Oral Care products include toothpaste, toothbrushes, oral rinses, dental floss and pharmaceutical products. The company has paid dividends since 1895 and has increased them the last 47 years. Current yield: 2.64%

Medtronic Inc. (MDT) is a global medical device manufacturer has leadership positions in the pacemaker, defibrillator, orthopedic, diabetes management and other medical markets. The company has paid dividends since 1977 and has increased them the last 33 years. Current yield: 2.68%

The Coca-Cola Company (KO) is the world’s largest soft drink company. It engages in the manufacture, distribution, and marketing of nonalcoholic beverage concentrates, fruit juices and syrups worldwide. The company has paid dividends since 1893 and has increased them the last 48 years. Current yield: 3.01%

McDonald’s Corporation (MCD) is the largest fast-food restaurant company in the world, with about 32,500 restaurants in 117 countries. The company has paid dividends since 1976 and has increased them the last 34 years. Current yield: 3.03%

The Procter & Gamble Company (PG) is a leading consumer products company markets household and personal care products in more than 180 countries. The company has paid dividends since 1891 and has increased them the last 54 years. Current yield: 3.21%

Abbott Laboratories (ABT) is engaged in the discovery, development, manufacture and sale of a diversified line of healthcare products including: drugs, nutritional products, diabetes monitoring devices and diagnostics. The company has paid dividends since 1926 and has increased them the last 38 years. Current yield: 3.29%

The Clorox Company (CLX) is a diversified producer of household cleaning, grocery and specialty food products is also a leading producer of natural personal care products. The company has paid dividends since 1968 and has increased them the last 35 years. Current yield: 3.30%

Johnson & Johnson (JNJ) engages in the manufacture and sale of various products in the health care field worldwide. The company has paid dividends since 1944 and has increased them the last 48 years. Current yield: 3.41%

Sysco Corporation (SYY), through its subsidiaries, engages in the marketing and distribution of a range of food and related products primarily for foodservice industry in the United States and Canada. The company has paid dividends since 1970 and has increased them the last 39 years. Current yield: 3.44%

Harleysville Group Inc. (HGIC) is a regional holding company for property and casualty insurance companies that operates in 32 states, primarily in the eastern half of the U.S. The company has paid dividends since 1986 and has increased them the last 24 years. Current yield: 4.12%

AT&T Inc. (T) provides telephone and broadband service, and the company holds full ownership of AT&T Mobility (formerly Cingular Wireless). AT&T Corp. was acquired in late 2005 and BellSouth in late 2006. The company has paid dividends since 1984 and has increased them the last 27 years. Current yield: 5.87%

The Bottom Line

Even if you never lose your job, one day you will retire and will face a very similar situation. Your salary will go away, replaced by much smaller Social Security payment, and possibly a pension payment (for a shrinking group of employees). More and more retirees have to manage their nest egg to ensure you don’t run out of money. A good plan, the ability to execute and multiple revenue streams including blue-chip dividend growth stocks will make the transition much easier.

Full Disclosure: Long GD, CL, MDT, KO, MCD, PG, ABT, CLX, JNJ, SYY, HGIC, T. See a list of all my income holdings here.

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Projected Inflation

First, let’s look at inflation, specifically the consumer price index for all urban consumers (CPI-U). I chose this index since it focuses on a typical market basket of goods and services consumed by all urban consumers. In the August 2010 Budget and Economic Outlook, published by the Congressional Budget Office (CBO), it offers a very mild outlook for inflation. The CBO is projecting the CPI-U for 2010 to be 1.6%, 1.0% in 2011, 1.7% in 2012-2014 and 2.3% 2015-2020.

Economic Growth

The mild inflation could be the result of a slow recovery. As for economic growth the CBO offered this:

In the past, many recoveries from deep recessions have been quite robust. After deferring purchases during a slump (especially for expensive goods like homes, automobiles, and capital equipment), households and businesses typically boost their spending quickly as economic prospects improve. However, international experience suggests that recoveries from recessions that were spurred by financial crises tend to be slower than average—perhaps because the losses in wealth and damage to the financial system that occur during such crises weigh on spending for a number of years. Following such a crisis, it takes time for consumers to rebuild their wealth, for financial institutions to restore their capital bases, and for nonfinancial firms to regain the confidence required to invest in new plant and equipment; all of those forces tend to restrain spending. In addition, under current law, both the waning of fiscal stimulus and the scheduled increases in taxes will temporarily subtract from growth, especially in 2011.

D4L-Inflation

With the above back-drop, I created an Excel model to compare a dividend growth stock to inflation. The model is simple to use. It has the following inputs:

Symbol: The dividend growth stock’s ticker symbol
Current Year: This year (2010)
Current Yield: The dividend growth stock’s current yield
Dividend Growth: The dividend growth stock’s estimated dividend growth rate
Inflation Rate: Estimated inflation rate

The Interpretative Analysis section calculates the net present value (NPV) of the annual differential between the dividend income investment and inflation (discounted at the inflation rate). The break-even button next to the Inflation Rate input field will calculate the inflation rate where the dividend stock investment equals inflation. Let’s run some numbers:

It is interesting to note that just a little dividend growth goes a long ways. One other consideration is taxes. To run the calculations on an after tax basis, simple enter the dividend yield on an after-tax basis. For example, if  the dividend yield is 4% on a pretax basis and your marginal tax rate is 30%, then enter 2.8% as the dividend yield (4% x (100%-30%)).

You can download D4L-Inflation.xls and be prepared for the next time someone tells you that dividend stock is not even covering inflation. Just ask them what is their projected inflation rate and the stocks projected dividend growth rate.

Full Disclosure: Long WMT, GD, CL, KO, JNJ, KMB. See a list of all my income holdings here.

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(Photo Credit)

My goals were defined in this December 1, 2007 Investing Goals post and updated in my 2010 Investing Goals post. Below is an updated version of the table found in the original post.

The above information covers the current month and year-to-date through the current month.

Click here for a Detailed Historical Progress Table.

For the month, annualized dividend income increased $330, and Yield on Cost (YOC) decreased 0.01%. This month’s changes were a net of new purchases and dividend changes (no sales for the month). Let’s examine each of the these categories:

Purchases: The $399 increase in annual dividend income and 0.02% decrease in YOC related to the following purchases (yield at the time of purchase):

• $79 McDonald’s Corp. (MCD) 3.12%  [Analysis]
• $81 General Dynamics Corp. (GD) 2.64% [Analysis]
• $90 Automatic Data Processing, Inc. (ADP) 3.37% [Analysis]
• $149 iShares S&P U.S. Preferred Stock Index (PFF) 5.67%

Only PFF increased my YOC, while three securities lowered it. As noted in earlier updates, I generally expect YOC to drop each month since most new investments will yield less than my current YOC, and dividend increases will not be sufficient to offset it.

Dividend Changes: The $4 decrease in annual dividend income and the 0.03% decrease in YOC related to the following dividend changes (a=dividend stated in annual terms, q=quarterly, m=monthly):

• ($4) Invest Grade Corp Bond (LQD) $5.53a>$5.48a
• $1 Long-Term Bond ETF (BLV) $3.94a>$3.95a
• ($2) Intermediate-Term Bond ETF (BIV) $3.41a>$3.39a
• ($3) Emerging Markets Sovereign Debt (PCY) $1.65a>$1.64a
• $4 Clorox Corporation (CLX) $0.50q>$0.55q

Sales: The $65 decrease in annual dividend income and the 0.04% increase in YOC related to the following sales:

• ($65) AFLAC Inc. (AFL)

This month I exceeded my 2010 goal of $9,500 in annualized dividend income. With four months to go, I am confident of achieving $10,000 in annualized dividend income by December 31, 2010, assuming minimal dividend cuts.

That’s it for this time. The next monthly progress update will be early October.

(Photo: sanja gjenero)

One concern is how will Social Security, pensions and other retirement vehicles withstand the strain. The 2008 market crash has added concern to the viability of these plans. In a New York Times article, “The Unloved Annuity Gets a Hug From Obama“, income annuities are what the administration is promoting to alleviate the pending problem, but is this really a workable solution?

What are income annuities?

The New York Times article describes annuities  as:

“At its simplest, which is how the White House seems to want to keep it, an annuity is something you buy with a large pile of cash in exchange for a monthly check for the rest of your life.”

What are the problems with income annuities?

Charlie Farrell in “Why Annuities Won’t Fix The Retirement Problem“, described the following problems with income annuities:

I. Cash Out Is Determined By Cash In
The income an annuity will produce is directly related to the amount of money you put into the annuity. So if you don’t have much money saved for retirement, you won’t get much of an income stream from an annuity. And most people don’t have much money saved for retirement.

II. Payment Rates Aren’t High
At today’s interest rates, you’ll get about $5.85 of income per year for every $100 you contribute to the annuity (based on a recent quote from a highly-rated insurer). And this $5.85 would be paid to you and your spouse for as long as you both live. That’s basically a 5.85% payout on your savings in retirement.

III. No Provision For Inflation
Annuity payments don’t increase and are fixed for life. So if inflation runs at 3% a year (the average for the last 80 years), your retirement income will be cut by about 45% by the time you’re 85. Meaning that the $5,850 of income will buy you about $3,220 of stuff in today’s dollars, and the $58,500 will buy you about $32,200. You can buy an inflation-adjusted annuity, but when you do that, your initial payout goes down to somewhere around 4%.

IV. Investment Risk
With an annuity, you lose access to your money. Essentially, you gave your money to the insurance company to purchase the annuity. It’s theirs to keep forever, and your income is dependent on the insurance executives running a sound insurance company for the next 30 or so years. That’s always hard to predict and carries it’s own risks.

Dividend Stocks – A Viable Alternative

Instead of turning over your life-savings to an insurance company (that could be the next AIG), why not build a diversified portfolio of dividend growth stocks? This works best if you have time before retirement. The initial rate may not be as high as the 5.85% quoted above, but careful stock selection will allow growth well in excess of inflation. Unlike depending on a single insurance company, a diversified portfolio of at least 30 stocks will greatly reduce the risk. Below are some good dividend growth stocks that will provide a yield-on-cost greater than 5.85% in ten years, based on the listed assumptions:

		Current	Dividend	10-Year
Company	Analysis	Yield	Growth	YOC
Sysco Corp. (SYY)	Link	3.16%	6.52%	5.95%
Piedmont Nat. Gas (PNY)	Link	4.17%	3.74%	6.02%
Clorox Company (CLX)	-	3.24%	6.83%	6.27%
Intel Corporation (INTC)	-	3.07%	7.44%	6.29%
Coca-Cola (KO)	Link	3.19%	7.32%	6.47%
Chevron Corp. (CVX)	Link	3.73%	5.95%	6.64%
General Dynamics (GD)	Link	2.68%	10.07%	6.99%
Procter & Gamble (PG)	Link	2.95%	9.87%	7.55%
Universal Health (UHT)	-	7.26%	1.47%	8.40%
CenturyLink, Inc. (CTL)	-	8.14%	3.57%	11.56%

Social Security was never intended as a retirement plan, but as a supplement to savings. The key to a successful retirement is not to rely on any single income stream, but to build multiple income streams. These would include Social Security, 401(k), IRA (Roth and/or Traditional), pension plan, bonds, and of course, good dividend growth stocks. There is a reason the insurance companies are excited that Obama is focusing on annuities, and it isn’t because they care about you.

Full Disclosure: Long SYY, CLX, INTC, KO, CVX, PG, CTL. See a list of all my income holdings here.

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(Photo: sanja gjenero)

Linked here is a detailed quantitative analysis of General Dynamics (GD). Below are some highlights from the above linked analysis:

Company Description: General Dynamics is the world’s sixth largest military contractor and also one of the world’s biggest makers of corporate jets.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

1. Avg. High Yield Price
2. 20-Year DCF Price
3. Avg. P/E Price
4. Graham Number

GD is trading at a discount to 1.), 2.) and 3.) above. Since GD’s tangible book value is not meaningful, a Graham number can not be calculated. The stock is trading at a 6.4% discount to its calculated fair value of $65.49. GD earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section there are three possible Stars and three key metrics, see page 2 of the linked PDF for a detailed description:

1. Free Cash Flow Payout
2. Debt To Total Capital
3. Key Metrics
4. Dividend Growth Rate
5. Years of Div. Growth
6. Rolling 4-yr Div. > 15%

GD earned two Stars in this section for 1.) and 2.) above. A Star was earned since the Free Cash Flow payout ratio was less than 60% and there were no negative Free Cash Flows over the last 10 years. The stock earned a Star as a result of its most recent Debt to Total Capital being less than 45%. The company has paid a cash dividend to shareholders every year since 1979 and has increased its dividend payments for 17 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:

1. NPV MMA Diff.
2. Years to > MMA

The NPV MMA Diff. of the $1,090 is below the $1,800 target I look for in a stock that has increased dividends as long as GD has. If GD grows its dividend at 10.1% per year, it will take 5 years to equal a MMA yielding an estimated 20-year average rate of 4.02%.

Other: GD is a member of the S&P 500 and a member of the Broad Dividend Achievers™ Index.

Conclusion: GD earned one Star in the Fair Value section, earned two Stars in the Dividend Analytical Data section and did not earn any Stars in the Dividend Income vs. MMA section for a total of three Stars. This quantitatively ranks GD as a 3 Star-Hold.

Using my D4L-PreScreen.xls model, I determined the share price would need to decrease to $51.39 before GD’s NPV MMA Differential increased to the $1,800 minimum that I look for in a stock with 17 years of consecutive dividend increases. At that price the stock would yield 3.19%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the target $1,800 NPV MMA Differential, the calculated rate is 11.7%. This dividend growth rate is higher than the 10.1% used in this analysis, thus not providing  any margin of safety. GD has a risk rating of 1.25 which classifies it as a low risk stock.

GD is an important supplier to the U.S. Department of Defense with strategic products such as the M1 Abrams battle tank and Virginia-class nuclear submarines. Near-term, funding for new Virginia Class submarines should provide continued growth. Defense spending will likely ease long-term due to budget deficits and shifting military priorities. However, GD’s varied products and acquisitions should allow the firm to continue to generate returns above their cost of capital for years to come. GD is worthy of additional consideration when trading below my buy price of $65.49. For additional information, including the stock’s dividend history, please refer to its data page.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I held no position in GD (0.0% of my Income Portfolio). See a list of all my income holdings here.

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Calculating A Dividend Stock’s NPV MMA Differential

The basis of this calculation is a hypothetical $1,000 investment in a stock and a Money Market Account (MMA) earning earning a 20 year average rate (I use a 20 year Treasury as a proxy).  The value calculated is the net present value (NPV) of the difference between the dividend earnings of this investment and the interest income from the MMA over 20 years.  Other assumptions include: 1.) dividends grow at the calculated dividend growth rate, 2.) dividends are reinvested, 3.) share price appreciation is not considered, 4.) interest income is reinvested in the MMA. The dividend growth rate used is calculated as the minimum dividend growth rate of the 1, 3, 5, 7, 10 year dividend growth rate or 15%, if dividends grew on average in excess of 15% for each consecutive 4 year periods, within the last 10 years of history.

Interpreting The NPV MMA Differential

The calculation takes into account the time value of money, thus if it takes too long for the stock’s dividend yield to exceed the MMA rate, then the calculation will return a negative value. This means you are financially better off to put your money in the MMA. If the dividend stock is a better investment then the NPV MMA Diff. calculated will be positive. Like dividend yield, it is desirable to have a higher NPV MMA Diff. But also like a dividend yield, if it is too high, you need to start asking why? The NPV MMA Diff. can be used to compare two or more investments.

Comparing Various Dividend Stocks NPV MMA Differential

Like all calculations, the value of the output is directly tied to the quality of the input (garbage in, garbage out). For the sake of the illustration let us consider the calculated inputs are correct and sustainable.

Which of these would you rather purchase:

- Vector Group Ltd. (VGR) with a 9.99% yield and a 3.61% dividend growth rate
- Chevron Corp. (CVX) with a 3.68% yield and a 5.95% dividend growth rate
- McDonald’s Corporation (MCD) with a 3.23% yield and a 15.00% dividend growth rate

Based on the NPV MMA Diff. they would be ranked like this:

1. McDonald’s Corporation (MCD) | NPV MMA Diff: 8,429
2. Vector Group Ltd. (VGR) | NPV MMA Diff: 6,640
3. Chevron Corp. (CVX) | NPV MMA Diff: 780

As you can see neither yield nor dividend growth is the sole determinant of value. Below are several other companies in ascending order of their NPV MMA Diff:

General Dynamics (GD)
NPV MMA Diff: (339) | Yield: 2.16% | Growth: 2.01%

3M Company (MMM)
NPV MMA Diff: (260) | Yield: 2.47% | Growth: 2.00%

Clorox Company (CLX)
NPV MMA Diff: 171 | Yield: 3.12% | Growth: 4.35%

Consolidated Edison (ED)
NPV MMA Diff: 537 | Yield: 5.37% | Growth: 0.85%

Lowe’s (LOW) | Analysis
NPV MMA Diff: 748 | Yield: 1.38% | Growth: 15.00%

The Coca-Cola Company (KO) | Analysis
NPV MMA Diff: 890 | Yield: 3.34% | Growth: 7.32%

National Retail Properties, Inc. (NNN)
NPV MMA Diff: 972 | Yield: 6.91% | Growth: 0.00%

Johnson & Johnson (JNJ) | Analysis
NPV MMA Diff: 1,245 | Yield: 3.33% | Growth: 8.42%

Raven Industries (RAVN) | Analysis
NPV MMA Diff: 1,855 | Yield: 1.87% | Growth: 15.00%

TC PipeLines, LP (TCLP)
NPV MMA Diff: 2,255 | Yield: 8.01% | Growth: 1.74%

And if you believe all the underlying inputs (which I don’t), the top stock on the list is:

Courier Corporation (CRRC)
NPV MMA Diff: 54,801 | Yield: 5.56% | Growth: 15.00%

As with any projection based on historical information, the analyst must determine the sustainability of the inputs going forward. Put another way, past performance is no indication of future results. I have always heard the luckiest people in the world are those who work the hardest. In the same vein, the secret to finding the best dividend stocks often involves rolling up our sleeves and doing our homework.

Full Disclosure: Long CVX, MCD, MMM, CLX, ED, KO, NNN, JNJ. See a list of all my income holdings here.

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