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Dividends: How to Milk the Stock Market’s Cash Cows

Yesterday we wrote about Australia’s property. investment prospects. One day, property will make a cracking investment. Rental yields will cover mortgage costs easily. Especially if interest rates fall as the economy goes into a panic over falling house prices. Until then, count us out.

So where do you put your money now?

Well, we’ve made one suggestion below – dividends. But to be honest, it takes a whole new newsletter to figure out which investment ideas are going to be best suited to a rapidly changing world. Which is why the After America symposium featured a newsletter launch. A new newsletter that will be edited by yours truly.

Here’s what we told symposium goers about our plans and why they’re needed:

Your retirement is facing the worst possible environment. The global economic revolutions taking place have fundamentally altered the way your retirement decisions can safely be made. We’ve seen welfare states imploding in Europe to the horror of pensioners. We’ve seen stock markets return to the level they were at ten years ago, to the disappointment of retirees who must now return to work. We’ve seen interest rates at literally zero and negative when you take inflation into account, to the dismay of responsible savers. And we’ve seen population pyramids come to resemble Jenga towers ready to topple over.

People in Europe, Japan and America are learning the hard way what can go wrong without the right preparations for retirement. In those places, retirement plans have been thrown into turmoil by all kinds of global changes. European retirees are having to return to work, Americans are being forced to invest their dwindling nest egg into risky assets in an attempt to recover lost ground, one in ten Britons is turning to gambling or the lottery to overcome debt, and in Japan the elderly have reportedly turned to a life of crime at record levels.

I am determined to make sure none of these will happen to you. I think we can learn from what has happened overseas. We’ve learned that you can’t rely on the government and you can’t rely on traditional ways of funding your retirement if you want it to be a good experience.

While the majority of Australians continue to ignore the global threats bearing down on the traditional ways of preparing for and living in retirement, I’m hoping you will be prepared.

After America symposium goers already know about the first idea we’ve been polishing up for our first subscribers. And a delegate known only as ‘Herr Otto’ introduced himself after your editor’s speech to regale a personal story about just how powerful the idea is. So we know it works. Now it’s a question of whittling down the shortlist of recommendations.

But for today’s Daily Reckoning. we have similar, but simpler, ideas in mind:

Dividends – Patient Investments for Impatient Times

Have you ever noticed how your neighbours, your friends, your work mates are more focused on what to do with their money today and tomorrow than what they might need to do with it next week or next year? Australian credit card debt surpassed a record $50 billion at the end of last year. Talk about sacrificing the future!

Sadly, the governments of the world prefer you to consume now to prop up the economy rather than prosper after their term is up. Low interest rates, taxes, bureaucracy and regulations all direct cash flow into the path of least resistance – Myers and David Jones – rather than investment in wealth creators like small businesses.

As miserable as this situation is for the economy, it means there should be a premium out there for those with a vision for the future and the fortitude to save for it; for the savers, lenders and investors of Australia. They should be able to do well for themselves while their spendthrift neighbours try to keep up with the Jones’s.

And there are groups of investors who do benefit from exercising patience now in exchange for amassed benefits later. The dividend-receiving shareholders of certain ASX-listed companies are one of those groups.

For instance, it took Campbell Brothers (CPB) shareholders 15 years to achieve a 100% dividend yield on their initial investment through dividend growth. That means they turned a $10,000 investment in 1997 into a $10,000-a-year income stream 15 years later. Not bad, right? And on top of that, during the 15 years they also received regular dividends… dividends which have grown beyond yielding 100% since.

Below is a list of other dividend-paying companies that have also yielded more than 100% on an initial investment. See how long it took them to reach 100% dividend yields on initial investments, given their dividends last year

or before.

BKL: Blackmores took 21 years to reach 100% dividend

AHD: Amalgamated Holdings took 16 years

COH: Cochlear took 17 years

NCM: Newcrest took 15 years (although only through a special dividend last year)

CCV: Cash Converters took 11 years

QBE: QBE Insurance took 22 years

MTS: Metcash took 14 years

TAH: Tabcorp took 19 years

The idea that a business would repay you the value of your initial investment each year is a pretty impressive proposition. Especially in a market where capital gains have gone missing as they have in the last seven years.

Seven Years of All Ords. With Nothing to Show

In the last seven years, you could have been receiving and further accumulating cash-paying dividends that steadily grew over time. Dividends that could be set to grow indefinitely.

But finding the stocks that will be the cash cows of the future isn’t easy. What do you need to look for?

Jim Nelson, editor of the Lifetime Income Report. uses this formula for finding successful dividend stocks:

Dividend Yield + Growth + Sustainability = Market-Beating Income

Nelson’s idea is to find a company paying a reasonable dividend yield, which it has been growing out of growing revenue and profits, using a sustainable balance sheet (low levels of debt). Stocks that have all three of these attributes are the market-beating income providers of their day.

So investing in dividend-paying stocks is not as easy as picking the one with the highest yield you can find. You see, dividend data is always out of date. And unlike other income investments, which are based on interest rates, dividends can fluctuate all over the place from payment to payment.

Then there’s the fact that you have to stomach capital gains and losses without panicking.

All this can add up to quite a bit of confusion for dividend investors.

For example, Billabong’s [ASX:BBG] dividend yield a few weeks ago was around 10%. But that was based on its 2011 dividend and 2012 share price. Billabong’s 2012 dividend is expected to be much smaller.

The same goes for Data Limited’s [ASX:DDR] reported 50% dividend yield if you uses 2012 prices, but 2011 dividends. This year’s dividend for both companies is a small fraction of 2011’s, lowering the dividend yield dramatically.

On the other side of the equation, dividend growth can turn a low dividend yield into a high one over time. So a share yielding 2% now might end up yielding far more than a share yielding 5% now.

The fact that a company is keeping its cash rather than paying it out to shareholders might signal that it is still using the cash to grow profitably. That in turn could lead to impressive dividend growth in the future.

There are other sources of confusion when you’re looking to invest in dividend-paying companies. Some companies pay out dividends as a percentage of their profits, or thereabouts. Others try and target a fixed dividend, only rarely raising or lowering that amount.

So why would you bother looking for dividend payers?

Why should you risk your hard-earned cash in what is, after all, a gamble – the stock market?

Well, dividend stocks have both yield and growth potential. That makes them a good bet in uncertain economic times.

Take a look at this simple chart we put together.

While interest rates are high, it may not seem like the greatest proposition to go dividend hunting. But savings and other income investments have a capped gain. Whereas stocks don’t – they can go up in value.

Dividend stocks are the happy medium.

A balanced approach would be to start drizzling your investments with a selection of high-yielding stocks, just in case things do improve in the market. If they don’t, you will probably still receive dividends.

There’s one rather odd factor that sometimes features in dividend-paying stocks. Falling interest rates might cause their prices to be bid up. If the Reserve Bank continues to lower rates, dividends will appear more and more attractive relative to interest income. Buying dividend stocks will push up their prices and thereby lower their yield. So dividend payers could hold up during bad times.

The number of moving parts in dividend investing seems to turn a straightforward proposition into a problem rather than a solution. But navigated well, dividends can become the biggest driver of any portfolio’s returns. And just the kind of returns you would want in retirement – cash flow.


Nick Hubble

for The Daily Reckoning Australia

The “After America” Archives…

2012-03-17 – Nick Hubble

Category: Forex

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