The Dividend Investing Resource Center

Letting Dividends Do Their Work

Dividend investing is a means of building wealth over a long period of time with reduced risk. Many brokers offer fee-free purchases and reinvestments and the ability to reinvest fractional shares. Dividend investing is for the long term buy-and-hold type investor who wants to sleep at night while their investments steadily build.

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Articles from The Prudent Investor

IBM Joins Dividend Champions

by George L Smyth

IBM joined the elite Dividend Champions with their dividend increase in May which completed 25 straight years of dividend increases. I look at whether or not it is time for dividend investors to add it to their portfolios.

     

On 28 April 2020 IBM announced that holders of their stock on 8 May would receive a quarterly cash dividend of $1.63 per share.  With the payment on 10 June, the company will have increased their dividend for 25 consecutive years.  This allows them to join the 140 other Dividend Champions that have accomplished this feat.

I bought my first computer in 1981, a TI-99/4A.  Back then many companies other than Texas Instruments sold computers, like Sinclair (which I also owned), Commodore (which offered the Amiga and VIC-20), and Apple.  Each had its proprietary operating system, as well as software that worked only on their machine.

During this time IBM, as well as other companies, built computers that were generically referred to as IBM-compatible.  They utilized the MS-DOS operating system, which over time morphed into Microsoft Windows.  The licensing arrangement of this operating system allowed hardware companies to use a common platform for software, building a base of users that eventually shut out all competitors other than Apple. 

Today IBM primarily sells infrastructure services, software, and IT services, hardware representing less than 10% of their revenue.  Operating in 175 countries they service 95% of all Fortune 500 companies and manage 90% of all credit card transactions.

Should IBM be added to your dividend portfolio?  This is a question only you can answer based on your personal needs and expectations.  There appears to be a major upside possible, as well as a significant risk.  Below is an argument for and against adding IBM to your dividend portfolio.

On the One Hand

IBM has been around seemingly forever.  The name was changed from the Computing-Tabulating-Recording Company to International Business Machines in 1924.  Their first experiments in computers date back to the 1940s, and until the 1980s the company name was synonymous with computers to the extent that a common saying amongst consultants was, “You won’t get fired recommending IBM.”

The current dividend yield of 5.2% is better than 2/3 of dividend-paying companies.  The average yield of the S&P500 is 2% and the industry only 1.6% so this is very attractive.  Dividend growth over the past ten years has been 10.1%

The payout ratio of 63.5% is high, compared to 36% in the industry, but not high enough to cause concern about the continuance of the dividend.  A payout ratio becomes concerning when it moves over 100%, at which point the company needs to borrow money or sell assets to afford to pay the dividend.  In 2017 IBM’s payout ratio reached 97%, but they showed that they consider the dividend to be an important element in their relationship with their investors by not having it affect the payout.

From a current valuation standpoint, the stock looks very attractive.  The P/E of 12 places it in the lower end of the spectrum, and if one is to believe the calculations of fair value at $163 then there is plenty of room for the price to grow.

On the Other Hand

It would be reasonable to discount fair value looking into the future as the company has missed revenue estimates six of the past seven quarters, so these prediction models may not be helpful.

The share price of IBM over the past several years, during a time when the market has been on an unprecedented run, has been, to put it mildly, disappointing.

IBM Dividend Adjusted Return
Chart provided by StockRover

One should not purchase only for the dividend, that is what interest-bearing savings accounts and certificates of deposit are for.  The investor should take both share price appreciation as well as dividend growth into account when considering a purchase.  IBM’s stock price loss of 10% over the past five years, at a time when the S&P 500 has increased by 50%, is notable.

Although the dividend growth over the past ten years has been 10.1%, over the past five it has fallen to 8%, and over the past three years dropped to 5%.  The dividend increase announced in May did mark 25 consecutive years of dividend increase but the increase was only one cent.  This token increase one might think is the culmination of, so to speak, a flattening of the curve, as far as dividend growth is concerned.

Dividend Increase History
Excel chart

The reason for the paltry increase stems from IBM’s $34 billion acquisition of Red Hat, IBM’s largest deal ever.  This has increased their debt to $69.4 billion, representing $78.21 per share.  The deal will help IBM with a larger presence in the cloud, which is one of its drivers of growth.  The hopes are that this will end three consecutive quarters of declining revenue.

It’s Your Decision

It is interesting to read the buzz at this point.  I have read articles decrying IBM’s lack of performance followed by others pointing to the opportunity.  If the Red Hat acquisition goes well then IBM could do some catching up on Microsoft and Amazon in the cloud infrastructure space.  If not then the debt could sideline IBM for years to come.

This is an essential growth area that could help IBM win new customers.  There is reason to be hopeful that it will happen, as the first-quarter report showed that Cloud & Cognitive Software was the only unit that recorded notable sales growth, increasing by 7% - and this was in a coronavirus atmosphere.

The question as to whether IBM’s debt will saddle the company with an inability to move strongly into the cloud space or the acquisition fuels the company into badly needed growth will eventually be answered.  The risk/reward factor is likely to be key with one’s decision on purchasing at this time.

4 ETFs for Dividend Growth Investors

by George L Smyth

There are ETFs that cover pretty much any groupings one can think of and that includes issues of interest to long term investors. I look at four ETFs that are geared toward the prudent dividend growth investor.

To understand exchange traded funds (ETFs) one needs to go back to 31 December 1975.  On that date John Bogle opened the First Index Investment Trust, a mutual fund that tracked the S&P 500.  Started with just $11 million in assets the fund was called "un-American" and referred to as "Bogle's folly" by his competitors.  Later renamed the Vanguard 500 Index Fund, it crossed the $100 billion milestone by the end of 1999.  Today Vanguard is the largest provider of mutual funds with assets over $5 trillion.

With the success of what Fidelity Investments Chairman Edward Johnson once referred to as “just average returns,” companies realized that there was money to be made bypassing mutual funds, which can be complicated for the investor and require minimum amounts to participate.  To make things easier for the investor to participate, after some fits and starts, the first ETF to be available in the United States was Standard & Poor's Depositary Receipts, or SPDR, which tracks the S&P 500.

With about 5,000 ETFs globally (1,750 in the U.S.), these instruments offer convenience and affordable exposure to a wide range of investments.  According to etfdb.com there are over 230 dividend ETFs currently being traded in the U.S., so that is a rather large bucket from which to choose.  That said, the prudent dividend investor generally looks for companies with strong dividend growth over a long period of time, so that narrows things down a bit.

What I will do is to look at four ETFs that track companies focusing on dividend growth.  After all, we have found that Dividend Champions, Aristocrats, and Kings have done quite well when compared to the S&P 500 Index, so if one is seeking to go the ETF route then it might make sense to find one that tracks one of those lists.

Alas, there are no ETFs that track Dividend Champions or Kings.  Why this is not the case it a mystery to me.  Dividend Champions and Dividend Aristocrats are pretty much the same with the exception that Aristocrats must be listed in the S&P 500 while the Champions do not have that restriction.  We will examine an ETF that follows the former.

As Dividend Kings need to have offered at least 50 consecutive years of dividend growth there are only 28 companies in the list.  While it seems to me that this could be an extremely low expense ratio ETF, one could make their own ETF by buying all of the companies themselves.

As this blog and website are geared to the small investor one might wonder how I can make such a suggestion.  After all, we do not have access to the resources for doing this.  One idea might be to copy the companies in the list  and paste them into InvestMete (AWR DOV NWN EMR GPC PG PH MMM CINF JNJ KO LANC LOW FMCB CL NDSN HRL TR ABM CWT FRT SCL SJW SWK TGT CBSH MO SYY), enter any number for the Amount, and click the Determine InvestMete button.

It will take a little while to process all of them, but when the numbers are displayed sort by InvestMete and buy what you can of those with the highest InvestMete amounts.  My guess is that by purchasing additional shares this way on a regular basis, over the years this dollar cost averaging strategy would eventually include a great many of these companies.  But this is an article about 4 ETFs.

ProShares S&P 500 Dividend Aristocrats ETF

NOBL is the best known ETF amongst those who look for dividend growth.  It is the only one to track the S&P 500® Dividend Aristocrats® Index, which consists of companies that have increased their dividend every year for the past 25 years, are members of the S&P 500, and meet certain liquidity requirements (actually, all of the S&P 500 meets these liquidity requirements).  The stocks within this ETF are equally weighted and are rebalanced four times a year.

Yield 5 Year Return 10 Year Return Expense Ratio
1.94% 10.86% N/A 0.35%

SPDR® S&P® Dividend ETF

SDY tracks the S&P High Yield Dividend Aristocrats (^SPHYDA), which are companies that have increased their dividend for at least 20 consecutive years.  Stocks are weighted within the index by indicated yield and adjusted every quarter.  The dividend growth streak gives the roughly 60 holdings the characteristic of being some of the safest companies and tend toward stable industries.

Yield 5 Year Return 10 Year Return Expense Ratio
2.52% 10.53% 13.02% 0.35%

Vanguard Dividend Appreciation ETF

VIG tracks the NASDAQ US Dividend Achievers Select Index, which contains companies that have increased their dividend over at least the past ten years.  (Disclosure – I recently started a small stake in this ETF.)  REITs are not included in this ETF because they do not receive favorable tax rates from qualified dividends.  About 180 companies comprise the ETF with exposure primarily in the consumer staples, health care, and industrials sectors.

Yield 5 Year Return 10 Year Return Expense Ratio
1.63% 12.13% 12.96% 0.06%

Schwab U.S. Dividend Equity ETF

SCHD, like VIG, contains companies that have increased their dividend for at least the past ten years.  It tracks the Dow Jones U.S. Dividend 100® Index, excluding REITs, master limited partnerships, preferred stocks and convertibles.  The index is modified market capitalization weighted.  The mix of dividend growth and yield in the roughly 100 companies allow for a greater payout than the above ETFs.

Yield 5 Year Return 10 Year Return Expense Ratio
3.03% 11.32% N/A 0.06%

Of Note

SDY and VIG have been around since 2006, so they have 10 years of history to report.  Since these ETFs have fairly strict consecutive streak requirements and are passively managed this is really of no advantage over others with less history.

Of definite advantage, however, is the fact that both VIG and SCHD have very low expense ratios.  Expenses can savagely cut into one’s holdings, so having a low expense ratio is an important part of maintaining one’s portfolio.  If a higher expense ratio is to be paid then there should be a strong reason for seeing more money taken out of one’s pocket.

Other Growth Dividend ETFs

Indeed there are other ETFs that base their selection on dividend growth and this was certainly not intended to be a complete list.  However, they do start to become redundant.  For instance, Invesco Dividend Achievers ETF (PFM), which was mentioned in Dividend Champions, Achievers, Kings and Aristocrats – A Comparison against the Indexes, is nearly the same as the Vanguard Dividend Appreciation ETF (VIG) with the exception that the former allows REITs and the latter does not.  However, with an expense ratio of 0.54% it does not compare well against VIG.

There are others, like iShares Core Dividend Growth ETF (DGRO), that are based on dividend growth but only require a consecutive string of five years, similar to Dividend Challengers.  It does offer an attractive expense ratio of 0.08%, but in my mind such a short streak, while certainly better over the long haul than companies not offering a dividend, is less of a growth streak we would normally seek.

Finishing Up

With research one should be able to find other ETFs that better fit their specific requirements.  If one is looking for ETFs that concentrate on dividend growth over a long period of time, any of the above can work well as the cornerstone in one’s portfolio.

Other Articles of Interest

InvestMete

Dividend Champions, Achievers, Kings and Aristocrats – A Comparison against the Indexes

Understanding Dividend Yield

 



This website is maintained by George L Smyth