Zolak Written by Sam Kovacs Introduction There are certain dividend stocks which will positively kill your portfolio’s ability to generate the level of cashflow you require to comfortably retire on dividends. As dividend investors, we aim at building a passive income snowball, an idea which I presented in detail in my previous article: “Sam’s Dividend Income Snowball Masterclass”. Author’s art When I talk about building a passive income snowball, some of you have asked me: But Sam, I thought you were an active investor, what’s the deal with passive income? It will take a minute to wrap your head around this idea, but even active investing generates passive income. Here’s why: The general definition of passive income, as I like to think of it, is that the work is done upfront, and the initial effort does the heavylifting of driving returns over time. When we think of active income, you work for money. It’s what you earn from your job or business where your time and effort directly generate income. Think salaries, wages, or profits from active business involvement. It’s hands-on, requiring ongoing effort to earn. When we think passive income, money works for you. It’s income generated with minimal ongoing effort once set up. Examples include rental income, dividends from investments, or royalties. “Work” is still required to generate these sources of income. Think about rental income: You need to purchase a property, find a tenant, maintain it, pay the bills, and so on. Even if you hire people to do those tasks, you decrease the degree of activity, but you still need to manage those people. Hire someone to manage those people, then you still need to periodically review this person’s performance. It gets less and less active but is never 100% passive. With dividend investing, the same could be said. If you’re a passive investor and put your assets into an ETF like the Schwab US Dividend ETF (SCHD) and drip it, there was still some selection of the ETF, still some reviews of the performance that need to be done and so on. If you’re an “active” dividend investor like we are, then the security selection requires more activity. To decrease the level of activity, many of you will likely subscribe to services which help you cut through the chaff, or at the very least, read research from other analysts to help you in your own research process. But by far and large, all investing is “passive income”. If you do research, buy a stock at a brilliant price, and let superior management do their thing, and grow your dividends year in year out, and that the dividend can be reinvested to grow your income even more, then it is easy to argue that your money works for you more than you work for your money. If you want your money to work for you, give it the best job. What did your parents want for you more than anything? For you to grow up, stay off drugs, find a nice person to marry, and get a good job. The best job you could get away with. If it was a lawyer, a doctor, an engineer, all the better. If not a trade job that would pay well would work brilliantly too. Author’s art You could even become one of those stock market guys (gasp). They important thing, is that your parents likely wanted you to do well. And you should want your money to do well too. And where you chose to invest your money, becomes its job. We demonstrated that not every investment was right for every investor, but there are some investments which are right for no investors. Just like there are jobs which are invariably low paying and less desirable, the same goes for investments. You should want the best for you money. The best comes in all shapes and sizes. Consider investing $10K today in UnitedHealthGroup (UNH). UNH DFT Chart (Dividend Freedom Tribe) The stock is currently yielding 1.75%, and has been growing its dividend at a 14% CAGR for the past 10 years. If the stock can keep it up for the next 20 years (and sure that’s a big if, but you could always move from such an investment to another attractive one if this one slows down) then 10 years from now, if you invest $10K today and reinvest dividends you can expect $645 in annual income. 20 years from now you can expect $2,777 in annual income. UNH Dividend Snowball (Dividend Freedom Tribe) That’s quite attractive numbers, especially looking 20 years down the line. Now consider investing that same $10K in Omega healthcare Investors (OHI), which is up 10% since we suggested investing in it in May. OHI DFT Chart (Dividend Freedom Tribe) Besides the fact that it is looking at attempting a 3 year breakout, OHI yields 8%. Now even if you don’t expect any dividend growth from OHI, reinvesting an 8% compounding dividend does marvels by itself. Invest $10K in OHI at 8%, reinvest the dividend at that same yield, then 10 years from now you can expect $1,619 in dividends per year. In 20 years, you could expect $3,515 per year. OHI Dividend Snowball (Dividend Freedom Tribe) For those of you wondering when UNH would take over OHI, it would be in year 23. This makes it quite clear that if you’re 30-40 y/o you might favor UNH, but if you’re planning on retiring in the next decade, OHI might be better suited to reaching your income goals. But there are certain stocks, which no matter what your profile is, have combinations of yields and growth which just don’t work, and which make them poor dividend investments as a consequence. Now it should be noted that being a poor dividend investment doesn’t mean you won’t get any capital gains. But why chose poor dividend returns, when you can have good dividend returns AND good capital gains? Why Dividend Aristocrats often make poor dividend investments. A Dividend Aristocrat is a company that is part of the S&P 500 and has a track record of increasing its dividend payouts to shareholders for at least 25 consecutive years. These companies are often considered reliable and stable, as they demonstrate a commitment to returning capital to shareholders through regular, growing dividends. Now there are a handful of dividend aristocrats that we like and cover. Realty Income (O), Chevron (CVX), Lowes (LOW) come to mind as great dividend stocks which will contribute positively to your dividend income snowball provided they are purchased at the right prices. But many of them no longer “got it”. And its understandable. Every time you increase your dividend generously, you make it harder to match that increase the next year. To grow your dividend by 10% when a company pays out $100mn, means a $10mn increase. For a company to increase the dividend by 10% when it pays out $10bn, means a $1billion increase in dividend payments. It’s a lot easier to generate an extra $10mn in profits than it is to generate an extra $10bn. But dividend investors measure their increases in percentage points, not in cents or dollars, so companies need to fight tooth and nail to continue increasing their dividends…until it becomes unsustainable. How many companies were considered safe, trustworthy Dividend Aristocrats only to slash their dividends and destroy shareholder value immensely in the process? Author’s art You can see on the DFT charts below the destruction in value in the areas behind the price chart. Walgreens Boots Alliance (WBA) cut its dividend in half, undoing 12 years of dividend growth. WBA DFT Chart (Dividend Freedom Tribe) 3M (MMM) cut its dividend, undoing a decade of dividend growth. MMM 20Y DFT Chart (Dividend Freedom Tribe) And worst of all Leggett & Platt (LEG) cut their dividend by 89%, undoing 30 years of dividend progress. LEG 40Y DFT Chart (Dividend Freedom Tribe) Not all dividend aristocrats will cut their dividends, but what this shows is that a firm’s reputation to maintain its dividend will mean that it will overextend itself, and do anything it can to keep growing their dividend, even if it means they will ultimately have to cut it. Now not all of them will have to cut it. Some have found a balance in growing the dividend by a modest amount each year, in line with their long term profit growth. And there is nothing wrong with growing at the same rates of profits, even if the rate of growth of those profits is low, in fact it is a lot more reasonable than committing to unsustainable dividend growth. But for low growth rates to work, we need higher dividend yields. But many Dividend Aristocrats never offer these higher yields. Investors have become enamoured with their perceived safety (despite the multiple instances proving they can be just as bad as any other stock) and in the process have bid them up to high valuations and low yields. Low yield and low growth = an unhappy dividend snowball. It’s like taking a very small snowball, and putting it on a hill with a very low slope: it never gets any momentum. 3 Dividend Aristocrats that will kill your passive income snowball With that in mind, these are 3 dividend aristocrats, which will absolutely kill your passive income snowball. 1. Colgate Author’s art Relative to its historical yield, Colgate (CL) is overvalued. Whenever it has yielded less than 2.2% in the past decade, it has spelt out danger, and subpar returns in upcoming years, as you can see from when the shares were in the red area on the chart below: CLX DFT Chart (Dividend Freedom Tribe) But even when CL yields slightly more, it doesn’t make a good dividend investment. Last year the dividend grew at 4%. Over the past decade, it’s averaged a 3% CAGR. The dividend is well covered, paying out only 55% of free cashflow, which shows me that CL is taking the more conservative approach regarding its dividend. I don’t expect it to be cut, I just don’t expect it to do much for your income snowball. Now let’s project the income from a $10K investment. Let’s assume that the dividend grows at 4% from here onwards, which would be higher than in the past 10 years. CL Dividend Snowball (Dividend Freedom Tribe) 10 years from now, you’d be looking at $342 in annual dividends, or just 3.4% of your original investment, and that is assuming dividend reinvestment. $614 in 20 years. Fellas, let me spell this out for you: This is unattractive growth at its best. For a stock to be growing at 3-4%, we’re generally looking for at least a 4% yield. The last time Colgate yielded that much was in the 80s. Forget this stock if you like money. 2. Johnson & Johnson Author’s art I feel like I’m going to get in trouble here. There are certain stocks which you should never place next to the words “sell” if you want to make friends on Seeking Alpha. Johnson & Johnson (JNJ) is one of those stocks. When in January 2021, I said that it was time to sell JNJ I was met with the usual criticism: you really can’t go wrong with JNJ. No sense in selling JNJ Superficial article. Not worth reading. Not impressed with the logic Your strategy smacks of market timing which is contrary to DGR strategy. Buy and hold works best, so long as you are willing to sell stocks when there is a problem. There is no problem at JNJ. Terrible article! Why would you chase people away from JNJ during a pandemic. It’s part and parcel of broadcasting an opinion on the internet. However, the proof is in the pudding, and since that article, the stock is down 12.65%, while the S&P 500 is up 45%. SeekingAlpha Now sure, I don’t invest in the S&P 500, but around the same time, I suggested Snap-On (SNA) at $180 which is today at $260, having increased by the exact same amount as the S&P 500, more after dividends. So no, I do not believe that “buy and hold works best”. Our results proove it. But surely this time around, things are different no? After all, back then JNJ yielded around 2.4-2.5%, a very low amount for JNJ. Today, after having corrected, JNJ yields 3.37%. Over the past decade, whenever JNJ has yielded this much, it has been a marker of the bottom. JNJ DFT Chart (Dividend Freedom Tribe) The problem is, that I don’t see JNJ growing at the same rate they have in the past. If we look at JNJ’s dividend growth over time, it has grown at a 7.6% CAGR over the past 20 years. It has grown at 5.8% over the past 10 years, 5.2% over the past 5 years, and only 4.2% this year. The trend is clear. As JNJ continues to mature as a business which has been growing dividends for an extremely long time, it becomes difficult for it to match past growth rates. So I believe the dividend will only achieve 4% dividend growth over the next decade or two. And even though it yields considerably more than Colgate, it still isn’t enough to justify the future growth. If you invest $10K in JNJ at the current price and reinvest the dividends at the same 3.37% yield while the dividend grows at 4% per annum, then 10 years from now you could expect $639 in dividends, and 20 years from now $1,301. JNJ Dividend Snowball (Dividend Freedom Tribe) As you can see, 10 years from now you’d have similar income as from a low yielding high growth name like UNH (and less than slightly higher yielding high growth names which we usually favor), but then another 10 years later and the income looks subpar compared to other opportunities. Our rule of thumb benchmark is that an investment should yield 8%-10% of the original investment 10 years from now. It would take JNJ 14-17 years to achieve this, making it undesirable. 3. Walmart I don’t like Walmart (WMT). I didn’t quite like shopping there as a student when I lived in Montreal, and I dislike it as investment even more. Especially given that it keeps proving me wrong from a capital gains point of view, which gives people who like the stock ammunition to criticize my strategy. They’ll like even more the fact that Walmart just increased the dividend by 9% this year, to prove that they’re right. Ok, now yes it is true that the stock’s 50% appreciation since 2020 is noteworthy. But let’s not forget that there are many stocks which have increased by similar amounts, or even way more, while providing attractive dividends. WMT is now closing in on a 30x PE, and yields just 1.2%, the most overvalued its been all decade relative to the dividend. WMT DFT Chart (Dividend Freedom Tribe) It grew the dividend by 9% this year. While I believe that it is extremely unlikely that they replicate this rate of growth over the next decade, given that they’ve increased the dividend at only a 3% CAGR for the past 10 years, I believe that we can use this growth rate in our simulation as an indication that WMT won’t compound into a worthy dividend snowball. Even if WMT were to increase its dividend at 9% per year, and you invested $10K in it today and reinvested those dividends, then 10 years from now, you couldn’t even expect $300 in dividends. 20 years from now, that number goes up to $760. WMT Dividend Snowball (Dividend Freedom Tribe) This rate of growth is extremely unsatisfactory, as in 20 years WMT wouldn’t reach the level of income that we’d expect a stock to reach in 10 years: and that’s assuming unlikley 9% growth from the stock. Now I realize that some of you might have purchased the stock way lower, and are looking at your “yield on cost”, but consider that if you sold Walmart and bought a stock which yielded 3%, even if you had a massive tax bill, you’d likely double your dividend income, and set yourself up for better income growth, capital protection, and future outcomes all over. Conclusion Dividends can be a beautiful way to compound and pay off in retirement, but you need to be cold-headed, rational, and look at these things objectively. Stocks are not sport teams, there is nothing to be gained by being a fanatical supporter of them. They are a means to an end. You want to put your money in the best job it can have. Sometimes the best job changes. Especially when stocks get overvalued, stop growing so fast, or both. This is often the case with dividend aristocrats, and if you don’t pay attention, they’ll kill your passive income snowball.
https://seekingalpha.com/article/4701257-sell-alert-3-dividend-aristocrats-that-may-kill-your-passive-income-snowball
Sell Alert: 3 Dividend Aristocrats That May Kill Your Passive Income Snowball
