Sunday, February 23

Week 138 - 20 Retirement Stocks for You to Consider, and Why

Situation: Owning 8 or 10 stocks in your Personal Retirement Plan can feel a bit weighty, so why do it? The main reason is that after you retire your take-home pay (dividend checks mailed to your home) goes up twice as fast as your expenses. But how can that be, you might ask? Well, if you invest $75 a month for 15+ yrs into an online dividend reinvestment plan (DRIP) for stock in a company that has increased dividends annually for 10+ yrs, you’ll build up a tidy sum. The tax rate for dividends is 15%, or 20% if you’re in the highest bracket, and the transaction cost for having a dividend check mailed (or electronically transferred) is typically less than 1% for DRIPs if you use computershare. That comes to 16% in fixed costs. Your only variable cost is inflation (historically 3%/yr). So, you’ll get to call ~81% of a dividend check "profit" (i.e., return on investment). But the cool thing is that the amount of future checks will grow at a rate of 5-25%/yr (see Column H in our Table). And, if the rate of inflation grows more than usual, so will the amount of your dividend check. 

What’s not to like? Mainly, you have to take great care in choosing which stocks to include in your DRIP portfolio. Here at ITR, we give only 20 companies our *Retirement Stock* Award. Our method is to “winnow down” the list of 146 Dividend Achievers. Remember, that’s Standard & Poor’s designation for companies that have increased their dividend payout annually for 10 or more years. Look at Column C in the Table. There you’ll see that the 20 *Retirement Stock* companies at the top have returned ~8%/yr more to investors since the last market peak in 2000 than the S&P 100 Index (OEF) at the bottom. That tells us what a difference dividend growth makes. 

We take 3 additional steps to remove stocks from the list that are too risky for inclusion in a portfolio designed to last ~40 yrs:

Step #1: Exclude any company that isn’t on the Barron’s 500 List. Why? Because that list ranks companies by the record of growth over the past 3 yrs in cash-flow based return on investment, and the most recent year’s sales growth. Once a company is on the list, it is unlikely to fall off. The list is a remarkable summation of the ability of a company’s managers to execute on a sustainable Business Plan. If a company isn’t on the list, you have received a clear message: don’t make a long-term investment in that company’s stock.

Step #2: Exclude any company that has less than an A- credit rating from S&P. Why? Because the risk of owning stock in a company = the risk of bankruptcy. You’ll lose your entire investment, without recourse. When investing retirement income from quarterly dividend checks, you don’t want to risk the loss or reduction in that income that would be posed by owning stock in companies that aren’t A-rated.

Step #3: Exclude any company that isn’t in the S&P 100 stock index. Why? The biggest companies are in that index, and they’re too big to grow earnings fast. But they all have more than one line of goods or services, and they all maintain reserves that will tide them over during a prolonged recession. That’s the reason to choose your DRIPs from that Index. Many of these companies have the size, the flexibility, the balance sheet, and the ability to ward off competitors that makes it possible for them to increase their dividend every year without interruption.  

Bottom Line: This week’s blog is about dividend growth rates (Column H in the Table). The 1% of companies that increase their dividend annually provide a unique opportunity for long-term savers to make a real profit (return on investment) after accounting for transaction costs, taxes, and inflation. Some investments, like a home mortgage and “whole” life insurance, have value mainly because they force you to save. Others give you the chance of making a big profit offset by a similar chance of taking a big loss (commodity futures, non-dividend paying stocks, emerging market stocks, gold). Investment-grade bonds protect you against loss during an economic recession but then present you with a risk of loss during an economic expansion. 

Academic studies have shown that investors stand the best chance of doing well in the stock market if they focus on owning dividend-paying stocks. Here at ITR, we take that a step further by focusing on Dividend Achievers (10 or more yrs of increases) and Dividend Aristocrats (25 or more yrs of increases). Those companies typically have a sustainable Business Plan that blocks out competitors so well that earnings increase much faster than inflation and taxes. Each chooses to return 20-50% of its earnings to stockholders as dividends. By owning stock in several such companies, you can expect part of your retirement income to beat inflation every year, whereas income from pensions and annuities (other than Social Security, which contains a cost of living adjustment) will have less buying power. If you retire at age 62 and inflation averages 3% thereafter, the buying power of your income from fixed-rate pensions and annuities will have fallen 60% by the time you’re 92. 

Risk Rating: 3

Full Disclosure of related investment activity: I dollar-average into DRIPs for WMT, PG, KO, ABT, JNJ, IBM, and NKE.

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