Tag Archives: dividends

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February’s Pick

It might seem as though choosing a stock is a tricky thing to do. It is. Every month we update the relevant financials for each stock we follow (all 194 of them), assign the scores and narrow the list down to two or three candidates. Anyone who’s been following this blog will recognize that we often have trouble settling on just one. We’ve committed to always choosing a single stock, so, sometimes with much hesitation, we force ourselves to make a single recommendation. Regular readers will also note that we often add “But, hey – any of these suggestions would be a great choice.” This month is no different…

Target (NYSE: TGT) came out on top once the scores had been assigned and that’s official choice. The stock has been beaten down from $78 to $63 the last three months and is currently 24% off their 52-week high. The decline seems to have stopped as the price has stabilized over the last month or so and that’s why we’re suggesting it now. The company hasn’t changed – they still still reasonably priced products that we all want. That’s a good thing. What’s changed is that we can now buy shares in the company at a price that seems to be a pretty deep discount. Target has EPS of 5.45 and a P/E of 11.7. That P/E puts them in the top 10 of all stocks we follow which means lots of people out there will soon discover this stock is underpriced and will want to buy it. That’s also good for us. The current dividend rate is 3.76% which is not stellar but for a $36 B company is pretty much a guarantee and sure to increase year over year. We are, after all, dividend investors so we can enjoy that dividend payment while we ride the share price up. The other thing we like about this purchase is that it’s in the retail sector so it increases the diversity of our portfolio.

In case you’re wondering, CIBC (TSE: CM, NYSE CM), General Motors (NYSE: GM) and Ford (NYSE: F) rounded out the top four picks this month in a very close race.

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September’s Pick

Well, the scores have been assigned to identify our stock pick for September and the winner is… General Motors Company (NYSE: GM) or Ford Motor Company (NYSE: F). You choose. Maybe you like a tie and maybe you don’t, but here’s the scoop.

GM earned a higher score (14) than Ford (12) but they both offer strong reasons to own them. GM came out on top for its strong earnings (EPS is 7.82) but is trading at only 14% below the 52-week high. To be sure, that’s a decent discount for a solid company. Ford’s earnings are not as good (EPS is 2.25) but they are currently trading at over 21% below the 52-week high. That’s a much better sale! The dividend yield for the two companies is essentially the same at 4.78% and 4.82% so we left that factor out of our decision. The price of each company has been pretty flat for the last few months so when they begin to recover Ford has a greater potential for capital appreciation. That’s not something to ignore, especially if you get the benefit of the same dividend in the meantime.

Soooo, if you want a company that is earning more per share for you buy GM. If you want to add the potential capital appreciation of Ford to the dividend yield, choose Ford. Our strategy identifies potential stocks to purchase using an objective method of assigning scores for a variety of factors. If you’re a regular reader, you know that we don’t always just simply buy the stock with the highest score. The system identifies potential purchases from which we then make a choice. Because the dividend yields are the same, we’re going to hope for the greater eventual price increase with Ford so that’s our official pick. Honestly, whichever you choose, you can’t lose in the long run with these two.

The Scoop on Dividend Taxes

Dividends are a great way to build passive income for a few reasons, one of which is the preferential tax treatment they get. Just knowing they enjoy this benefit is enough for some people, but others like to dig into how things work. If you’re a bit of a tax nerd, this post is for you!

dividends_taxRemember that a dividend is a portion of the earnings of a corporation that it pays to its shareholders. Corporations have already paid tax on the earnings they distribute as dividends so governments in Canada and the U.S. give shareholders a tax break on dividend income to avoid it being taxed twice. In Canada, dividends are grossed-up and qualify for a tax credit to “credit” you for the tax already paid by the company. In the U.S., dividends are taxed at a considerably lower rate than regular income to reflect the tax already paid by the corporation.

Here’s how it works in Canada. You have to convert the amount of your dividend to what it was worth before the corporation paid tax on it. This is done by grossing it up by 38% (i.e., multiplying it by 1.38). Next, you figure out how much tax you would expect to pay on that grossed-up amount, based on your marginal tax rate. Last, you subtract the dividend tax credit, which represents the tax already paid by the corporation. The net result is the tax you actually have to pay. For 2015, the federal tax credit in Canada is 15.02% of your taxable amount of dividends while the provincial credits vary by province (find them here). Note that we’re only discussing “eligible dividends;” that is, those paid by public corporations in Canada.

Let’s look at an example for Josh, who lives in Ontario. In 2015, Josh received $3,500 in eligible dividends. His grossed up amount is 3,500 x 1.38 = $4,830. Josh has to report this amount on Line 120 of his tax return. Because of Josh’s employment income, his dividends are taxed at the 22% marginal rate and his provincial tax rate in Ontario is 9.15%. Josh’s federal and provincial tax payable would be $1,062.60 and $441.95, respectively, for a total of $1,504.55. Now he subtracts his federal tax credit of $725.47 (4830 x 15.02%) and his provincial credit of $483 (4830 x 10% – the Ontario rate) to find his actual tax liability is only $296.08. This is an effective rate of 8.4%!!! (296/3500)

The math looks like this:

Dividends $3,500.00 (A)
Grossed up amount (A x 1.38) $4,830.00 (B)
Federal tax (B x 0.22) $1,062.60 (D)
Provincial tax (B x 0.0915) $441.95 (E)
Federal dividend tax credit (B x 0.1502) $725.47 (F)
Provincial dividend tax credit (B x 0.10) $483.00 (G)
Tax payable (D + E – F – G) $296.08

In the U.S. the situation is a little different in that there is a period of time (called the holding period) that you must own the stock before you have to pay tax on dividends you receive. Because we tend to hold shares for the long term we’ll ignore this restriction. Other than that, the calculation is actually easier than is the case in Canada. Dividends are tax-free for amounts in the 10% and 15% brackets, taxed at 15% for those in the 25% up to 35% tax brackets and taxed at a 20% rate for people above the 35% tax bracket.

Here’s an example: Rebecca’s salary puts her in the 25% tax bracket and she collected $4300 in dividends in 2015. While her other income is taxed at 25%, her dividends would be taxed at only 15%.

I should point out that if your shares are held inside a tax-free investment vehicle (like a RSP or TFSA in Canada or an IRA in the U.S.) the tax-preferred status is irrelevant because your dividends are sheltered from tax anyway. The bottom line is that dividends enjoy preferential tax treatment and paying less tax is a great way to build wealth!

The Benefits of Dividends

While there are lots of ways to earn passive income (writing a book, selling a product online, affiliate marketing, real estate, etc.), we prefer dividends for three reasons:

  1. They’re the most passive we can think of.
  2. The benefits of DRIP (or equivalent) investing.
  3. Their preferential tax treatment.

Let’s talk a little about each of these. First, they’re truly passive. Other than a little work a couple of times a year to choose a stock to buy, you shouldn’t be spending any time managing or worrying about your portfolio. We’re buying companies that are stable and we’re in the market for the long term, which means at least five years. Take a look at what the S&P 100 index has done since 1982.

SP100_history

Notice a trend? Sure, there are periods when the index drops significantly (that’s called a correction), but the recovery follows soon after. Check out the Dow Jones Industrial Average over a similar period.

DJIA_history

Same trend! Pick nearly any 5 year period you like and you’d have made money. In other words, if you’re in the market for the long term rather than trying to get in and out at the best times (we call that timing the market) you really can’t lose. Basically, don’t worry about it. Buy a good company and hold it – forever.

Second, the advantages of DRIP investing. A DRIP (dividend reinvestment plan) allows you to use the dividends you receive to purchase additional shares in the company with no trade fee. If you don’t need the cash from the dividends this is a great idea because those additional shares are also eligible to earn dividends in the future. The compound growth that occurs is a powerful way to grow your portfolio. Sometimes, your broker will even offer a discount on shares purchased in a DRIP. These plans are automatic so, again, completely passive. Let’s look at an example. Imagine you have 100 shares of ACME Widgets that are trading for $40 per share and pay a quarterly dividend of $0.50 (5%). In the first quarter, you would be paid a dividend of $50. In a DRIP, $40 of that dividend would be used to buy an additional share and the remaining $10 would be collected in cash. In the next quarter, you’d own 101 shares so you would be paid a dividend of $50.50. Again, you would buy another share in the DRIP and receive the difference in cash. At the end of the fourth quarter, you would own 104 shares and have $43 in cash. If we imagine the stock price was still $40, your effective rate of return for the year would be 5.1%.

Third, preferential tax treatment. Dividends are paid out of the after-tax profits of the company (i.e., they’ve already paid tax on them) so it wouldn’t be fair for the shareholder to also pay full tax. In Canada, dividends are grossed-up and qualify for a tax credit to “credit” you for the tax already paid by the company. In the U.S. dividends  are taxed at a considerably lower rate than regular income. In a later post we’ll describe the preferential treatment of dividends in detail.

So there you have it. The reasons we love dividends. We think you should too!

Choosing a Stock – Part 7: Scoring

If you managed to stay with me through the last 6 entries, you’re familiar with the technique I use for choosing a stock. Now let’s get practical and look at how I actually apply the scoring system.

First, I find the latest price, 52 week high and low, dividend payment, P/E and EPS for shares of each company on the S&P 100. I use RBC Direct Investing (http://www.rbcdirectinvesting.com/) because it’s my online broker but you can use any site that appeals to you. Google Finance (https://www.google.ca/finance) is great and Yahoo Finance (http://finance.yahoo.com/) is another good choice that’s easy to use but there are plenty more.

scoringI have an Excel spreadsheet which lists all the companies on the S&P 100 (including any I’m considering that are not on that list) and has a column for each of the factors we’re using. There are also columns for dividend yield, % below the 52 week high and % above the 52 week low.

Now for assigning the scores. I start by sorting the companies in order of decreasing dividend yield so that I can easily assign the dividend score to each one. I use a simple 5 point scale as in the table below:

Score Yield (%) % below 52 week high P/E EPS
5 6 or greater 30 or greater 10.0 or less 15 or greater
4 4.5-5.9 25.0-29.9 10.1-12.9 10.0-14.9
3 3.5-4.4 20.0-24.9 13.0-14.9 7.0-9.9
2 – 10.0-19.9 15.0-16.9 5.0-6.9
1 – – 17.0-20.0 4.0-4.9

Notice I don’t consider a stock that pays a dividend of less than 3.5%. There are always great deals on companies that pay higher dividends so why choose a lower-paying one? Once this step is complete, I sort the stocks by the % below the 52 week high and assign scores for that. I continue doing this for each factor in turn until scores have been assigned for all the factors, then I simply add up the scores for each stock.

In a perfect world, the stock with the highest score would always be the stock to buy but, unfortunately, we don’t live in a perfect world. Rather, the score highlights the top options but you might need to decide between a few of the top contenders. My preference is usually for a stock which is currently at the deepest discount. Remember, we never consider a company that doesn’t pay a good dividend so it makes sense to take advantage of the potential growth in share price of a stock that is beaten down. I have found that this system really helps to removes the emotional or subjective element in choosing a company by using hard numbers to narrow down the options to just a few.

I don’t always assign a score for the % above the 52-week low. To be honest, that metric only becomes useful when a stock is sliding in price and you want to see if it has started to rebound. A stock that is barely above the 52-week low might still be falling and we want to buy when it is still on sale but recovering. A later version of my system might assign a score based on the 52-week low but for now it’s really not one to worry too much about. Check back for our next post where we’ll use the system to score a real stock to get some practice using the system.

Choosing a stock – Part 6: How much of the value will be mine?

In the last entry we talked about using the P/E ratio to help us determine if the current stock price is overvalued. Let’s now take a look at another measure that lets us see how much of the company’s value will be ours as a shareholder. This is the earnings per share (or EPS).

choosing a stock 6If we think of the P/E ratio as being the number of positive reviews our prospective purchase has, the EPS tells us how many of the total number of reviews these positive ones represent. Think again about online reviews posted by customers. For any product we might be considering, there are generally three categories it can be in (if we ignore bad products with only negative reviews). First, it might have lots of reviews that are all positive. This is a stock that has a great (i.e., low) P/E ratio. We like those. Second, it might have only positive reviews but they have been posted by few customers. This is a stock with a poor (i.e., high) P/E ratio. We want to avoid those. Third, it might have lots and lots of reviews but they’re mixed. In order to make our decision we have to decide what fraction of those reviews need to be positive for us to feel comfortable making the purchase. The EPS can help inform our decision.

EPS tells us the portion of a company’s profit allocated to each outstanding share. In other words, how much money does the company make compared to how many shares are out there. This is like asking “how many of the reviews are positive?” If the EPS of company A are higher than those of company B, company A generates more money per share, and, as a shareholder, you own part of that income. Experts will say that EPS is the single most important factor in determining  a share’s price, but as buyers of blue chip companies on the S&P 100 we needn’t be very concerned about it. It’s more important to institutional investors and speculators who might be making decisions to own a stock for the short term. That’s not us. As with the other 4 factors, I assign a score to each company on the S&P 100 but, admittedly, I put less weight on EPS than the others. These established companies are long-lived because they’ve shown the ability to be profitable. EPS serves as a good tie-breaker if I need it.

That’s it. That’s how I choose a stock. By considering these five factors, each stock earns a score and, often, the stock with the highest score wins. That’s the one I buy. In the next post we’ll look at the scoring system I use and practice applying it using an example.

Choosing a stock – Part 4: Don’t buy if the price will be better next week.

So far we’ve looked at two of the five factors I think are important in choosing a stock. Hopefully you agree that the system seems quite simple and requires very little time. Remember, the name of this blog is Passive Dividend Income. I don’t want to spend too much time or effort on this and I certainly don’t want to have to think about my portfolio all the time. I invest a little time in choosing a stock and then pretty much forget about it until it’s time to buy again, letting that small investment pay dividends in the future. Ok, I couldn’t resist that pun. In the last entry we talked about buying a stock that’s on sale. Now let’s talk about making sure there won’t be a better sale on that stock in the future.

Back to our analogy. I’ve picked the supplier I want to buy from, I’ve found the item I want and now I’m checking to see if it’s on sale. I’m in luck! It is. The trouble is, how do I know this is the best price I can get? In other words, what if I buy it now and then it goes on sale the following week at a deeper discount? Oh, the horror! Last time we learned we can determine if the stock is on sale by comparing the current price to the 52 week high. As with the camping gear, how do I know this is the lowest the price will go? I don’t. But what I can know is how the current price compares to the lowest price people have paid in the last year (known as the 52 week low).

picking_a_stock_part_4Time for another calculation. For each company on the S&P 100 I figure out how far above the 52 week low it is. This gives me an idea of whether the sale price is the best price for this stock or if it’s likely to go lower in the future. In the example at the left, we see the stock is 0.8% above the 52 week low. This is exceptionally close to its 52 week low which means that, while it’s still on sale, the price could go lower still. In other words, if the stock were trading at, say, 10% higher than the 52 week low, it suggests that the price is recovering. To be sure, we could simply look at the price history for the last few weeks. Lots of websites provide that kind of information but the charts at www.google.com/finance are especially easy to use.

A stock that is far from the 52 week low is not at the best sale price anymore. Remember, share prices fluctuate between the 52 week high and 52 week low. Our goal is to try and buy when they are far below the high but not yet far above the low. Incidentally, being a little above the 52 week low also suggests the price is recovering and less likely to go lower after I buy it. I’m a little wary of stocks that are at their 52 week low for that very reason.

Of course, lots of things affect share prices but these are big, blue chip companies with high daily trading volumes that are being bought and sold by lots of institutional investors so the prices don’t move very much day-to-day. Lots of people are doing in depth analyses of company valuations which means we don’t have to – thankfully! We can let the price history be our guide to what people are willing to pay now and what they might pay in the future. While our long-term focus is dividend income, we’d like to see growth in the value of the stock too!

Choosing a stock – Part 3: Buy on sale.

In the last entry we talked about the second factor to consider when buying a stock – the dividend rate. My overall goal is to develop a stream of income from my portfolio and collecting regular dividend payments is one way to do that. I buy companies on the S&P 100 which pay the highest dividend rate. In this entry we’ll move on to step 3.

Let’s go back to our analogy. I’m trying to buy a new piece of camping gear and I’ve decided to go with a well-known supplier. I’ve chosen a good quality piece of equipment (companies on the S&P 100) that will last and add value to my hiking experience (companies that pay the highest regular dividend). Being a frugal person (some friends would say ‘cheap’) I’m going to wait until the item I want is on sale. Why pay more than I have to right? If I wait for a sale I can get the same item for less!

walmart_priceWhen choosing a stock, I apply the same principle. The good news is, with so many companies on the S&P 100, there’s nearly always something on sale. You might be wondering what on earth I’m talking about when I say a company is on sale. Let me explain. I figure a good way to estimate the value of something is to see what people are willing to pay for it. This is true of camping equipment and stocks alike. It’s easy to see what people are willing to pay for a stock because that’s what the current trading price is. We can see from the image above that Walmart was trading at $61.30 per share on December 31, 2015.

Ok, now we know what the current price of a stock is but how do we tell if that’s a sale price or not? Easy! I look at the maximum price people were willing to pay over the last year (called the 52 week high) and compare that to the current price. Pretty simple, right?! Again, I find that price for every company on the S&P 100 and calculate how far below the 52 week high the current price is. Let’s look at an example.

picking_a_stock_part_3Basically, people were willing to pay $66.36 for this stock within the last year and I can now buy it for $33.49 – a discount of 49.5%. This is a solid company on the S&P 100 so, chances are, it’ll be back to that high within a year or so and I will have realized a 98.1% return. Oh yeah, and collected my 5.49% dividend in the meantime. Sweet! Would you be excited to buy something you think is valuable at that kind of discount? Of course, you would!

Just like with the dividend rate, I assign a score to each stock depending on how far below the 52 week high it’s trading. In other words, I look to see which stocks are really on sale. That score is added to the score the stock earned from its dividend and I’m one step closer to making a decision.

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We sold Apple!

Apple (NASDAQ: AAPL) has been flat for several months now and they’re currently paying a dividend of only 1.98%. We don’t usually hold stocks that pay less than 3.5% so it was time to sell. We bought them in April, 2013 for $61.40 (adjusted before  a 7:1 split) because they were undervalued at that time. We happily accepted the less than stellar dividend because the share price was appreciating nicely. They’ve given up some ground lately and don’t seem to be recovering so it was time to take our profit. We sold at $107.50 to realize a return of 75% – not bad for 33 months! We’re confident their share price will improve again but in the meantime we’d like a better dividend. Thanks for the ride Apple!

apple_history

 

 

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Choosing a stock – Part 2: It’s all about the dividend!

Our last post described the first criterion we use when choosing a stock to buy. We stick to companies listed on the S&P 100. These are safe, solid companies that have a proven track record. They’re not going to post meteoric gains but won’t you lose any sleep worrying about the bottom falling out either. The name of this blog is, after all, Passive Dividend Income, so we don’t want to be spending lots of time working on or worrying about our portfolio. Having said that, let’s move on to step 2.

dividendsRemember our analogy of purchasing a piece of camping equipment (or whatever you want to imagine buying)? We decided to buy from a major supplier – one we feel we can count on to be there if we need them. What else do I want from my purchase? I want the equipment to last so I can enjoy it for years to come. I want it to ADD value to my experience. This is like the dividend a company pays – it’s going to add to the value of my portfolio and, when it comes time to retire, is going to provide the income I’m looking for.

Some companies choose to distribute a portion of their earnings to their shareholders. This is called a dividend. Our goal is to build a stream of income from our investment portfolio and this income will be in the form of dividends. That means it’s important to choose stocks that pay the highest rate. As you learn more about companies on the S&P 100 you’ll see that most of them pay a quarterly dividend but you’ll soon discover that the rate of return of those dividends vary considerably from company to company.

For example, on December  AT&T Inc (T:NYSE) closed at 34.64 and paid a quarterly dividend of $0.48 which is a return of 5.5% (0.48 x 4 times/year divided by 34.64). This means for every $1000 you invest in this stock, you’d be paid $55 in dividends. By contrast, on the same date FedEx closed at $149.65 and paid a quarterly dividend of $0.25 which is a return of 0.67%. For every $1000 you invest in FedEx, you’d be paid $6.70 in dividends. As you can see, the stock you choose makes a HUGE difference. The first step in our strategy is to look up the dividend for every company on the S&P 100 and assign a score to each one based on the dividend it pays. While this score is mostly arbitrary, it serves as a means of ranking the companies based on several factors (the dividend is only one of 5 factors we consider) that we use to make a choice. It’s a way of removing emotion and bias from our investing choices. We’ll see the criteria for assigning scores in a later post.

And that’s step 2. Short and simple. Buy shares in companies that pay the best dividends.

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