Dividends Part Two

Key Metrics for Dividend Paying Stocks

Measure
Formula
What to Look For
Dividend Yield
Dividend per share divided by stock price
Yield at least equal to that of the S&P 500 and not out of line with that of the S&P industry yield.
Price to earnings ratio
Stock Price Divided by per-share earnings
P/E that is not excessive compared with company's historical P/E and with S&P industry P/E
Cash flow per share
Net income plus depreciation and amortization divided by number of shares outstanding
Should be at least three times dividend payment
Quick ratio
Current assets minus inventory divided by current liabilities
Should be at least 1.0
Payout ratio
Per-share dividends divided by per-share earnings
Should be higher than 50% but not exceed 100%
Dividend coverage ratio
Cash flow per share divided by dividends per share
Minimum should be 120%
Short-term debt coverage ratio
Operating income divided by short-term debt
Should be at least 2.0


The yield of a stock is simply calculated by dividing the indicated annual dividend by the market price of the stock.

If the quarterly dividend is $.50, multiply that by four to get the indicated annual dividend of $2. If the price of the stock is a $40, the yield is 5% ($2 divided by $40).


Traditional Income Stocks


Traditional income stocks include stocks of electric, gas, and water utilities, real estate investment trusts (RE I TS), banks, energy companies, and pharmaceutical firms. These stocks have historically carried relatively high yields and str favorites with income oriented investors.


S&P 500 Sector Average Yield of Dividend Payers (%)

Consumer Discretionary 1.55
Consumer Staples 2.07
Energy 1.30
Financial 2.39
Health Care 1.16
Industrials 1.52
Information Technology .81
Materials 1.7
Telecommunications Services 4.05
Utilities 4.07
Total 1.93

The Varying Sectors and Their Key Measures

Electric Utilities

Key measures:

PE ratio and PEG ratio

Gas Utilities

Key measures:

ROE
ROA
PE

Utility Mutual Funds and ETF's

Banks

Key measures:

ROA
Rate paid on funds
Net interest margin

Real Estate Investment Trusts (REITS)

Key measures:
Funds from operations - similar to cash flow
The average payout ratio is close to 90%
A high S&P quality ranking B+ or better

Energy Stocks

Key measures:

Operating margin
Long-term debt to total capitalization ratio
PE ratio

Telecommunications Stocks

Key measures:

PE
Cash flow

Pharmaceutical Stocks

Key measures:

Recent and historical sales performance
Consistent sales growth
Operating margin
Pretax net returns and are only.

Preferred Stocks

Key measures:

Predictable dividends, carrying a high yield
Good track record of paying dividends

Cons:

Do not qualify for the low 15% tax rate.
Inflation and interest rate risk.
Investors can not participate in the growth of the company.
They do not have the safety of a bond.

Long-term Dividend Payers

Bank of Nova Scotia BNS
American Express AXP
Royal Bank, Canada RY
Exxon Mobil XOM
Procter and Gamble PG
Colgate Palmolive CL
Gen Mills GIS
Gillette Co. G
Wrigley Junior WWY
3M MMM
Avon Products AVP
Hormel Foods HRL
Connect Company GCI
Hershey Foods HSY
Anheuser-Busch BUD
Walgreen Co WAG
Wells Fargo WFC
Knight Ridder Inc. KRI
Tootsie Roll Industries TR
Johnson and Johnson JNJ
Sara Lee Corp SLE
Smucker SJM
Churchill Downs CHDN
PepsiCo Inc. PEP






Stocks With Strong Ten-Year Yields

Name
Ticker
Quality Ranking
1995 Avg Price
2005 Div Per Share
% Yield on 95 Avg Price
95 - 2005 Div Increase %
AFLAC
AFL
A
38.72
0.444
1.1
423
American Int'l Group
AIG
A+
68.35
0.5
0.7
553
Cintas Corp.
CTAS
A+
48.28
1.76
3.6
1660
Allied Irish Banks - ADS
AIB
NR
42.49
1.52
3.6
311
Bank of Nova Scotia
BNS
A
32.4
1.28
4
313
Barclays ADS
BCS
NR
44.34
1.77
4
372
Citigroup Inc.
CTAS
A+
48.28
1.76
3.6
1660
FNB Corp
FNB
B+
19.45
0.92
4.7
267
Gallagher (Arthur J.)
AJG
A+
29.95
1.12
3.7
362
Laurel Cap Group
LARL
B+
23.3
0.8
3.4
42
Royal Bancshares
RBPAA
A
24.64
1
4.1
1.145
Royal Bank Canada
RY
A
58.99
2.2
3.7
273
Sovram Self Storage
SSS
B+
41.1
2.42
5.9
357
Home Depot
HD
A+
40.58
0.4
1
848
Johnson and Johnson
JNJ
A+
66.22
1.14
1.7
256
McDonald's Corp
MCD
A
32.98
0.55
1.7
319
Pfzier, INC
PFE
A
26.86
0.76
2.8
339
Sysco Corp
SYY
A+
34.6
0.6
1.7
445
T. Rowe Price Group
TROW
A
61.29
0.92
1.5
475
Wal-Mart Stores
WMT
A+
51.49
0.52
1
441
Wells Fargo
WFC
A
59.9
1.92
3.2
324



Mutual funds and ETFs provided an easy and convenient way to diversify.


1.) Mutual funds = income funds or balanced funds.

· They invest in the money market instruments.
· Bonds.
· And were preferred stocks.

Their main objective is income with secondary objective of capital gains.

Growth and income funds (large blend)
Equity income funds (large value)

· This is a common nation of both income and capital appreciation

A.) Growth and Income (mainly large-cap stocks)

· Steady, though not high income payouts.
· Equal weight on capital appreciation.
· Less susceptible to economic recessions and sectors going in and out of favor.
· Invest in stocks with above average yields and price per share should potential.
· Typically PEs are below, the S&P 500 PE.
· Called "large blend"by MorningStar and S&P.

B.) Equity Income

· Seeks relatively high current income and growth of income by investing 60% or more of assets in stocks.
· Risk is low.
· Yields typically 50% higher than S&P.
· Typically includes utilities, financials, health care, energy and consumer staples.
· Over the 15 year period ending 2004, the average annual total return for equity income funds equaled 10.3%.
· Spence ratios are less than or equal to 1% typically.

2.) ETFs

· Trade like regular stocks.
· Basket of stocks are based on an index.
· These are more tax efficient than mutual funds, because trading turnover is lower. Last, capital gains are at a minimum equals lower taxes, and commissions are down.
· Expense ratios are how those of similiar mutual funds.

Examples:

· I Shares S&P 500, expense ratio .09%
· Vanguard 500 Index, expense ratio .18%
· NASDAQ 100 trust you QQQQ.

Websites that offer DTS.

· A.m. EX.com.
· I shares.com.
· Holders.com.
· Street tracks.com

Disadvantages of ETFs

· You have to pay a commission to buy and sell them.
· It is harder to dollar cost average because of commissions. Each time you put money in, you have to pay a commission.

3.) SPDR (S&P depository receipts)

· Barclays global investors (I shares)
· Vanguard vipers
· Vanguard Index participation equity receipts.
· SPDR, trust series (SPY) tracks the S&P 500 index.
· NASDAQ 100 trust series, I (QQQ) equals tracks the NASDAQ 100 index.
· Diamonds trust series, I (DIA) equals tracks the DJ I A.
· SPD our trust series (MDY) equals tracks the S&P 500 mid-cap index.


Recommended dividend oriented mutual funds

The following have good long-term performance records, art, below, have relatively low expense ratios, and high S&P performance right.



Name
Symbol
S & P 10 Year Ranking
Avg Annual 10 Year Return
Expense Ratios
Fidelity Dividend Growth
FDGFX
4
13.7
0.65
Fidelity Equity Income
FEQIX
3
10.97
0.69
Parnassus Income Trust Equity Income Fund
PRBLX
5
11.8
0.95
T. Rowe Price Equity Income Fund
PRFDX
4
12.4
0.78
USAA Income Stock
USISX
3
9.09
0.79
Vanguard Equity Income Fund/Investor
VEIPX
4
12
0.32
Vanguard Growth & Income Fund/ Investor
VQNPX
4
11.9
0.42



Recommended dividend oriented ETFs

A.) I shares Dow Jones Select Dividend Index (DVY)

· includes 100 of the highest yielding stocks in the broader Dow US
· does not pay out a dividend fund holder

B.) I shares S&P Global Financial Sector (IXG)

· long-term maximum capital appreciation

C.) Select Sector SPDR Utilities (XLU)

· long-term maximum capital appreciation

D.) Power Shares Higher Yield Dividend Achievers (PEY)

· invests in the 50 highest yielding stocks of companies that have raised their annual dividend in every year for the past 10 years.

E.) I shares Dow Jones US utilities sector (IDX)

· long-term capital appreciation

F.) S&P Quality Rankings Global Equity Mutual Trust (DQY)

· current income and capital appreciation by investing primarily in high-quality stocks with above average dividends.


Withdrawal plan option

1.) You can set up a fixed dollar amount.
2.) You can set up a specific type of fixed dollar amount designed to pay you the entire value of your account over a certain period of time.
3.) You can receive a percentage of your account value.

Points to Remember:

· A good way for dividend oriented investors to diversify is through no load mutual funds and ETFs that concentrate on companies that pay dividends and constantly raise them.
· ETF's trade like regular stocks, equal baskets of stocks usually based on a market index. ETF's have a commission on them, much like that of a stock. Us each time you purchase or sell, you will pay a commission making dollar cost averaging more difficult.
· ETF's are tax efficient, they have low expense ratios and they have the ease of trading - they can be sold short and bought on market.

4.) Dogs of the Dow or the Dow Dividend Strategy

At the end of the year, you buy the 10 highest yielding stocks of authority in the DGI a, putting equal amounts of money in the 10 issues. Hold these issues until the year in and repeat. In recent years, performance has been inconsistent, but the same strategy can be applied to the S&P 500. The S&P 10, in which you apply the same strategy to the largest 100 stocks in the S&P 500, via Jeremy Seigel has had better results. You can further modify this strategy by investing in the highest yield S&P100 companies that have also not reduced their dividend over the past 15 years. This strategy is known as the Core 10 and the results of this strategy have beaten the Dogs of the Dow. The S&P Top 10, or essentially, the Dogs of the S&P, has had a return of 15.69% over the past 46 years. The S&P Core 10 has returned 15.68% and the dogs of the Dow has returned 14.43%.

5.) Yields Versus Increases

The following strategies were tested to see which delivered the best return:

· Highest dividend yields.
· Lowest yields.
· Largest dividend increases.
· Stocks with dividend cuts.

The low yield strategy won by 3.6% annually.
High yield lost by 6.6%.
The largest increases came in second by 2.4%.

Conclusion: stocks of companies with low yields and high dividend increases at higher profitability (ROE) and higher expected earnings growth (E/Y) thAn stocks with high yields and dividend cuts. Ultimately, these low yield stocks produce better returns for investors.

The strategy of buying stocks with relatively low yields a record of sizable dividend increases as well as at least a 10 year history of steady dividend boost equals a winning long-term investment portfolio.

Dividends indicate that a company's finances are strong. A corporation that has paid a dividend over a long period usually has a record of increasing revenues, profits and cash flow.

Steady increases in payments also reflect management's confidence that the company will continue to enjoy its good fortune.

1.)Stocks, you can buy directly

BAC*
XOM
FITB
GE*
IBM
PFE
PG*
WMT*

2.) Stocks with outstanding dividend growth

AFL
CYN
HD
MCD*
MDT
SYY
TROW

3.) Good quality stocks with higher yields = current income

MO*
AEE
C
KIM
RPM
SLE
WRI
WI

The Dividend Aristocrats

The stocks are all members of the S&P 500 index, and each have increased its dividend in every year of the past 25 years.

AVY
KO
FDR
JP
LOW
PEP
SWK
WMT
BAC
CMA
FHN
JNJ
MAS
PFE
SVU
WAG
BCR
CAG
GCI
JCI
MAY
PPG
TGT

BDX
ED
GE
KEY
MCD
PG
TE

CTL
RRD
GWW
KMB
MHP
RF
MMM

CB
DOV
HNI
LEG
MRK
ROH
USB

CLX
EMR
HI
LLY
NUE
SIAL
VFC

The Real Estate Plan - Beginning Real Estate Investment

First, you need a team of professionals in place so …

Step One: Build a Team

Team-members:

Attorney
Accountant
Property Manager
Realtor/broker
Insurance Agent
Banker
Handy Man
Property inspector
Appraiser


The best way to go about this is to first find a reliable, knowledgeable accountant or attorney and then ask them for references for the rest of the team. As you begin looking at properties certain names may begin surfacing multiple times. Go with these leads and check out the individuals.

I used a knowledgeable accountant as the cornerstone for my team and built from there. Don’t scrimp on the fees for these services. This is not an area to be cheap – you get what you pay for.

Form the Correct Entity

In real estate you need two forms of protection;

1) The correct type and amount of property and casualty insurance and

2) Asset protection provided by entity formation.

I recommend holding your real estate in an LLC. The reason being is that it offers more asset protection than a sole propreitorship, it is not taxed twice like a C Corp, it has more flexibility than an S Corp and it does not have the headaches of a partnership. For more information see “Why You Should Turn Your Hobby Into a Small Business.”

If you own many pieces of investment property you should consider splitting them up into separate LLCs. Multiple assets in the same entity bucket are exposed to each other.

Step Two: Identify a Real Estate Market and Submarket

Level One Research

After identifying the city you wish to invest in, start keeping up with local newspapers business journals and online publications. You are looking for a picture of population growth, planning and development and employment in order to further narrow down your market into a submarket which can be a specific area of town such as a neighborhood or an area defined by its proximity to major employers and/or highway access.


Level Two Research

Now is the time to go to your market, if out of town and develop your team. Spend time interviewing people, realtors, real estate investors, government officials and staff people. Try to determine a supply and demand picture in the area. Are certain areas overbuilt? Is a new employer coming to town and where will they be located? With everyone you meet, clearly communicate your goal. This will help your resources be of more service to you.

Level Three Research

Call up any referrals you may have received and see if they can point you to more websites and information that can narrow down your submarket.

ID the Submarket

In the end, ideally the supply of rental in your submarket should be low and the demand should be high.

There are three drivers for real estate supply and demand:

1) Employment, improvements and access – jobs are plentiful, redevelopment is planned,
New highways are on the way.
2) Population – people aren’t fleeing the area for warmer climates.
3) Location – the specific building has drive-by visibility.

Step Three: Submarket Microanalysis


1.) Compare rates, features, and amenities on properties in submarket – use an analysis spreadsheet.
2.) Read up in the paper, etc. for submarket changes.
3.) Drive the submarket, write-down potentials, other addresses and phone numbers of high potentials in visible locations – it could be that some potential properties are not for sale.
4.) Meet with people in submarket and get info.
5.) Narrowing down to the property.

a. Already have a property goal in place – example: looking for a 4 plex.
b. Look for out-of-state owners.
c. Look for distressed owners.
d. Seek out property that meets your criteria.
e. If not for sell then contact owner and tell them you are interested in buying.

Step Four: Analysis
I have included a sample analysis spreadsheet at the bottom for reference.

1.) Verify property income -- verify rent roll which is the rent for each unit and check for vacancies

2.) On the gross rent multiplier analysis spreadsheet -- find a gross rent multiplier at 8, 7 and 6. Anything over 8 is difficult to cash flow from.

3.) Run the operating budget using the cash flow analysis spreadsheet (8% vacancy estimated expenses. Taxes verified, insurance quote) If you verify expenses great. If not, estimates for the rest - reserves, repairs/maintenance, yard work etc. -- find cash flow from this.

4.) Find the Cap Rate Value = NYOI / R.
This and the gross rent multiplier value will give you a price target that you should not go over in your offer.
Note: if the building is older, repairs and maintenance and reserve will be higher than previous figures in the owner’s budget. Utilities can go up.

5.) Calculate the loan payment in cash on cash return.

Step Five: Tie Up the Property

Issue a letter of intent.

This maps out the deal points, the price and leads to the price negotiation.

Purchase and sale agreement – this can be issued in addition or in lieu of the LOI but an attorney drafts this generally after the terms of the letter of intent have been sorted out. This document details the purchase price, down payment, initial deposit, escrow, time frames for contingencies, pro rated rents, taxes, insurance and security deposits. It also lays out the details for securing a title report, financing and due diligence, the time frames for pest control and physical and lead based paint inspections.

The main contingency that should be included is that the buyer must find financing suitable to his or her needs. This will serve as a catchall.

Step Six: Perform Due Diligence on the Property

Part One:

In this step, you uncover 100% of the details about a property and you generate an operating plan, a plan to improve the cash flow of the property. You perform a thorough walk-through of every unit and factor adjustments into purchase price – either a detrimental discovery is fixed or the price is lowered.

For a thorough due Diligence Check list, see Rob McElroy’s book, “The ABCs of Real Estate Investing”, pages 134 through 137.

General areas covered:

File audit
Interior inspection
Government agency reviews
Service agreement review
Exterior inspections

Part Two:

Obtain all books and records.

24 months of income and expenses.
Service agreements.
Current rent roll.
Utility bills.
Payroll info.


B. The property plan = the goal for the property

Develop a plan to increase the property cash flow and value.
For example, can you build a laundry facility and/or raise rents? Would it be beneficial to seek out new insurance quotes for a lower rate? How can you attract new, quality residents in a timely manner? What if you bid out the landscaping or hired a maintenance man?


Step Seven: Develop an Operating Budget

Fill in what you are finding out to be the real numbers in the cash flow analysis operating budget.
Use the standard income but also look for other income opportunities.

Expenses
Marketing
Utilities
Capital repairs
Management costs
Repairs and maintenance
Property taxes
Insurance

What are the true costs you are finding?

Step Eight: Confrontation Time, Bringing Your Findings to the Table


Again, for any detrimental items found, the sales price should be adjusted lower or the property findings should be fixed.

Confrontation items that should be addressed:

Vacant units
Future vacancies
Bad tenant profiles
High maintenance expenses
Pest control issues
Higher utility costs
The property tax is higher
Fire code violations
Other violations



Step Nine: To Property Manage or To Not

If you decide to go with property managers, the following is a short list of the tasks a
property manager should handle:

Solving general problems
Leasing the property
Increasing the cash flow
Handling legal and contracts
Maintenance
Rent collection
Paying the bills
Managing the budget
Evictions
Customer service
Handling other legal issues


Guidelines for hiring a property management company

1.) The fees should equal 8 to 12% for single-family residence, 4 to 8% for multiple.
2.) The property manager should have at least three years in the business.
3.) Has an accounting department.
4.) Ask for references.
5.) Has policies and procedures already laid out.
6.) Belongs to professional affiliations and associations such as the National Association of Realtors.
7.) Has real estate licenses.
8.) Perform legal and background checks.
9.) How many employees and what are their backgrounds and duties.

You should fire the property manager when:

1.) The property does not perform well.
2.) Operations do not improve.
3.) No partner mentality from the property manager.
4.) He neglects the physical condition of the property.
5.) There is high employee turnover.
6.) Inconsistent or incomplete reporting.


D. Set up systems for maintenance accounting and rent collection.

Interview property managers.
Run criminal and credit background checks on new applicants.
Enforce the policies and procedures.


Step Ten: To Sell or Not

Maximum future potential income = 100% occupancy
Raise the rents and minimize expenses to have good reporting of income for selling purposes.

Passive Income Achieved for the month of September, 2008 - $125

Alright, so this is a low start. But it is a start nonetheless. The $125 all comes form a Fidelity International Income fund – FNMIX - Fidelity New Markets Income and, unhappily, this is the only one of our approximate 10 funds that has not taken a bath during the “meltdown.”

My initial goal is to create $1000 a month in passive income by January 1st, 2009. Yes, three months seems like a very short time to increase passive income by $875, but we have a large cache of capital (a swiftly, dwindling cache of capital) that can be reinvested to generate passive cash flow as it is currently invested for capital gains. Also, I will double check – there might be more dividends here that I have not reported on.

Here’s my plan:

• Generate $175 a month cash flow from 3 high, reliable dividend yielding stocks. I have a screen to id high yielders with a good fundamental analysis rating. I will then perform a Lynchese fundamental analysis on the top 5 and also run them through a dividends part 2 screening. Preferrably, these guys will be option able.
  
• I will generate an additional $175 in dividend income from three mutual fund income funds - $125 has already been accounted for.
  
• I will generate $200 a month by writing covered call options against the individual stocks. Although this is not 100% passive, it surely does not require 40 hrs per week.
  
• I will generate $100 a month from a piece of investment rental property.
  
• I will generate $200 a month from website affiliate ads and online revenues – Amazon, Adsense, Linkshare, and Barnes.
  
• The last $150 will come from either a dividend stock, rental property or increased online revenue – to be determined.
  

This will give me a monthly, passive cash flow figure of $1000. I will then go on to create $2000 a month in passive cash flow by July 4th, 2008 – thus exiting the rat race and go on to create $3000 a month by December 25th, 2008 thus solidifying the exit.