Do the Math

Looking at BankAmerica (BAC) from the perspective of its income alone offers a very clear view of the hidden power of rising dividend investing. Assume you invest $1000 in BankAmerica common stock. Based on BAC's current dividend, it will produce income in the coming year of approximately $38, a yield of 3.8%. In the past decade, BAC's dividend has grown at just over 12% per year. If its dividend continues to grow at this rate over the next ten years, the dividend will grow to just over $118 from our original investment of $1000. Ten per cent growth over the next ten years will result in an ending dividend of $98.50, and 7% growth will result in an ending dividend of $76. These three dividend-growth scenarios all provide solid 10-year ending cash on cash rates of return of 11.8%, 9.85%, and 7.6%. They are not true rates of return in the classical sense, however, first, because these ending dividend amounts take 10 years of dividend growth to reach, and second, because there is no consideration of the ending price of BAC common stock. But working backwards from our expected ending dividends, we can quickly compute the expected range of total returns, considering both time and price changes. To simply matters let's assume BAC's 10-year dividend growth is 7%. We saw earlier that at that rate BAC's dividend would grow from $38 to $76. Still keeping things very simple, let's assume that BAC's ending dividend yield in 10 years is the same as it is today, 3.8%. Using nothing more than fifth-grade math we can now calculate BAC's expected price in 10 years. And if we know that, we can know its expect rate of total return. We can calculate BAC's ending price by dividing its projected ending dividend ($76) by its projected ending dividend yield (3.8%): $76/3.8%= $2000. This calculation shows that our original investment is projected to grow from $1000 to $2000, or 100%. We know that the dividend also grew by 100%, which represented a 7% compounded rate of growth. Because in this example it is BAC's rising dividend that, in effect, pushes up its price, we can take a short cut to the total return calculation. BAC had an initial dividend yield of 3.8% and if we assume that all dividend growth is translated into price growth, BAC's total return is the beginning dividend plus dividend growth: 3.8% + 7% = 10.8% In a world of 3% and 4% bond yields, a projected rate of return from a high quality company of 10.8% is remarkable.

Dividends Talk

Last week Pfizer raised their dividend 12% just days before the surfacing of the news of the issues surrounding Celebrex. I'm convinced PFE probably knew bad news might be coming on the trial, and the dividend decision may have been a tough one. I like it when dividend decisions are tough. Oftentimes, we learn a lot about what a company thinks of their near and intermediate-term prospects based on their dividend actions in tough times. Pfizer could have ducked the dividend issue and made a token increase, lots of drug companies are doing so. In my judgment, the 12% increase, in the face of bad news, is a signal that they believe they will make it through this rough spot in reasonably good shape. This is certainly not the consensus view on Wall Street. They are painting PFE with a Merck brush, but Merck's Vioxx was a much bigger deal to them than Celebrex is to PFE. With the news that Naproxyn is also a possible contributor to heart attacks and stokes, I believe it will be very difficult to pull Celebrex, which has not shown the heart problems in two other tests. The board had to weigh all the issues when making their call on the dividend hike. I think they made a positive call, and if they are right, PFE is incredibly cheap.

So goes GE . . . .

GE's announcement of a 10% hike in its dividend this week is very good news. GE has long been a bellweather of the US economy, and the double digit increase is a plus not only for GE, but also for the entire US economy and stock markets. CEO Jeffrey Immelt also announceed future earnings growth in the range of 10-15%%. We believe this guidance says three things: 1. Earnings will grow faster than 10%, 2. Dividends should also grow at least at 10%, and 3. Average US profit growth should be also close to 10% over the next few years. More importantly, GE's dividend and earnings growth pronouncements allow us to compute its intrinisic value. Starting with a dividend of 86 cents,growing at 10% per annum over the next five years then gradually slowing it to a long-term growth rate of 6.0%, all discounted at 9%, produces an intrinsic value of just under $42.00. We think its just a matter of time before the stock trades there. It is currently trading at $37.26 This is the best news on dividends I have seen in a long time. GE is so big and so important to our economy that their guidance sheds a light on the whole economy. Well done Mr. Immelt.

Rising Dividend Primer

Dividends are being talked about more and more over the past few years as dividend-paying companies have out performed non-dividend payers, but the value of dividend investing is still staggering. A whole generation of people are retiring with most of their investment assets in 401ks and mutual funds. This is the first generation to have the responsibility of making a finite amount of assets last a lifetime. Before the advent of the self directed retirement plans, which came into vogue in the 1980s, most people who retired lived off of a stream of income provided by their employer. The stream of income was either fixed or growing, but in either case it was someone else's responsibilty to invest the assets that were to produce the income. That has changed.