Book Review

Book Title: The Little Book of Big Dividends: A Safe Formula for Guaranteed Returns

Author: Charles B. Carlson

Date Published: 2010

Rating: 7.5/10

The Little Book of Big Dividends

The Little Book of Big Dividends – Author Background

Charles B. Carlson, CFA, is CEO of Horizon Publishing and Horizon Investment Services, a money management firm. He is the editor of the DRIP Newsletter and a contributing editor to Dow Theory Forecasts. Carlson has written eight books, including the bestselling “Buying Stocks Without a Broker”. He earned his MBA from the University of Chicago.

The following is a summary of the book chapters and some key words/notes extracted directly from the text. They are the words of author Charles B. Carlson.

The Little Book of Big Dividends: Chapter One – The Check is in the Mail

  • Dividends are usually paid quarterly (every three months), although some companies (especially foreign firms) pay dividends only once or twice per year
  • A stock ’ s total return — the total amount you get paid for investing — is capital gains plus dividends
  • Roughly 40 percent of the stock market’s long – run total return comes from dividends
  • Procter &Gamble, the consumer – products giant, has paid a dividend every year since 1891
  • Johnson &Johnson, the health – care company, has raised its dividend every year for more than 45 years
  • A dividend represents an outflow of assets to shareholders
  • Dividends are ultimately paid out of a company’s profits
  • The payout ratio reflects the percentage of a company’s earnings that are paid out in the form of dividends. The payout ratio is the single most powerful factor in analyzing the health, stability, and growth potential of a stock’s dividend
  • Dividend yield equals the total sum of dividends paid over the last year divided by the stock price
  • A stock price adjusts downward when a dividend is paid
  • This downward adjustment in the stock price takes place on the ex – dividend date. The ex – dividend date is that it represents the cut – off point for receiving the dividend. You have to own a stock prior to the ex – dividend date in order to receive the next dividend payment
  • At the time of writing in the USA, qualified dividends are currently taxed at a maximum rate of 15 percent. The rate drops to 0 percent for lower-income individuals in the 10 percent to 15 percent tax brackets for ordinary income (note that tax implications will vary from country to country)
  • Final chapter summary:
    • Dividends matter. Nearly half of the stock market’s long term total return comes from dividends
    • Less taxing. When comparing yields on investments, remember to take into account the favorable tax rates (maximum 15 percent) on qualified dividends. After-tax yields are what really matter
    • No free money. Stock prices adjust downward for dividend payments. Don’t let anyone tell you differently
    • Bye-bye dividend. A company that isn’t making a profit is a company that isn’t going to be paying a dividend for long
    • Buy before the ex. Want the dividend? Buy the stock before the ex-dividend date.

 

The Little Book of Big Dividends: Chapter Two – Super Size Me, without the Heartburn

  • Yield Equals Risk, More or Less – Dividend yield is a pretty good proxy for investment risk
  • If a stock’s yield is considerably higher than the yield of the typical stock in its sector – perhaps three percentage points or more higher – that’s a red flag that something may be amiss. Usually, extraordinarily high dividend yields don’t result from increasing dividends. They result from plummeting stock prices
  • Smart investors consider the following:
    • Safety and dependability of the dividend
    • Capital – gains potential of the stock
    • Yields on alternative investments
    • Yields on comparable investments
    • Pre – tax versus after – tax yields
    • Dividend – growth potential
  • You have to pick dividend – paying stocks on their merits, not your needs
  • A better approach is to filter stocks based on total-return merits and then use yield as a second filter
  • Final chapter summary
    • Yield not to temptation. Yield and risk are joined at the hip. Stocks with yields that seem too good to be true are disasters waiting to happen. Avoid them.
    • Too much of a “good” thing can kill you. If a stock yields more than 3 percentage points above its peers and more than five times the S&P 500 yield, just say no.
    • Avoid pond scum. Relegating your investment “fishing pond” to only the highest-yielding stocks is a recipe for disaster. Just ask anyone who did this in 2008.

 

The Little Book of Big Dividends: Chapter Three – If Einstein Was a Dividend Investor

  • Big, Safe, Dividend (BSD) Formula – my basic BSD Formula looks at just two data points:
    • Payout ratio – Take the stock ’ s annual indicated dividend (compute this by taking the most recent quarterly dividend and multiplying by four) and divide by trailing 12 – month per – share earnings
    • Overall Quadrix score – Quadrix (a proprietary solution) ranks more than 4,000 stocks based on more than 100 different variables across six categories:
      • Momentum (growth in earnings, cash flow, and sales)
      • Quality (return on investment, return on equity, return on assets)
      • Value (price/sales, price/earnings, price/book ratios)
      • Financial strength (debt levels)
      • Earnings estimates
      • Performance (relative stock price performance)
    • Use 60 percent as your upper limit for the payout ratio
    • The best way to use Quadrix is to focus on stocks that score in the upper quartile (75 and above out of a possible 100)
    • Refer to the website — www.bigsafedividends.com — that provides payout ratios, Overall Quadrix scores, and BSD scores for every dividend – paying stock in the S & P 1500 Index
    • Recommended approach:
      • Filter 1: Focus on stocks with payout ratios of 60 percent (0.6) or lower
      • Filter 2: Narrow the field to stocks with Overall Quadrix scores of 75 and higher
      • Filter 3: Filter pick stocks with yields greater than 2 percent
    • Don’t look at yield until you’ve analyzed the safety of the dividend, the ability for the dividend to grow, and the overall investment merit of the stock
    • Final chapter summary:
      • It pays to use this ratio. Payout ratio is the single most powerful tool for assessing the health of a company’s dividend. Ignore it at your own peril
      • Don’t pick one without the other. Buy stocks that score well on dividend criteria and investment criteria. Remember: the best stocks to own are those with the best total-return potential
      • Help is just a click away. Not into math? Go to bigsafedividends.com for current BSD scores and information on all dividend – paying stocks in the S & P 1500 Index.

 

The Little Book of Big Dividends: Chapter Four – The World Is Your Oyster

  • There are lots of attractive U.S. dividend stocks. And there are lots of attractive dividend payers based outside the United States. Smart investors include all of them when building a portfolio of big, safe dividends
  • Some “Steady Eddies” stocks:
    • Abbott Labs (ABT)
    • Aflac (AFL)
    • Automatic Data Processing (ADP)
    • Campbell Soup (CPB)
    • Chubb (CB)
    • Clorox (CLX)
    • ConAgra Foods (CAG)
    • General Mills (GIS)
    • Hasbro (HAS)
    • Johnson & Johnson (JNJ)
    • Kellogg (K)
    • Kimberly – Clark (KMB)
    • Lockheed Martin (LMT)
    • McDonald’s (MCD)
    • PepsiCo (PEP)
    • Procter & Gamble (PG)
    • Sysco (SYY)
    • Travelers (TRV)
  • Some “tiny titans”:
    • Paychex (PAYX)
    • Buckle (BKE)
  • Some “nose – bleed ”stocks have super – high yields up to 12 percent, Advanced BSD scores of at least 63 (out of a possible 100), and Overall Quadrix scores of 60 and above:
    • Alliance Resource Partners LP (ARLP)
    • DCP Midstream Partners LP (DPM)
    • EV Energy Partners LP (EVEP)
    • Hi – Shear Technology (HSR)
    • Legacy Reserves LP (LGCY)
    • Linn Energy LLC (LINE)
    • Markwest Energy Partners LP (MWE)
    • Penn Virginia Res. Partners LP (PVR)
    • Suburban Propane Partners LP (SPH)
    • Sunoco Logistics Partners LP (SXL)
  • More than two out of every three dollars invested in stocks globally is invested in companies outside the United States
  • Some “jet Setters”:
    • AstraZeneca (AZN — United Kingdom)
    • China Life (LFC — China)
    • China Mobile (CHL — Hong Kong)
    • Fresenius Medical (FMS — Germany)
    • Infosys Technology (INFY — India)
    • Novartis (NVS — Switzerland)
    • Novo Nordisk (NVO — Denmark)
    • PetroChina (PTR — China)
    • Sanofi – Aventis (SNY — France)
    • SAP AG (SAP — Germany)
    • Smith & Nephew (SNN — United Kingdom)
    • Unilever PLC (UL — United Kingdom)
  • Final Chapter summary:
    • All shapes and sizes welcome. When buying big, safe dividend stocks, make sure to include large, midsized, and small stocks, you’ll improve portfolio diversification
    • Don’t forget your passport. Some of the best dividend stocks are located outside the U.S. It’s never been easier to buy them via ADRs
    • Frisky for risky? Take a chill pill. It’s okay to include a few super-high yielders in a dividend portfolio. But remember that such stocks tend to move in tandem, which reduces portfolio diversification and increases risk.

 

The Little Book of Big Dividends: Chapter Five – It Pays to Be Direct

  • Every dollar you pay to buy stock is one less dollar in cash flows generated by your investment
  • Today, more than 350 U.S. companies allow investors to buy stock directly, without a broker. And many of these companies are among some of the best dividend – paying stocks in the market
  • Young investors possess the most important ingredient in producing big returns: time
  • Final chapter summary:
    • No excuses. With direct-purchase plans, any investor has an easy and affordable way to buy quality dividend stocks.
    • No fee means more dividend cash in your pocket. Want to know a guaranteed way to boost investment returns? Reduce or eliminate transaction costs with direct-purchase plans
    • No height requirement. Young investors can start building serious wealth via direct-purchase plans. All it takes is $50 to buy attractive dividend payers.

 

The Little Book of Big Dividends: Chapter Six – Postcards from the Hedge

  • WHAT IS PUBLIC ENEMY No. 1 for income investors? The answers may vary in specifics, but you will find a common thread: they all involve the loss of purchasing power otherwise known as inflation
  • One way to hedge against inflation is to focus on stocks that are likely to boost their dividends on a regular basis
  • In many cases the biggest dividends over time come from moderate yielders that grow their dividends regularly
  • Companies that boosted their dividends outperformed—by nearly 2 percent per year—those that didn’t boost their dividend
  • Buying dividend growers is not just a good idea as an inflation hedge; it’s a good idea because dividend growers, as a group, outperform the market
  • The 10/10 Club – For investors searching for consistent dividend growers, the following stocks should fit the bill:
    • Aflac (AFL)
    • Automatic Data Processing (ADP)
    • Colgate-Palmolive (CL)
    • Johnson & Johnson (JNJ)
    • Medtronic (MDT)
    • PepsiCo (PEP)
    • United Technologies (UTX)
    • Wal-Mart Stores (WMT)
  • These stocks, all with Advanced BSD and Quadrix scores of at least 70, meet the following criteria:
    • Higher dividends every year for at least 10 years
    • Annual dividend growth averaging at least 10 percent over the last 10 years
  • Final chapter summary:
    • Hedge me if you can. Higher dividends are a great inflation hedge
    • Payback is a pitch for dividend growers. Dividend growth accelerates the payback on your investment
    • Put on your signal. Companies that increase their dividends signal their confidence in the future—a confidence that should manifest itself in market-beating returns.

 

The Little Book of Big Dividends: Chapter Seven – Lifeguard on Duty

  • Research suggests that an initial withdrawal rate of 3 to 4 percent, with an asset allocation of 50 to 75 percent in stocks and the remainder in bonds and cash, gives you the best chance of fully funding your retirement
  • Consider an initial 3 to 4 percent withdrawal rate, especially if you expect to live 20 years or more
  • You always want your portfolio to show the maximum increase in total value
  • On average, I expect a portfolio with a yield of 2 percent to have higher dividend growth than a portfolio with a 5 percent yield
  • If you viewed Medtronic, Bristol – Myers Squibb, and Microsoft as a “ mini ”three – stock portfolio, what you would discover is the following — by owning all three stocks, an investor would receive a dividend check every month of the year
  • Final chapter summary:
    • Lifeguard on duty. When draining the pool, start with an initial withdrawal rate of 3 to 4 percent.
    • Sell for cash. Maximize the total return of your portfolio, regardless if you need cash flow from your investments. You can always sell stock to generate additional cash.
    • Stay in sync . Sync cash flows with bills by matching dividend payment schedules with monthly expenses.

 

The Little Book of Big Dividends: Chapter Eight – Juice Your Portfolio without Striking Out

  • Real Estate investment trusts (REITs) are securities that trade like stocks.
  • If you invest in a REIT, make sure it is paying its dividend with cash, not stock
  • Final chapter summary:
    • Have a good eye at the plate. Don’t be swinging at every stock with a super-high yield. Be selective, focusing on those with good BSD and Quadrix scores. To obtain scores for REITs, MLPs, and royalty trusts, visit our web site www.bigsafedividends.com
    • Expect to strike out a time or two. Even the best baseball hitters are successful only 3 out of every 10 times at the plate. If you buy exotic dividend investments, be prepared to have some clunkers. For that reason, make sure your portfolio is not heavily weighted toward such risky investments. If you have more than 20 percent of a portfolio in the types of risky dividend stocks discussed in this chapter, that’s too much
    • Know the rule book. REITs, MLPs, and royalty trusts typically do not receive favorable tax treatment; in most cases you will pay taxes on these investments at your ordinary tax rate. Make sure you take that into account when considering these investments versus dividend-paying stocks that qualify for the maximum 15 percent tax rate.

 

The Little Book of Big Dividends: Chapter Nine – When DRIPs Become Floods

  • If you want to build wealth over time, cashing your dividends is not the way to go. Reinvesting them is
  • By reinvesting dividends, you take advantage of what Einstein reportedly called the eighth wonder of the world — compounding
  • Consider Dividend Reinvestment Plans (DRIPs)
  • One of the most underrated aspects of dividend reinvestment is the “forced buying” that occurs with each dividend that is automatically reinvested to buy shares
  • Reinvesting dividends may be the only way some of us buy during down markets
  • Final chapter summary:
    • Take a pass on the cash. If you are not dependent on dividends to meet your basic financial needs, plough those dividends back into the company to buy more shares.
    • Do it for free. Don’t pay fees to reinvest dividends. If your broker or DRIP charges a reinvestment fee, find another broker or DRIP.
    • Discount shopping. Reinvesting dividends assures that you’ll buy stocks when they go on sale.

 

The Little Book of Big Dividends: Chapter Ten – If You Build It, Dividends Will Come

  • Long-term investment success depends on the whole—your portfolio
  • I would go as far as to say that diversification may be the only true free lunch in the stock market
  • By employing diversification correctly, investors can reduce risk without sacrificing returns
  • For my most up – to – date thinking on dividend stocks, including current BSD and Quadrix scores on all stocks in the S & P 1500 Index, visit our free web site, bigsafedividends.com
  • Final chapter summary:
    • Age-old wisdom. Subtract your age from 110, and that is a benchmark for determining the appropriate percentage of stock in your portfolio.
    • Avoid portfolio vertigo. If your optimal allocation between stocks and bonds gets out of whack by 10 percent or more, it’s time to rebalance your portfolio.
    • Weighty matters. When creating a portfolio, investing equal dollars in each investment will help ensure your portfolio doesn’t get overweight in just a few stocks.

 

The Little Book of Big Dividends: Appendix A – Advanced BSD Formula

  • The following 10 factors used to evaluate dividend stability and growth:
    • Payout ratio
    • Interest Coverage
    • Cash flow to net income
    • Dividend yield
    • Six – month relative strength
    • Tangible change in one year book value
    • Long – term expected profit growth
    • Three year cash flow growth
    • Three year dividend growth
    • Three year earnings growth
  • The following is a sampling (at the time of writing) of dividend – paying stocks that meet the following criteria:
    • Advanced BSD scores of 80 and above.
    • Overall Quadrix scores of 75 and above.
    • Yields of 2.5 percent or more
      • Abbott Laboratories (ABT) 3.0
      • Alcon (ACL) 2.5
      • AstraZeneca (AZN) 4.6
      • Automatic Data Processing (ADP) 3.1
      • Biovail (BVF) 2.7
      • Brookfield Properties (BPO) 5.2
      • Buckle (BKE) 2.8
      • Darden Restaurants (DRI) 3.2
      • DCP Midstream Partners (DPM) 9.4
      • EV Energy Partners (EVEP) 11.9
      • Hawkins (HWKN) 2.6
      • Innophos Holdings (IPHS) 3.1
      • ITC (ITC) 2.8
      • Legacy Reserves (LGCY) 11.9
      • Linn Energy (LINE) 10.3
      • Meridian Bioscience (VIVO) 3.0
      • National Healthcare (NHC) 2.8
      • Olin (OLN) 4.8
      • Polaris Industries (PII) 3.4
      • Safety Insurance (SAFT) 4.5
      • Sanofi – Aventis (SNY) 3.0
      • Shaw Communications (SJR) 4.2
      • Sysco (SYY) 3.6
      • WD – 40 (WDFC) 3.0

 

The Little Book of Big Dividends: Closing thoughts

This is the second book I have read in the “Little Book” investment series. I enjoyed the read. The concepts presented were relatively straight forward and made good investment sense to me. As I have mentioned in earlier book reviews and articles, it is so easy to over think and to complicate investing. Keeping it simple is always going to win out just as long as you make a start and approach in a common sense manner.

So, in light of the underlying theme of this book, I agree with Charles, that you cannot go too far wrong if you adopt the following:

  • Invest from an early age (this is the most important as it allows compounding to take effect)
  • Diversify investments
  • Invest in stocks that pay regular, increasing dividends, where possible
  • Don’t necessarily invest in stocks that pay higher dividends, eg greater than say 5% – do some research; higher dividends can suggest increased risk
  • Use dollar-cost averaging and invest on an ongoing and regular basis
  • Invest in stocks/low costs funds across the world, not just stocks from the USA
  • During your investment portfolio growth phase, reinvest dividends back into buying more shares
  • Review your portfolio, minimum 12-month basis and cull any shares / funds that are not performing as per original reasons for buying or that have stopped paying dividends for any reason
  • Don’t forget to seek advice from your financial planner or financial professional before making any significant investments.

If you enjoyed this book review, you will enjoy my review of the book, “Elements of Investing“.

Read, learn, enjoy, be persistent and most importantly, take action!

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