Tag Archives: dividend

Building A Dividend Stream With The Best U.S. REIT ETF

Summary The uncertainty around the interest rate hike was not resolved in September. The high level of volatility is expected to continue in the coming months as well. Take advantage of the occasional dips to build a position in an income stream ETF. Back in June, after the second quarter of high volatility in the REIT sector, I wrote about the opportunity in U.S. REITs. The latest dip was marked during the first half of September towards the Fed’s decision when we saw both the REITs and utilities dropping dramatically. Since the Fed announced that it is essentially pushing out its decision to a later date, there is no reason to believe that the high volatility is behind us and that we will not see high levels of anxiety towards the Fed’s announcements, the one in October or in December. The volatility in REITs is well seen in this Vanguard REIT Index ETF (NYSEARCA: VNQ ) graph. The ETF hit $72 just after Yellen’s announcement, but in the following couple of weeks, it rallied pretty nicely, closing at $75 on September 25. (click to enlarge) Is it still the best U.S. REIT ETF? The next table compares VNQ to the other 15 ETFs that are focused on U.S. REITs. I marked the top five in each of the categories of dividend yield, management fees and the total return during the last 3 and 5 years in green. (click to enlarge) VNQ was favorable in all of the categories, delivering more than 4% yearly yield at only 0.12% yearly management fees with an impressive 72% return during the recent five years. Throughout 2015, through times of uncertainty and concerns, not only has VNQ continued to pay uninterrupted dividends, but also on top of that it grew its dividends by ~10% compared to the year before. The next graph shows VNQ’s quarterly dividends starting Q1’10 until the recent Q3’15. For Q4’15, I have plugged a $1.1 dividend, which is equal to the one paid back in Q4’14. While the other three dividends this year went up by 10%, it would be very hard to believe that the forth one will not grow, but I always like to be conservative: (click to enlarge) How can we model it forward? The 2015 dividend per share is estimated at $3.13, growing 10% year over year. An investor who wants to build a position during the next 10 years can generate some interesting strategies assuming they are willing to invest in VNQ regularly. What can one expect from this type of investment? First thing, let’s examine the dividend growth rate. Nothing can grow forever at the level of 10%. Moreover, this sector like any other sector is exposed to risks. REIT risks are associated with macroeconomic slowdown, space overflow and rental pricing. For a long-term model, let’s judge the growth rate to be 4-5% per year for the next decade. Model Assumptions Dividend rate: The current VNQ dividend rate is 4.2%. Let’s use it in the first year. Dividend growth rate: If we should pick a number between 4% and 5%, let’s go with 4.5%. Tax rate: Since not every investment can be tax free, let’s assume a 25% tax rate on the dividends. Investment: $1,000 invested per month or $12,000 yearly investment across a time period of ten years. The dividends, net of taxes, are assumed to be reinvested as well. VNQ’s price: The ETF price across the years is highly unknown. In order to mitigate that, let’s look at two scenarios. Scenario 1: VNQ’s yearly prices change at the same pace as the dividend per share. That means that in this scenario the ETF price will go up by 4.5% every year. Scenario 2: VNQ’s price remains at $75, or in other words the investment and reinvestment are taking place through the time of dips in the ETF pricing. Scenario 1 results In this case, where the ETF prices are growing alongside the dividend per share, after ten years, the investor has accumulated a holding of 2,093 VNQ shares. This holding has the potential to generate $9,739 in dividends per year. The investor invested $120,000 and therefore can expect 8.1% return on his investment in the tenth year. An income stream that potentially will continue to grow afterwards. Scenario 2 results In this scenario of flat ETF prices through the ten-year horizon, the amount of accumulated shares is ~30% higher than in scenario 1. The holding is getting to a total of 2,783 shares. It has the potential to generate a yearly income stream of $12,946 per year pre-tax. The following year, if we’re maintaining the same assumptions of reinvestment, the income stream after taxes is expected to exceed the $12,000 threshold. After ten years, the investor had invested $120,000 and expects to receive 10.8% in annual dividend return on his investment. Conclusions The anxiety regarding the interest rate will accompany us in the coming months and years. This will generate great opportunities for the long-term investor who is pursuing an income stream. The REIT sector is expected to grow even if the interest rate will rise. I find VNQ to be the best ETF that focuses on U.S. REITs. The patient investor has the potential to gain significant returns by setting their investment strategy straight. As there is no way to best optimize the entry or time the market, the investor should build a position through several purchases. And lastly, an investor should take advantage of the days of panic. These will be the days that will serve them well in the long run.

The Dividend Discount Model And You: Proper Use And Limitations

Summary The dividend discount model is a simple valuation model for dividend investors to use in valuation. Like all models, it is only as good as the inputs used. Regardless of its drawbacks, the use of models forces investors to forecast company results and evaluate their own risk tolerance, which can only be positive for investor returns and contentment. Valuation can be a tricky subject for investors managing their own portfolios. As investors, we might like a particular company, its business, and its future prospects. But what exactly is a fair price to pay? Sure, we can look at valuation measures like P/E and EV/EBITDA and compare those numbers against historical values, but then we are just speculating that the company will return to its long-run average. Is there a better way? Financial models can be one answer to that problem. Novice investors usually start with the dividend discount model. The dividend discount model is an extremely simple, conservative valuation technique for evaluating dividend-paying stocks. While every model has its weaknesses, I believe that at the bare minimum, applying the dividend discount model to your holdings encourages you to think about, understand, and then model your portfolio holdings. Understanding the application and foundations of the dividend discount model is fairly simple. It fits into the broad bucket of discounted cash flow analysis. What we are trying to accomplish when using the model is to put a value on what a company’s future dividend cash flow is worth to us in today’s money. When we talk about “discounting” those future cash flows, we’re adjusting those numbers to reflect its value today. For example, because of the time value of money, a payout of $1,000 one year from now is worth less than $1,000 to you today. Money today has the ability to earn returns and avoid inflation, something that money in the future cannot claim. The median point where we are ambivalent between two amounts of money at different times can help us calculate our required rate of return, along with evaluating the riskiness of holding a particular stock we are analyzing. So, if our required rate of return is 8%, the discounted value of $1,000 one year from now is $925.93 ($925.93 * 1.08 = $1,000). The Basic Formula (click to enlarge) What you’ll notice from the formula is that it assumes a constant dividend growth rate. We all know dividend growth rates vary from year to year, but in the best case for modeling, we attempt to use what the long-run average will be. The weakness here as well is that the greater the dividend growth, the more minor differences between your hypothesized growth and real-world results can skew our model. So this simplistic model works best for securities with lower dividend growth rates and stable earnings. For income investors, using this model for utilities stocks should spring to mind quickly. Real-World Application Example Below, we have an example of ALLETE (NYSE: ALE ), a utility that generates energy for customers in Wisconsin, Michigan, and other surrounding states. It currently trade at $48.55/share. I’ve written a fairly pessimistic article on ALLETE , but we can see if the results from the dividend discount model back or disprove my thesis, based on various inputs. ALLETE currently yields $2.02/share annually, and has grown its dividend at an average 2.2% annual rate for the past five years, so we’ll use those numbers to run our valuation, along with an 8% required rate of return. We will assume the dividend will be $2.12 next year. P = 2.12 / (.08 – .022) P = 2.12 / 0.058 P = $36.55/share Based on this valuation, we come to a fair value of $36.55/share, or roughly 25% below current prices. To show how the model can be sensitive, let us instead change our assumptions. Perhaps based on our research, we find that going forward, management will be able to raise the dividend 3.25% annually instead of 2.2%, because maybe we have found information that has led us to believe the utility will be allowed a higher rate of return by its regulators. Additionally, we find that our own required rate of return is only 7% for ALLETE, because the stock has less financial risk than we previously thought. P = 2.12 / (.07 – .0325) P = 2.12 / 0.0375 P = $56.53/share Our calculated fair value per share is now $56.53, or more than 15% above current prices. Which is correct? That depends, based on your analysis of management’s ability to continue to raise dividends into the future and your own assumptions on the riskiness of the holding, which factor into your required rate of return. Multi-Step Models What if we think the dividend will grow at 3.5% for the next five years for ALLETE, and then 2.25%, after using an 8% required rate of return? The dividend discount model can be adapted to be used for multiple stages of growth to suit the reviewer’s needs. Year One Dividend = $2.12 * 1.035 = $2.23 Year Two Dividend = $2.23 * 1.035 = $2.31 Year Three Dividend = $2.31 * 1.035 = $2.39 Year Four Dividend = $2.39 * 1.035 = $2.47 Year Five Dividend = $2.47 * 1.035 = $2.56 Year Six Dividend = $2.56 * 1.025 = $2.62 Once we have the values, we can then discount those to their net present value: $2.23 / (1.08) = $2.06 $2.31 / (1.08) 2 = $1.98 $2.39 / (1.08) 3 = $1.90 $2.47 / (1.08) 4 = $1.82 $2.56 / (1.08) 5 = $1.74 We can then apply the constant growth model we used previously to determine their value, based on the fifth-year dividend value: P = 2.62 / (.08 – .0225) P = 2.62 / 0.0575 P = $45.57/share This value has to be discounted to net present value as well. P = 45.57 / (1.08) 6 P = 45.57 / 1.5868 P = $28.72 Add up the values of the five higher-growth dividends with your constant growth value: P = 2.06 + 1.98 + 1.90 + 1.82 + 1.74 +1.65 + 28.72 P = $39.87/share Conclusion Like any and all financial models, the dividend discount model is sensitive to the inputs used to value the security. Thus, financial modeling isn’t the grand answer to record-beating returns, and I wouldn’t advocate for retail investors to bury themselves in Excel spreadsheet models. However, financial modeling can force investors to think about issues that are extremely important to the stock valuation process, which can drive critical re-evaluations of your positions based on your own inputs and expectations. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

3 Best ETFs To Consider When Looking For Passive Income

Summary Investors who pursue income should consider income ETFs. ETFs have the advantage of buying a portfolio of one’s favorite stocks in a single buy. Here is the list of my top three income ETFs. The week after Labor Day continued to be highly volatile. The high volatility was seen both in intra-day trading as well as the day-to-day change in sentiment. This is how the trading board ended up on Tuesday: And this is how it looked at the end of the following trading day: While traders and short-term investors are waiting to see where the markets are going to trend in the coming future, the long-term investors should look for opportunities to achieve their long-term goals. By taking advantage of the recent fear and stocks selloff, long-term investors’ goals can be achieved even earlier than the original plan. One way to do it is to put buy orders of your favorite stocks and buy those each separately. An alternative way is to buy an ETF. The advantage of an ETF is that it can give the investor an exposure to a bunch of stocks, sectors or indexes without the commotion (and the commissions) of individual stock picking. There are investors who are seeking to generate passive income by holding U.S. large cap blue chip stocks. The ETF market possess several opportunities for this type of investor. To find the best list of top income ETFs, I started with the full list of large cap value equity ETFs using etfdb.com, and from that initial list carved out the income ETFs. The list of the 29 income ETFs can be found here . In order to narrow down the list, I filtered out high management expense ratios, leaving in only ETFs that charge less than 0.4% per year. This filter allowed to narrow down the list to 16 ETFs. Since I was looking for high-income ETFs, the next step was to filter out the ETFs with the lowest dividend rate. My benchmark was the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) which is a good representative of the S&P 500 index. SPY’s current dividend yield is at 2.06%, hence I used that as my dividend rate cutoff. Following this filter, I was left with a list of 11 ETFs: iShares Core Dividend Growth ETF (NYSEARCA: DGRO ) WisdomTree Equity Income ETF (NYSEARCA: DHS ) WisdomTree LargeCap Dividend ETF (NYSEARCA: DLN ) WisdomTree Total Dividend ETF (NYSEARCA: DTD ) WisdomTree Dividend ex-Financials ETF (NYSEARCA: DTN ) iShares Select Dividend ETF (NYSEARCA: DVY ) iShares Core High Dividend ETF (NYSEARCA: HDV ) ALPS Sector Dividend Dogs ETF (NYSEARCA: SDOG ) PowerShares S&P 500 High Dividend Portfolio ETF (NYSEARCA: SPHD ) Vanguard Dividend Appreciation ETF (NYSEARCA: VIG ) Vanguard High Dividend Yield ETF (NYSEARCA: VYM ) The profile of this list can be found in this table: The next step was to assess the dividend growth history. DGRO paid dividends only since September 2014, hence due to its short history it was taken off the list. The next two tables summarize the ETFs’ yearly dividend since 2010 and the year-over-year dividend change percentage: Most of the ETFs were found to have high swings in the year-over-year paid dividend. Though most of the years the dividends have risen, there are years of dividend reduction. An income investor will pursue a growing dividend ETF and only three managed to increase their dividends since 2010: DVY, HDV and VYM. (click to enlarge) If I had to choose the single best ETF, it would have to be HDV . HDV delivers the highest annual dividend yield (3.94%) and carries a low expense ratio (0.12%). Its top holdings include an impressive list of blue chip cash machines like Exxon Mobil (NYSE: XOM ), Verizon (NYSE: VZ ), Pfizer (NYSE: PFE ), Johnson & Johnson (NYSE: JNJ ), General Electric (NYSE: GE ), Philip Morris International (NYSE: PM ), Procter & Gamble (NYSE: PG ), AT&T (NYSE: T ), Chevron (NYSE: CVX ) and The Coca-Cola Company (NYSE: KO ). In total, the ETF has 76 different holdings. The top 10 holdings account for 58% of the HDV’s investment allocation. DVY and VYM hold similar top 10 holdings in their lists and have higher diversification and a larger number of total holdings in their portfolio. Conclusions: An investor looking for an income stream based on U.S. best of breed blue chip companies, but would like to avoid accumulating these stocks separately, should consider one of these three ETFs: DVY, HDV or VYM. Based on this study, my favorite is HDV but each should do his own due diligence. Happy investing. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: The opinions of the author are not recommendations to either buy or sell any security. Please do your own research prior to making any investment decision.