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Users of crystal balls are usually concerned with the ability to foretell the future. “Will I marry?” “Will I grow old?” “Will I be rich?” Most of us would admit having interest in the first two questions. All of us, as investors, would certainly have great interest in the third.
It is with this in mind, as an income investor, that I concern myself with discovering historical patterns that can be used in conjunction with important metrics like free cash flow, earnings growth, and especially dividend growth. When interpreted correctly, many ingredients can be combined in a way that will lead us to investments that help bring us closer to our goals, to reach retirement with a continuing stream of growing income that outstrips inflation.
It was just a few days ago that I postulated that our core holding, AT&T (T), was on the cusp of raising its dividend, by another penny per quarter. This, I said, would bring the annual dividend payment up from $1.96 to $2.00 per share.
I readily admit it: This fortune teller is much easier on the eyes than my old puss. However, even my rusty crystal ball is on the money sometimes.
AT&T Declares An Increased Dividend
On Friday, December 15th, AT&T declared a $0.50/share quarterly dividend, which is a 2% increase from the prior dividend of $0.49.
Forward yield 5.24%.
Payable Feb. 1; for shareholders of record Jan. 10; ex-div Jan. 9.
34 Consecutive Years of Dividend Increases Reflects Strong Cash Flows
Not many companies can boast of such a long period of increasing their dividends to shareholders. A company that increases its dividend for 25 consecutive years is referred to as a dividend aristocrat. AT&T has superseded this designation by nine years, to date.
The board of directors of AT&T Inc., doing what it’s done for 34 consecutive years, approved yet another in a long series of increases in the company’s quarterly dividend.
The annual dividend will in fact increase from $1.96 to $2.00 per share.
Randall Stephenson, chairman and CEO, said:
Our strong cash flows and outlook for the business allow us to raise our dividend for the 34th consecutive year. We’re committed to returning value to our shareholders, and we’re pleased to deliver yet again.
AT&T Inc. is a holding company. It is the largest telecommunications company in the U.S. AT&T products and services are provided or offered by subsidiaries and affiliates of AT&T Inc. under the AT&T brand and not by AT&T Inc. Additional information about AT&T Inc. is available at about.att.com.
Source: Business Wire
Crystal Ball Prediction
That prediction of mine was based on the aforesaid history of 34 consecutive years of dividend increases. It was also based on the fact that free cash flows have been increasing, and that is what supports a growing dividend. It was also based on recent history indicating AT&T has been raising the dividend by this same amount the last several years – nine years in fact.
AT&T Recent Dividend History
Going back 9 years, penny a quarter increases have been the norm (4 cents per year).
Source: Yahoo Finance
Fed Having Difficulty Getting Inflation Off The Ground
Though the Fed just raised the fed funds rate another 1/4 point recently, and three more hikes are expected for 2018, the Fed continues having difficulty getting the economy to produce inflation above its target rate of 2%. In fact, it’s been running below this target range for quite some time, confounding many economists and the Fed chair herself.
This Is What Winning Is
As long as AT&T keeps delivering dividend increases to shareholders like this one, running at a 2.04% increase while inflation runs below 2%, stakeholders like us continue to run ahead of the game and preserve our purchasing power. For us, that’s the name of this game we call dividend growth investing.
We Are Not Unhappy With The Capital Gains, Either
Our recent purchases In AT&T to expand our core positions further, for both the RODAT Subscriber Portfolio and the Fill-The-Gap Portfolio, have paid off quickly and handsomely.
On November 6, while most investors were down on AT&T because of all the confusion surrounding the merger with Time Warner (TWX) and the worries about how much debt T would take on to accomplish the marriage, we stepped into the morass and bought more shares for both portfolios at $32.60 per share.
We based our analysis, among other data, on the fact that T’s dividend yield normally flies in the 4.5% to 5% range, as discussed in “AT&T’s Downward Spiral: What, Me Worry?”. We secured a 6.01% dividend yield at that $32.60 price. As soon as the $2.00 annual increase takes effect on February 1st, our effective yield will rise to 6.13%. This amounts to capturing 36% more income from our shares than investors who bought at much higher prices and obtained the much lower 4.5% yield.
If you translated this type of extra income to a total portfolio, you could easily visualize the difference in income produced by making well-timed investments like this:
$100,000 portfolio yielding 4.5% generates $4500 in annual income.
$100,000 portfolio yielding 6.13% generates $6130 in annual income.
For investors fortunate to have accumulated a higher portfolio amount:
$500,000 portfolio yielding 4.5% generates $22,500 in annual income.
$500,000 portfolio yielding 6.13% generates $30,650 in annual income.
The $64,421.38 Question
Here’s a rhetorical question for you: Which of the above annual dividend supplemental incomes would you choose for your retirement to supplement your Social Security benefit, $22,500.00 or $30,650.00?
There’s Always A Sale, Somewhere
Waiting for your watch list candidates to suffer undeserved beat-downs can lead to much higher income in retirement. If you make your watch-list bench deep enough, you’ll find there’s always a sale, somewhere in the markets that you can take advantage of.
With shares selling for $38.50 as I write this, we have bought ourselves, our followers, and subscribers an early Christmas present: capital appreciation of 18.1%. We can buy a whole lot of Xmas presents with that, not to mention those hefty dividend payments.
The Fill-The-Gap Portfolio holds 1,530 shares of AT&T. Our annual income from this name has now climbed to $3060.00 and $765.00 will flow to our accounts on February 1, 2018.
Please adjust your digital tracking tools to reflect this new dividend amount of $2.00 per year.
New Net Neutrality Rules
The changes in the rules will have various outcomes to all parties concerned, including consumers of internet services, the providers of those services, and the investors who look to profit from ownership in those providers. Included among them are these:
The FCC’s recent decision to free up internet service providers, allowing them to charge higher prices to whomever they choose and to slow down speeds for sites they desire, or speed up others, or charge for faster speeds may harm some of us as consumers.
As an internet service provider, or ISP, this change in rules will certainly benefit companies like AT&T which provide the pipes and now will have more control over how the internet flows through those pipes.
As investors, higher charges should flow through to higher free cash flow, thereby enabling a sustaining of the dividend at a minimum, and a faster dividend growth rate at the maximum.
By this time next year, the results of this rule change and the ultimate decision as to whether the merger with Time Warner is allowed to proceed should come further into focus, and we will see if the thesis for a higher dividend growth rate pans out as I believe it will.
Free Cash Flow Picture Brightening
The company has projected free cash flow of $18 billion for the full year.
Because of a decrease in investment activity, free cash flow was substantially higher year to date than was expected. Thus, the $18 billion target seems attainable.
Because the $18 billion is achievable, this casts even better light on the payout ratio.
The last five years, the payout ratio (dividends/free cash flow per share) has ranged from about 65% to 75%. This year, the company is on track to sport a dividend/free cash flow payout ratio near 50%.
What does this mean? For one, it means that AT&T will have no difficulty paying its dividend obligations to shareholders. For another, it means that the dividend is covered by a factor of two. The dividend is not only safe and sustainable, but also a dividend increase is to be expected for shareholders again next February 2019. If they conform to the pattern of the last several years, investors should expect another penny per quarter increase going forward, or greater if free cash flow is positively impacted by the new net neutrality rules and the proposed TWX merger.
The Fill-The-Gap Portfolio
The FTG Portfolio contains a good helping of dividend growth stocks, like AT&T. It was built with the express purpose of benefiting from this and other strategies.
Two and a half years ago, I began writing a series of articles on December 24, 2014, to demonstrate the real-life construction and management of a portfolio dedicated to growing income to close a yawning gap that so many millions of seniors and near-retirees face today between their Social Security benefit and retirement expenses.
The beginning article was entitled, “This Is Not Your Father’s Retirement Plan.” This project began with $411,600 in capital that was deployed in such a way that each of the portfolio constituents yielded approximately equal amounts of yearly income.
The FTG Portfolio Constituents
Constructed beginning on 12/24/14, this portfolio now consists of 21 companies, including AT&T Inc., Altria Group, Inc. (MO), Consolidated Edison, Inc. (ED), Verizon Communications (NYSE:VZ), CenturyLink, Inc. (NYSE:CTL), Main Street Capital (MAIN), Ares Capital (ARCC), British American Tobacco (BTI), Vector Group Ltd. (VGR), EPR Properties (EPR), Realty Income Corporation (O), Sun Communities, Inc. (SUI), Omega Healthcare Investors (OHI), W.P. Carey, Inc. (WPC), Government Properties Income Trust (GOV), The GEO Group (GEO), The RMR Group (RMR), Southern Company (SO), Chatham Lodging Trust (CLDT), DineEquity (DIN), and Iron Mountain, Inc. (IRM).
Because we bought most of these equities at cheaper prices since the inception of the portfolio and because most of our stocks have increased their dividends regularly, the yield on cost that we have achieved is 7.67% since launch on December 24, 2014. Current portfolio income, including recent dividend raises by AT&T and Realty Income, and our newest addition of AT&T shares, now totals $31,573.30, which is $505.36 more annual income than the previous month. This represents a 1.64% annual income increase for the portfolio.
When added to the average couple’s Social Security benefit of $32,848.08, this $31,573.30 of additional supplemental income brings this couple annual income of $64,421.38. This far surpasses the original goal set to achieve a total of $50,000.00, which is accepted as a fairly comfortable retirement income in many parts of the country. That being said, this average couple now has the means to splurge now and then on vacation travel, dinners out, travel to see the kids and grandkids and whatever else they deem interesting.
Taken all together, this is how the FTG Portfolio generates its annual income.
FTG Annual Dividend Income
Chart source: the author
An investor could get whiplash watching the stock price gyrations of some stocks. The sentiment on AT&T has turned from decidedly negative to positively positive the last five weeks. Dividend investors who initially abandoned the stock have rushed back with a vengeance, pushing down its yield from 6.01% to just 5.09% today. This dividend aristocrat that has come through for dividend investors for decades has once again returned to favor.
We can’t normally predict with much accuracy what a stock’s price will be from one day to the next, no matter how clear our crystal ball might be. However, if we use history as a guide and take present data like free cash flow growth into account, we can sometimes come to a decent projection of where the dividend is headed.
In this instance, my crystal ball, cloudy though it may be, was just clear enough to make a prognostication of AT&T’s dividend growth that was right on the money. I don’t doubt that some other investors may have come to the same conclusion, and they joined the march back with me to this solid stalwart that provides dependable and reliable dividend income to retirees and others for decades.
In fact, it is my contention that a steady decline in stock price lopping off 22% of market value is right about the time investors should start contemplating adding to their current stakes or starting a new position. Opportunities like this to enhance yield and income do not come along often. But when they do, the opportunities usually evaporate almost as quickly as they appear. In this case, it took only 5 weeks for the dividend yield to revert back close to the mean.
If you missed this opportunity that I presented weeks ago, don’t fret. There will always be others. There’s always a sale somewhere in the market.
Over the past five weeks, these recent gains in both capital appreciation and dividend growth couldn’t be more timely and beneficial.
Total portfolio dividend income has now risen to $31,573.30, providing plenty of manna with which to share our bounty this Chanukah, Christmas, and Kwanzaa.
From our family to yours, we wish you the best of the holiday season.
As always, I look forward to your comments, discussion, and questions. Did you view AT&T’s price deterioration in real time as a loss or an opportunity? do you still harbor doubts whether the dividend from this name is sustainable? Are contemplating taking a quick profit or will you hold for continued, future dividend growth? Please let me know how you approach these situations in your own portfolio and how you arrive at your decisions.
Author’s note: Should you be interested in reading any of my other articles detailing various strategies to enhance your returns on a dividend growth portfolio, you will find them here.
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Have a prosperous day!
Disclosure: I am/we are long ALL FTG PORTFOLIO STOCKS.
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.