We all know the story learned in childhood in bible studies, or the movies that portrayed it. As an advisor to the Pharaoh, Joseph counseled him to set aside surplus grain from bumper harvests so that the country’s people would not go hungry or starve when the next drought came and farmers would not be able to grow grain. This advice, that avoided a famine, was much appreciated and admired by Pharaoh as it saved Egypt from destruction.
Sadly, in modern times, central bankers no longer heed this well-worn advice. Though budget surpluses have been achieved occasionally, the rule today is quite different. Rather than aspiring to achieve surplus, today’s central bankers simply print more money electronically. Magically, they expand the money supply to pay for spending and create ever-larger deficits and expand the national debt.
In order to pay for the administration’s huge tax cut for corporations, some of the burden will fall to middle class taxpayers to make up some of the shortfall. The balance will be paid for by additional debt creation by the Fed.
Nationally, the annual deficit has reached $1 trillion. We’ve been there before, but never with a national debt burden of over $21 trillion where we find ourselves today.
Private Lives, Private Finances
In our own private lives, we never get the luxury to print money like central banks to pay our bills. Anyone nurturing such a fantasy should jettison it now.
The only way we can reliably sail through life with a modicum of financial safety and comfort is to follow Joseph’s advice. Save our own personal surplus and store it for the next drought or famine.
Spend Less, Save More
In practical terms, this simply boils down to saving on a regular basis, and never spending more than you earn. If you always spend less than you earn, mathematically, you’ll never run out of money.
However, this mathematical formula breaks down somewhat, when we must finally retire from the active work environment. Some of us will have to do this due to sickness, physical disability or even an accident that renders us unable to work.
Others, more fortunate, will face retirement on a more proactive basis, choosing to retire at a time of our own choosing. Whatever the situation, while in retirement mode, earnings from active work will no longer flow into our coffers.
This is precisely when Joseph’s brilliant advice will pay off for those of us who have taken his message to heart and prepared accordingly.
And Then There Was Inflation
In Genesis, when the Creator deemed it, “Then there was light.” For the retirement cohort, then there was inflation.
Perhaps we scrimped and saved all of our working lives, diligently preparing for the day the paycheck would no longer show up in the mailbox. But even some of those good Boy Scouts and Girl Scouts, always prepared in all things, did not prepare their financial future for one where the prices of goods and services always rise.
Failing to take account of this one small detail can easily derail even the best saver’s retirement savings plan.
Bonds Can’t, CDs Won’t
Bonds can’t do it. CDs won’t do it. Each of these investment vehicles pay a fixed rate of interest. No matter what inflation does in the economy, your bond or CD couldn’t care less. You can beg or plead, but the bank that issued your CD won’t raise your interest income. It will stay the same amount, from the day you bought it, till the day it matures.
Bonds are no different. When you buy a bond, whether a corporate or treasury issue, whatever the coupon rate is, that’s the rate you’ll receive for the length of time you hold it.
If you buy the bond at par when first issued, and the yield is fixed at 3%, you’ll receive $3.00 of interest annually for each $100 of face value you purchase. But if inflation is running at a 2% annual run rate, your return looks like this:
When taxes on that ordinary interest is figured in at the state and federal level, your return is diminished once again by your combined tax rate. Assuming a combined rate of 25%, this might bring your interest return down to something closer to .25%.
3% X.75= 2.25%
2.25%-2% inflation= .25%
Once inflation breaches the 2% mark, the interest you receive will go negative. The only party to gain from the transaction will be Uncle Sam who will happily collect taxes from your interest payments. Inflation was reported recently at a rate .5% higher than the previous month.
Try and take this case to the bond issuer and ask for more interest on your bond investment. You won’t get very far. The interest payment on your bond is fixed. The semi-annual or annual interest payment you receive will be the same in the tenth year as it as in the first year you bought it. Plead as you might that inflation is ravaging the purchasing power of those interest payments, the issuer will have only deaf ears for you.
Dividend Growth Stocks To The Rescue
There is an investment class that won’t send you home begging every year. In fact, dividend growth stocks are named as such because they actually increase your income each year. They do this by growing their dividend, year in and year out.
No Guarantees, But…
Of course, nothing is guaranteed. But if the investor is willing to do some research on high quality companies with long, enviable histories of increasing the dividend on a regular basis, if good stocks are chosen, they can battle inflation. And since these types of stocks have established records, the investor never has to go begging, hat in hand, for a raise.
The inflation-beating quality is basically understood and built into this type of investment.
Dividend Kings, those stocks that have 50 years or more of dividend raises under their belt, or Dividend Aristocrats, companies that are part of the S&P 500 Index and have raised their dividend for at least 25 years, are always a good place to start prospecting for these type of reliable dividend payers and growers.
Strategy Session: Here’s One That Makes The Argument
AT&T (NYSE:T) is a company familiar to most consumers and investors. If you watch TV, it is hard to miss this company’s deluge of constant advertising.
If they’re not trying to sell you their phone, internet and TV packages, they’re offering you a free phone to sign on to one service or another. Other ads are aimed at persuading businesses to sign on to their specialized business services.
If you haven’t been hiding in a cave for the last year, you’re also familiar with their bid to acquire more content to sell through their many services by acquiring Time Warner (NYSE:TWX).
The drama is nearing the end game as the Justice Department has challenged this combination as anti-competitive. In a November 20, 2017 Justice Release, Justice believes that concentrating too much media content in one company will adversely affect AT&T’s customer base, causing them to pay higher prices for the content they consume.
The first round in court began in early March, when the company and T sketched out their early arguments. The judge is scheduled to render judgment in the beginning of June.
T believes that the Justice Department is doing the president’s bidding, trying to block the merger due to the president’s antagonism towards CNN, which he refers to as “fake news” purveyors.
A group of former top Department of Justice lawyers are arguing the Trump administration’s attempt to challenge the AT&T-Time Warner merger violates the Constitution if the action is punishment for CNN’s news coverage.
Media reports have suggested that the DOJ’s recent threats against AT&T are politically motivated, noting Trump openly pledged to block the merger when it was announced last year, just weeks before he was elected president.
Source: New York Post
I am among the analysts that believe that T will prevail in this battle, and that it will acquire a very valuable asset that will help to expand AT&T’s footprint and add large revenue and profit to the bottom line. Though the merger will cost AT&T $85 billion to effect this transaction, the eventual accretion of revenue and profit will be sufficient to pay the additional interest that will accrue from the new debt.
Joseph Counsels Us
Again, remember what Joseph counseled Pharaoh? Save surpluses for when we’ll need them come the next drought or famine.
For those of us planning for retirement, our big drought or famine will come once we leave the work force. No regular paycheck from work equals the biggest drought and famine we’ll ever face.
So, we need to get our affairs in order, preparing for this eventuality all our working lives. Always spending less than we earn is just the beginning. It is the foundation that allows our surplus to accumulate.
Then, it is what we do with those surpluses that determine if our grain will last a lifetime.
Buying a stock like AT&T will serve all of our purposes. Investing our surplus in a company like this will see our grain grow inexorably as it sits in the storehouse, waiting to be used. We will see our surplus grow by the regular dividends they pay as well as the regular increases in the dividend. If we choose to reinvest those dividend payments into additional shares, our surplus will grow from this double compounding effect.
And when we finally reach the day we earn our gold watches and punch the clock for the very last time, we can count on AT&T to continue raising our income like clockwork. AT&T will help to keep our heads above the inflation waves and preserve our purchasing power.
Here’s a compelling illustration of the length and reliability and growth of AT&T’s dividend.
You can see that AT&T has been nothing if not consistent in raising the dividend by a penny per quarter for years on end. It is true that raising the dividend the same amount each year, as the previous year’s divisor grows bigger, the next year’s percentage increase grows smaller. However, one penny divided by last year’s 49 cent quarterly dividend is still trending above inflation that the Fed continues, but fails, to get up to the 2% level.
$.01/$.49 = 2.04% increase
Gather Grain Opportunistically
If you’re willing to take a more activist approach to your investing, as we do for our subscribers, it is always possible to buy one stock or another when it goes on sale.
AT&T is a company whose dividend yield has trended in the 5% range for quite some time. Whenever it drifts one way or the other, it eventually returns to that well-defined trend line.
As investors fretted that the Time Warner deal would necessitate too much debt that would sink AT&T’s ship, they sold off their shares. As they did so, shares moved from weak hands to strong hands and fell into our buy zone. Our limit order at $32.60 was executed and we received a very healthy 6.01% yield. Weeks later T raised the dividend to $2.00 per share, giving us a yield on cost of 6.13%.
6.13%- 5.0% usual yield = 1.13%
1.13% / 5.0% = 22.6%
When’s the last time you got a 22.6% raise at work?
When’s the last time your wheat field yielded 22.6% more grain than the previous year?
AT&T’s Prospects Going Forward
In light of the amount of cord-cutting we’re witnessing in the cable ecosystem, AT&T is looking to aggregate large amounts of TV and movie content, which it can sell through its various streaming services. Time Warner embodies such content in its enormous library of TV and movie properties. In turn, the large recurring revenue streams that this content represents will be available to investors in the form of growing revenue and profits, which fund the dividend.
In order for a dividend to be sustainable, free cash flow derived from revenues and earnings must be sufficient to cover it. Because I believe the merger with TWX will ultimately be approved, AT&T will have additional resources at its disposal to pay for the dividend.
TWX’s free cash flow of $4.2 billion, added to T’s $17.2 billion will make for a formidable trove of cash to cover the dividend going forward.
Time Warner’s dividend of $1.61 translates to a payout ratio of just 24.3% as compared to AT&T’s much higher payout ratio of 41.3%. TWX’s very low ratio means that when the merger is completed, the combined companies will have enormous resources to not only sustain but grow the dividend.
Time Warner Profit Drivers Going Forward
Since Time Warner is an integral part of this thesis, the future profit drivers of each of its entertainment segments take on added significance. The company, in its April 26th release, is giving guidance of single digit to double-digit growth in subscription and operating income.
FULL-YEAR AND SECOND QUARTER DRIVERS OF 2018
For the full year 2018, the Company continues to expect Turner’s subscription revenues to increase in the mid single-digits compared to the prior year. Additionally, for the full year 2018, the Company continues to expect growth in Turner’s programming costs and total expenses to moderate compared to 2017. The Company expects subscription revenues in the second quarter of 2018 to grow at a similar rate as for the full year. Scatter pricing for advertising sales at Turner’s domestic entertainment networks has increased high single- to low double-digits in the second quarter to date compared to the prior year’s upfront. The Company anticipates flat to low single-digit growth for Turner’s total advertising revenues in the second quarter of 2018 compared to the prior year quarter. For the second quarter, the Company expects Turner’s total expense growth to be in the low double-digits compared to the prior year quarter, primarily due to higher sports costs, including costs related to Turner’s rights to air NBA playoff games, and increased original programming expenses. As a result, Turner’s Operating Income in the second quarter of 2018 is expected to decline modestly compared to the prior year quarter.
Home Box Office
The Company anticipates Home Box Office’s subscription revenue growth rate in the second quarter of 2018 will be in the low double-digits relative to the prior year quarter. In addition, the Company expects Home Box Office’s programming costs to increase in the high teens in the second quarter of 2018 relative to the prior year quarter, primarily reflecting the timing and mix of programming. The Company anticipates Home Box Office’s revenue growth will more than offset expense growth and, as a result, expects its Operating Income to increase slightly in the second quarter of 2018 compared to the prior year quarter.
The Company expects Operating Income at Warner Bros. to increase at a rate well into the double-digits in the second quarter of 2018 compared to the prior year quarter primarily due to higher television licensing of both television and theatrical product.
Source: Time Warner Business Outlook Release
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.
Three 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 23 companies, including AT&T Inc (T)., 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),Iron Mountain, Inc. (IRM), Roku (NASDAQ:ROKU), Helios and Matheson (NASDAQ:HMNY) and LTC Properties (NYSE:LTC).
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 8.28% 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, and LTC Property now totals $34,098.78, which is $1162.92 more annual income than the previous month. This represents a 3.53% annual income increase for the portfolio.
When added to the average couple’s Social Security benefit of $32,848.08, this $34,098.78 of additional supplemental income brings this couple annual income of $66,946.86. 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
As discussed in “Even A Cloudy Crystal Ball Comes Into Focus Twice A Year,” paying too much attention to the everyday price swings, even with stodgy stalwarts like AT&T can drive investors totally batty.
We used a biblical story to illustrate the brilliance of saving for a rainy day. Joseph saved a nation. You can save your retirement.
It can’t be repeated often enough, especially in a nation that constantly spends more than it earns. This applies to the nation as a whole as well as a majority of individuals who live within it. Spend less than you earn and you’ll have taken the first step towards financial independence.
The next step on your retirement journey is to invest your newfound surplus in companies like AT&T and other Dividend Aristocrats. A dividend a day will keep the droughts and famines away.
When AT&T’s yield shot up from its usual 5% range to 6.01% we could not stand by passively and look that gift horse in the mouth. We acted, for ourselves, our readers who follow me, and subscribers.
It is my aim to share a lifetime of investing lessons I’ve learned with you.
Your Engagement Is Appreciated
As always, I look forward to your comments, discussion, and questions. Have you been able to draw any interesting lessons from childhood into your investing? Please share those in the comment section along with 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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Disclaimer: This article is intended to provide information to interested parties. As I have no knowledge of individual investor circumstances, goals, and/or portfolio concentration or diversification, readers are expected to complete their own due diligence before purchasing any stocks mentioned or recommended.
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Disclosure: I am/we are long ALL FILL-THE-GAP 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.