Past versus Future

[Kerim]

So I just read one of Tim McAleenan’s recent articles up at his blog The Conservative Income Investor, titled "What If You Only Make One Good Investment Your Entire Life?" I truly admire and enjoy Tim’s writing and approach, and only wish that I had understood as much as he does when I was his age. If I had, I might be retiring comfortably about now in my mid-40s. I think Tim is right about almost everything he writes, and I recommend his articles to anyone interested in dividend growth investing.

So with all of that said, I feel compelled to examine one small aspect of Tim’s writing. Very often, in supporting the merits of dividend growth investing, he will point out that an investment in a good dividend growth stock many years ago would bear amazing fruit today. Yesterday’s article is a great example of this. It is a neat read. He argues that if you had made ten separate $5000 investments in the 1980s in blue-chip dividend-paying companies, and had the bad luck to have nine of the ten go bankrupt, a lone excellent investment could outweigh all of the loss. In his hypothetical, a $5000 investment in JNJ at the beginning of 1983 would today be worth $304,000, and would be throwing off $8760 in dividends annually. That one investment would more than compensate for the nine losers. It is a great illustration of the power of time and compounding with a good dividend growth stock.

But is there any reason to expect similar performance out of JNJ for the next 30 years? This is what always jumps out at me about these examples. Of course we all know that past performance does not indicate future returns, but it does seem to be the implication underlying the examples.

So let’s look forward instead of back. A $5000 investment today would get you about 53 shares of JNJ. Let’s assume that the dividend grows by 8 percent each year for the next 30 years, and that all dividends are reinvested. To calculate the share price over time, I’m going to assume for simplicity that the current yield of 2.8 percent persists. Here’s a rough take on how the next 30 years will go:
   
Of course this is crude. Share price and yield will fluctuate (which I think would bias the results upward). And you could argue about whether 2.8 percent is a good choice for yield. And dividends are reinvested quarterly, not annually (though I think this would only boost the results by a few thousand dollars over 30 years).

In my opinion, the results seem impressive. That initial $5000 investment, with no other work, turns into $115,000 in 30 years, and an annual dividend of $3223. Not too shabby. But they are not even in the same ballpark as the $304,000 and $8760 that Tim uses as an illustration from the last 30 years.

Now, if you inflate the initial investment of $5000 dollars from 1983 to $11,724 today (using the Bureau of Labor Statistics’ calculator), you’ll have a more impressive $270,000 value in 30 years (approximately). Still shy of the example from the last 30 years, but at least in the same ballpark.

I’m not sure whether we can expect even the venerable, but already huge, JNJ to continue to grow earnings and dividends at that pace for the next three decades. There are lots of reasons to think that, for companies like JNJ, the next few decades will see slower growth than the last few. So I certainly would temper my expectations and hedge my bets.

But as Tim’s article points out, if you are careful, the odds of you choosing nine losers out of ten are low. So even with lesser returns, given enough time, a well-constructed dividend growth portfolio should do well. At bottom, I think that Tim’s core points, if simplified, are unassailable.

Now, if only I had 30 years until retirement. I’ve got to pull it off in 20!

[Dividend Mantra]

I also enjoy Tim's writing. He's a very smart young man.

It's impossible to know whether or not JNJ, or any other firm, will continue growing at a similar rate in the future as they have at any period in the past. That being said, I think it's likely JNJ will still continue growing at a rapid pace for the foreseeable future. The economy is totally different now than it was back in the 80's. It's a global economy now, instead of us vs. them. There are a lot more people alive now than there were back then as well. That means more people to consume their products. And the middle class around the world is burgeoning. There are billions of people around the world that can actually afford basic goods now, and have access to some semblance of modern medicine. In addition, demographics here in the U.S. bode well for JNJ with the boomers growing old.

However, JNJ doesn't need to explode. Steady growth over the long haul, coupled with reinvestment of the dividends means you're looking at solid risk-adjusted returns. In addition, as Tim pointed out you only need a few of these investments to pan out as expected. Diversifying across even more than 10 and having 90%+ of them succeed means one should do very well. I'm currently invested in 43 companies, so even if 3 go completely bankrupt over the next couple of decades (unlikely), the math is on my side.

Best wishes!

[NilesMike]

Excellent points, both of you along with the blog post.

I too look back over the time frame mentioned, JNJ-and all companies-went through many challenges. Wars, world unrest, oil price fluctuations, competition, bull markets, bear markets...and have come out the other side.

That alone gives me the confidence going forward.

[cannew]

That really is the DG advantage, isn't it! But add some reality to the picture, because if one is invested in good DG stocks than you will probably be adding additional funds periodically.

Your re-invested dividends will probably increase your income by about 4% per year, If one just stuck with the 4 % growth (which I consider extremely low) and added the growth from additional funds added, one would not have to wait 30 yrs to see your income grow to a respectable amount.

[Kerim]

(12-08-2013, 08:22 PM)Dividend Mantra Wrote: That being said, I think it's likely JNJ will still continue growing at a rapid pace for the foreseeable future. The economy is totally different now than it was back in the 80's. It's a global economy now, instead of us vs. them. There are a lot more people alive now than there were back then as well. That means more people to consume their products. And the middle class around the world is burgeoning. There are billions of people around the world that can actually afford basic goods now, and have access to some semblance of modern medicine. In addition, demographics here in the U.S. bode well for JNJ with the boomers growing old.

Really great thoughts there, DM. I tend toward the pessimistic side sometimes. Glad to be reminded of the tailwinds too!

[rnsmth]

Say JNJ does not keep growing the dividend at an acceptable rate?

My mantra is buy and monitor, sell and replace. None of the companies I own are exempt from that. If the dividend growth rates drops below a certain percentage, most would go on probation. A second year of dividend increase lower than the percentage, it gets sold. The exact percentage depends on the company and its yield, to some extent, along with an analysis of its future prospects. A buggy whip maker like Pitney Bowes would be gone more quickly than a MCD, for example

T is gone, COP is gone, CINF is gone, LLY is gone and others are gone under that rule. I would not necessarily wait for two years, depending on the company, nor is it my only sell criteria. DRI's last earning report and guidance sucked so much I sold it.

It is the safety and sustainability of the dividend and the dividend growth that are my guidelines. It is what can help you avoid owning companies with decreasing dividend growth rates.