Every now and then Value Line publishes a screen "Stocks for Dividend Growth with Low Risk." All the stocks in the current screen are expected to up their dividend payments well above the inflation rate over the next three to five years, at rates between 7% a year to 12% a year.

There are, I believe, 19 stock in the iPig portfolio. There are 14 in the recent Value Line screen. There are three overlaps: Air Products & Chemicals, Hasbro, and Texas Instruments.

One of the criteria for inclusion in the Value Line screen is an estimated yield of at least 3% for the year ahead. I think at least half, if not more, of the iPig stocks would be automatically eliminated as they would fail this test; that is, their yields are too low.

I'm aware that one reason to sell an "iPig" stock is because the valuation is (now) considered to be too high. Conversely, wouldn't another reasonable sell signal be because the yield is now too low?

Hypothetically, If you chose to buy the Value Line portfolio, instead of the iPig portfolio—concentrating only on the dividends—the dividend yield of the portfolio would be greater and the anticipated CAGR of the dividend increases averages about 9%.

Maybe time for a little rotation for the iPig, or is the possibility stymied by tax considerations, ideology, or both? Which leads to the observation that dividend yielding stocks are better off in tax exempt accounts, not only because the dividend isn't taxed ever, or at least for now, and the same goes for capital gains. It's much less painful to sell a stock to buy a better dividend yielder instead if taxes are not a consideration.

kelbon

Interesting concept, my friend. Is there a publically available link to the Value Line report or screen? It'd be interesting to see the selections & method to try and see why there's only a 3 stock overlap between the methods.

If I had to guess, I'd guess valuation, balance sheet, or diversification. At minimum, I could get an article or two out of contrasting the methods, and it may even offer an opportunity to pick up a new selection for the portfolio.

Thx,
-Chuck
Inside Value Home Fool

kelbon,

Which leads to the observation that dividend yielding stocks are better off in tax exempt accounts, not only because the dividend isn't taxed ever, or at least for now, and the same goes for capital gains

Not completely true in every case. If the stock is in a Roth, yes.

If the stock is in a trad IRA, no. With the favorable rates on qualified dividends and capital gains, you are better off with these in a taxable account since the withdrawals will be taxed at normal income rates.

Gene

Gene,

I had a traditional IRA in mind with the "or at least for now" comment.

Depending on circumstances, you might well be better off with a traditional IRA rather than a taxable account. Money can compound over many years undisturbed (if you're lucky). And, for most people, when they have to start withdrawing money from their traditional IRAs at seventy and a half, they are likely in a lower tax bracket than they were during their working years. They don't have to withdraw all their money all at once, which, if they did, might have led to a hefty tax bill (depending on financial circumstances).

But, the salient point I was trying to make was that, within the shelter of a tax free (or "not taxed now") account you can buy and sell to better position your portfolio without being subject to capital gains. Hopefully, at the end of the day, you're going to do really well and be flush enough to not feel the pain of paying your taxes; after all, paying taxes is something most people have to do each and every year anyway.

I'm guessing that most stock investors aren't really affluent; they are just working towards a little financial security and independence. For the really rich, it's a different ball game. They, the rich, are adept at minimizing, or completely avoiding, the taxes they "owe."

kelbon

Is there a publically available link to the Value Line report or screen?

No.

But, I'm sure there's a public library in striking distance that subscribes to Value Line.

Occasionally, I post this screen (eliminating a few columns of info) on the Dividend Growth Investing board. I have mixed feelings about doing this. At least one TMF poster who ran a screen based on proprietary VL info. received a severe cease and desist notice from Value LIne. I'm guessing another poster did too; he terminated his weekly screen that also contained proprietary VL data.

Anyway, one more time (maybe the last)…

http://boards.fool.com/vl-dividend-growth-with-low-risk-5-13...

kelbon

kelbon,

The 2013 rates for income tax and capital gains/qualified dividends:

Inc.  CG/QD
10%    0%
15%    0%
25%   15%
28%   15%
33%   15%
35%   15%
39.6% 20%

I do not see any bracket jump where a reasonable reduction of income at retirement will make paying taxes on income better than paying taxes on capital gains and/or qualified dividends.

I know you will say, "But the returns are lower in taxable because they have to take money to pay the current year taxes, reducing capital."

My answer: No. Most people pay taxes from earnings. They do not sell securities in their brokerage account to pay them. (Ok, except me since that is what I live on.)

You mention 70 1/2, which is partially correct. In trad accounts, you will be forced to take distributions starting, normally, in the year you become 70 1/2. This is a 2-edged sword.

If you live below your means, have your SSA coming in and maybe a small pension, you may not need the nearly 4% withdrawal you are forced to take because of the RMDs. In this case, you are required to take a distribution you do not need and you pay income tax on it.

Some people will save the RMD or invest it. Others may just spend(waste) it since it is "extra cash" or "mad money".

The downside here, if you are a good saver/investor in the above situation, the RMDs can push you into a higher tax bracket for money you do not need. In a taxable account, you aren't required to sell hence do not pay the tax.

The one advantage to putting dividend payers into a trad IRA is for dividend reinvestment. Over a long period of time, maintaining cost basis on lots of small dividend purchase lots can be tedious in a taxable account when you do sell. You pay more in taxes for it but it is simpler.

Gene

I know you will say…

First, a disclaimer: I think a Roth IRA is the best choice, most of the time, for most people.

But, there can be advantages to contributing to a traditional IRA in some circumstances. Often what is overlooked about traditional IRAs are the benefits on the front end. The amount you contribute comes off the top of your taxable income, so it's a tax-free contribution. This can have several advantages for individuals; it can push them into a lower tax bracket, or it can just reduce the amount of tax they owe. When you are strapped this is an issue. If, and when, you choose you can transfer all, or some, of a traditional IRA to a Roth and pay taxes due at the time. In the past I have done this when the market has been low because you are taxed on the current amount in the IRA, not the principle that you contributed. As it happens, I contributed to a traditional IRA last year, rather than a Roth. I did this to reduce my taxable income because it got me down to a level of taxable income that afforded me an additional tax advantage.

Anyway, this is all a bit of a detour. Whether you are operating within a traditional IRA, or a Roth, there are no consequences (in the here and now) of selling a winner to invest in a better prospect; not so, in a "taxable" account.

kelbon

Thanks, Kelbon --

Value Line is generally an incredibly trustworthy source, and the screen seems reasonable. I used to own Mattel and Sysco, for instance, and I've talked about General Mills as a potential iPIG Pick and why it was passed over: http://www.fool.com/investing/dividends-income/2013/01/21/wh... ...

Judging by the list of companies in the screen, it looks as though the Value Line screen & the iPIG portfolio actually have very similar tastes in stocks. To the extent there are differences from a screening perspective, Value Line seems to have a higher minimum yield requirement, slightly looser payout ratio standards, a bit less strictness on the valuation front, and not much in the way of a diversification restriction.

-Chuck
Inside Value Home Fool

Chuck,

You may want to revisit GIS. Because they are a commodity based enterprise the time to invest is often counter intuitive. They have managed to pass the additional costs of their inputs onto, at least in some part, to their customers. The price of their products are not likely to drop when the cost of their inputs drop.

Looking at this years crop inputs at this time of year is a crap shoot. Planting is late in the heart land and people are getting worried and if we get a long summer it will solve all our problems. Record amounts of crop land is expected to be planted this years as prices are still high. Who knows if it will actually get planted or what the actual yield will be. And this whole paragraph is short sighted. Over the many years GIS has managed dozens of these swings quite well and I see nothing coming from management that suggest early onset idiocy.

Now some numbers
IV $42 - $90 (depending on how you discount and what you discount). I would suggest low 40's would be the natural low. Waiting for a lower price would depend on some macro event that drives all stock prices low. I would suggest that $52-$57 would be a fair but not a deeply discounted purchase price, we should be able to make some capital gains money here but not by the truck load.

TTM
ROIC 8.4%
ROE 28%
ROA 6.6%
Payout Ratio 54%
Reinvestment Rate 87%
Operating Margin 14%
Net Margin 10%
Interest Coverage Ratio 3.7(A- equivalent rating, neither downgrade or upgrade would be expected)

jack

I would suggest that $52-$57 would be a fair but not a deeply discounted purchase price, we should be able to make some capital gains money here but not by the truck load.

For what it's worth Morningstar disagrees with you. They rate General Mills a "two star stock" meaning that they consider the stock price to be somewhat above fair value.

Value Line is in a similar boat. They expect a modest return over the next three to five years given the current stock price. They estimate the stock price for the period will be between $55 and $70 a share based on a projected P/E ratio of 16.5. On a price to operating cash flow basis the stock hasn't been this pricey since the height of 2008, just before the big downdraft as the housing bubble burst. To find a time when the stock was higher (price/operating cash-flow) you would have to revisit 2002.

I think the stock is probably a buy in the low $40s, but not in the low $50s. All the same, if your focus is dividend yield this stock is yielding about 3% currently and it is expected that the dividend will rise in step with earnings over the next few years at around 7.5% annually.

kelbon

kelbon,

All the same, if your focus is dividend yield this stock is yielding about 3% currently and it is expected that the dividend will rise in step with earnings over the next few years at around 7.5% annually.

This is really the most important part of the post to consider; what are you buying it for? If you are seeking cap gains plus dividends then absolutely the buy in price is in the low to mid 40s. If you are buying it for a long term dividend yielding asset then low $50s with a 3% yield is a reasonable purchase point. In the case of the second approach the income stream of the dividends is valued higher then the potential of waiting for a much better purchase price because it could take years before that opportunity arises.

Margin of safety is measured two different ways based on the differing approaches. For the cap gains seeker they want a low entry price to maximize profits and minimize losses. For the dividend or dividend growth seeker the priority is the company's ability to pay the dividend and preferably grow it; the 2nd group is less concerned with month to month or year to year price fluctuation while it is tantamount to the success of the cap gains investor.

jack

This can be a tough one. Even if dividends are your focus. Do you buy a (hypothetical) stock which has averaged a dividend yield of about 3.5% for a while after the stock price rises and the yield falls, to say, 3%? I suppose it all depends on whether you are prepared to settle for that 3% yield knowing that you are buying in on the pricey side.

Stock prices matter just as much for a dividend investor as for an investor focused on capital appreciation. In the case of the dividend investor the lower the entry (stock) price the greater the income generated from dividends.

kelbon

kelbon,

Agreed, its about the investing thesis, the portfolio thesis and the parallel risk management approach. There is risk to the income investor if they wait, they lose the current price, they lose the near term income. The trade off is that they wait and receive no income on the educated guess that the stock price will come down, they will receive a higher yield and some capital games. This is why pricing a stock is so varied, there is no ONE correct answer because there are many ways to invest and many ways to manage risk and many risks to manage.

What is the opportunity risk/reward profile for waiting? Is the reward worth the risk? What is the risk/reward profile of buying now? Is the reward worth the risk?

I think low 50's is a fair value with limited risk to a long term buy and holding dividend income stream investor. The price will go lower than today and it will rise higher than today. GIS has a history of increasing dividends. GIS is financially sound. GIS has a history of being reasonably well run. GIS sells a product that must be replaced. Is this enough of a reason to buy? If and only if you are seeking to buy good companies at fair prices and are seeking their dividends and it is the best one you can find.

Circumstances and methods matter. If someone bought this just after the meltdown for $20 it would make perfect sense for them to sell and take the capital gains then roll that into a stock that provided them with greater income. They could hold because its not over valued but only if value is the primary focus. If income is the primary focus then rolling that capital into a larger income stream makes more sense.

Buying 1000 shares @ $20 which was about a 5.75% yield gives them an income stream of $57.50. Which grew and they cashed for 5 years. They have earned, estimated, $2,043 and have cap gains of 30,000. If they cash out they have $50,000 to work with, even if they got 3% yield they would more than double their income stream.

This example isn't an argument for value investing its an argument for income investing, how do we increase the income stream? From this prospective if they hold it now do they continue to hold for this income stream? Is there a better stream available worth the friction costs to switch? If they don't own it now is it the 'best' income stream currently available to them?

I repeat circumstances and methods matter.

I love value investing but if income stream is the game value investing is not likely to give you consistent predictable income. The value games returns are lumpy. Value players ought to be holding on poor yielding cash which has limited value to the investor seeking income but great potential returns to the value investor. I'm not saying price doesn't matter or that value doesn't matter what I am saying is that for an income investor value isn't in the drivers seat, income is.

jack

Damned if you do; damned if you don't. This dilemma faces everyone trying to put money to work after a step up in stock prices. Will the market pullback, or will it keep rising? Unfortunately, there's no way to know. Given relatively recent history it's tempting to think there will be a pullback. But, consider those who stayed on the sidelines in the early nineties because they thought that the market had already risen too fast, too far.

I do think, that for an income investor, it makes sense to sell some winners whose yields have contracted substantially and to rotate into stocks with better yields, thus increasing income/cash-flow. But, round in circles here; it depends on tax implications brought about by capital gains too.

kelbon