The Secret To Becoming A Great Dividend-Earner

When I sit down to select dividend-paying stocks for my readers, my personal portfolio, and my mother’s portfolio, I don’t just consider the “usual” numbers.

Of course, I look at important things like brand quality, profit margins and sales growth.

But I also use a little-known, very powerful concept called the “payout ratio” to guide my decisions.

The payout ratio is the percentage of a company’s earnings used to pay its dividend. My rough rule of thumb is to stick with companies with a payout ratio of less than 60 percent.

You see, a company with a high payout ratio—one that pays out around 75 percent of its earnings as dividends—may struggle to maintain its dividend if it hits a rough patch or if the economy weakens.

Utility companies tend to have higher payout ratios. Often, it’s because they are mature companies with less room for growth. But even in this industry I stay away from super-high payout ratios. They don’t provide a “cushion” for tough times.

However, 60 percent is a great middle-of-the-road number for investors interested in a safe payout AND some future growth.

You see, if a company has a payout ratio of less than 60 percent, it’s plowing 40 percent or more of the earnings back into the business, investing in its own growth. (A 2008 study showed 60 percent of the companies with a payout ratio of 60 percent or less raised their dividends down the road.)

To compute a company’s payout ratio, I divide the annual dividends per share by the annual earnings per share. I find both numbers in the company’s annual report. (For an even faster check, Yahoo Finance lists the payout ratio on its “key statistics” page.)

Here are a few of my favorite dividend-payers and their payout ratios:

Company Payout Ratio
McDonald’s48%
Microsoft26%
3M37%
ExxonMobil22%
As you can see, each company has a payout ratio well below 60 percent. They have plenty of money to both pay dividends and invest in their businesses. And earnings could theoretically fall in half before they’d have to think about cutting their dividends.
Even better, these are all companies that will grow earnings in good times and bad. And with their super-safe payout ratios, they’ll pass on that growth to you no matter what.
Here’s to our health, wealth and a great retirement,

-Dr. David Eifrig,

Editor, Retirement Millionaire

P.S. In addition to these kinds of common sense investment tips, I’ve compiled a handful of safe investments you can make right now… all of which pay a high yield. Many retirees are using these investments to get all the income they need for the rest of their lives. I think you’ll be surprised at what these investments are… and how simple they are to use. You can learn about them right here.

One Of My Favorite Income Opportunities Just Got Cheaper

Last month, one of the market’s best high-income opportunities got a little cheaper.

If you take action right now, you can earn a safe 5 percent interest, tax-free.

The opportunity is in municipal bonds.

As you may know, municipal bonds are loans made to State and municipal governments. To encourage folks to invest in the government, interest received from “munis” is exempt from Federal income tax and, in many cases, State and local income taxes. These bonds are one of the great friends to the income-seeking retiree. And despite some mindless bearish forecasts over the past few years, “munis” have been a terrific income investment.

They still are. And last month, they went on sale.

In March, the biggest municipal bond fund and the largest exchange-traded fund tracking municipal bonds fell sharply — losing 1.5 percent and 2.5 percent, respectively — in less than three weeks. This may not sound like a big move, but for “boring” bonds, it is.

The decline was the result of a report from Moody’s, a credit-rating agency. Moody’s said the default rate for municipal bonds has doubled in the past two years relative to the average default rate from 1970 to 2009. The ratings agency also said it expects more local governments to default on bond payments.

I don’t pay much attention to what ratings agencies like Moody’s have to say. These are the same agencies that gave pristine ratings to the worthless mortgage bonds that helped cause the 2008 credit collapse.

Remember: The municipal bond market is huge; it’s over $3 trillion. Since 2010, defaults totaled close to $6.4 billion. The average recovery rate is nearly 70 percent. Even now, with higher defaults, only 21 have defaulted (compared to 28 this time last year). But most of the bonds are priced as if they’re expecting 10 percent to 14 percent default rates. To put that into perspective, in 2011, defaults totaled $2.8 billion — less than 1 percent of the total market. So even if defaults doubled (to $5.6 billion), that is still less than 1 percent of the market — and a long way away from 10 percent to 14 percent.

I expect prices to rise as the U.S. economy slowly improves. After falling 1.7 percent in 2009, State personal income rose in 2010 and 2011. And tax revenue has climbed for the past eight quarters. More tax revenue means more secure interest payments and lower default risk. Last month’s muni selloff was a huge overreaction by skittish investors.

Also, keep in mind that we saw a similar overreaction back in April 2011. My Retirement Millionaire subscribers have made a super-safe 23 percent because of it.

That overreaction was due to banking analyst Meredith Whitney. On 60 Minutes, Whitney claimed the municipal bond market was facing “hundreds of billions of dollars” in defaults. At the time, I wrote:

In my investing lifetime, 2008 was the record for muni defaults, but only a tiny $8.5 billion defaulted. And last year, 2010, it was only $2.8 billion.

Remember, the muni bond market is gargantuan: more than $3 trillion in outstanding municipal bond debt. You would think we’d have seen a lot of defaults by now. But we haven’t. It seems things are getting better, not worse.

When Whitney made her prediction, $30 billion exited municipal bond funds in just three months. The biggest muni bond fund is the Vanguard Intermediate-Term Tax-Exempt Fund (VWITX). Shortly after Whitney made her claims about massive defaults, VWITX plunged below $13 a share (from close to $14 a share).

But Whitney couldn’t have been more wrong about munis. In 2011, defaults totaled just $2.6 billion. That’s a hair less than the $2.8 billion defaults in 2010 and hardly the disaster industry “experts” were expecting.

And last year, the Barclays Municipal Bond index returned 10.7 percent, while the S&P 500 returned only 2.1 percent. And one of my Retirement Millionaire picks — the Invesco Insured Municipal Income Trust (IIM) — returned 23 percent. But earlier this month, after the Moody’s report, it fell an absurd 13 percent.

IIM Falls 13%

Just like last year’s overreaction, this one is an opportunity.

Right now, IIM is trading at almost a 3 percent discount to its net asset value (NAV). This fund is the equivalent to holding a long-dated (15 years to maturity) municipal bond paying around 5 percent in tax-free interest — which means you’re making safe, steady income for years.

The payout is all from real income and is tax-free at 5.82 percent. That equates to a taxable dividend of almost 9 percent for those in the top 35 percent tax bracket. Many other muni funds are offering similar deals.

In summary, many people are scared of the sector, but the numbers and facts just don’t support such a stance. And just like last year’s muni selloff, this one presents a great buying opportunity for folks seeking retirement income.

Here’s to our health, wealth and a great retirement,

–Dr. David Eifrig
Editor, Retirement Millionaire
 

P.S. In addition to muni bonds, I’ve recently recommended a handful of very safe investments you can make right now — all of which pay a high yield. Instead of depending on government programs and conventional Wall Street investments, many retirees are using these investments to get all the income they need for the rest of their lives. I think you’ll be surprised at what these investments are and how simple they are to use. You can learn about them right here.

Keystone XL: America Passes The Oil To China?

Like former University of North Carolina Head Basketball Coach Dean Smith, another famous on-the-sly smoker, President Barack Obama ran out the clock on an important game.

Coach Smith devised the “four corners” offense as a way to maintain possession of the ball late in a game his team led. By stationing players at each of the four corners that define the offensive side of the court and quickly passing the ball around the perimeter, Smith hoped to draw out a desperate defense, exposing gaps that could be penetrated for easy layups or forcing the opposition to commit fouls, sending Tar Heels to the free throw line to add to their lead.

Obama’s current situation can hardly be described as a “lead,” though “incumbency” is probably worth much more than any snapshot poll this far out in the 2012 game. But his “players” — left-leaning interest groups critical to get-out-the-vote efforts — aren’t of the same mind on Keystone XL, and he could not afford to offend environmentalists opposed to anything that encourages the use of fossil fuels.

So this $7 billion, 1,700-mile pipeline project won’t be settled on matters of policy. It will be settled according to politics, and Obama has decided that Keystone XL must go away until after his re-election campaign climaxes.

Because the pipeline crosses the U.S.-Canada border, standard procedure was designed to culminate with a final decision by the U.S. State Department. But in Foggy Bottom, too, are new impediments lurking that serve the President’s electoral interest.

Spurious allegations of conflict of interest by the consulting firm that prepared an environmental impact study for the State Department prompted a group of U.S. Senators to write a letter.

TransCanada, acting as instructed by the State Department and in accordance with Federal Energy Regulatory Commission (FERC) third-party contractor practice, upon which the Department of State practice is modeled, issued a request for proposal in late 2008 for the Department of State that led to the hiring of Cardno ENTRIX, a unit of Australia-based Cardno Ltd (ASX: CDD, OTC: COLDF). This is the same third-party selection process that has been used on a regular basis for many years by FERC, which processes certificate applications for interstate natural gas pipelines.

TransCanada screened the contractors who responded to the request for proposal for technical ability, experience and appropriate personnel, and recommended a number of qualified candidates to the State Department — standard practice for selecting a third-party contractor to carry out a review under the U.S. National Environmental Policy Act (NEPA).

There are a limited number of firms that specialize in this type of work, Cardno ENTRIX among them. As the permit applicant, TransCanada is handed the bill for the work that the State Department directs Cardno ENTRIX to carry out for this part of its review. The work is done at the sole direction of the State Department; TransCanada had no say in directing that work.

It is not in Cardno’s interest to submit compromised work. To believe Cardno Entrix is in the tank for TransCanada is to believe it, its managers and its shareholders don’t care about its business. “Conflict of interest” is a red herring.

As for the fact that a former lesser light in Hillary Clinton’s 2008 Presidential campaign now lobbies for TransCanada, undoing a massive infrastructure project that will employ many people on the U.S. side of the border because of the well-known revolving door between public and private in Washington, D.C., is the equivalent of selective prosecution.

At any rate, Paul Elliott did not have the kind of role in the Clinton campaign that would even afford him access — forget influence — on any kind of decision made at the State Department. The emails he exchanged with an equally diligent but unknown official at the U.S. embassy in Ottawa, Canada, are irrelevant, too.

Let’s concede that TransCanada’s forecast of the number of jobs that will be created by construction and operation of Keystone XL is rosy. Nevertheless, if not 20,000 direct jobs, then certainly more than one will be created. For a President leading a party that a little more than two years ago spoke of the importance of “shovel-ready” infrastructure projects to jump-starting the economy, shutting down a privately funded $7 billion project should be political suicide. It’s this reality, as well as the pain of close to 10 percent unemployment, that had American unions lined up in favor of the pipeline.

Opposition at the local level is overstated. This is not a monolithic coalition out to stop all manner of oil exploration and development. Nebraskans, Democrats and Republicans are interested only in protecting the Ogallala Aquifer. Had the original footprint of XL followed the existing path of the Keystone Pipeline System, I wouldn’t have written this.

And then there are those who fear and oppose any exploitation of fossil fuels. They are right to point out risks of environmental damage from a potential leak in the pipeline and warn of resulting cleanup costs. As much as Greens want the era of fossil fuels to end, we seem still to be short of alternatives capable of providing, for example, reliable baseload electricity or constant access to transportation fuel.

Any attempt to speed up the arrival of the day when we finally transition from petroleum-based fuels will bring extra costs that will have disproportionately large impacts as you move down the socioeconomic scale. Keystone XL would help reconcile the price disparity between U.S.-focused, cheaper West Texas Intermediate crude oil and global-oriented, more expensive lately Brent crude and, theoretically, result in incrementally higher gas prices. This is a short-term concern. Over the long-term, facilitating the development of a local resource under friendly political control is in the best interests of consumers and the United States.

The long-term, big-picture concern also includes the fact that the oil sands will be processed, regardless of what happens with Keystone XL. And crude from the play will undoubtedly end up traversing the U.S.-Canada border and making its way to Midwest and Gulf Coast refineries.

Keystone XL’s 700,000 barrel-per-day capacity would relieve the buildup of crude in the Midwest, which doesn’t have enough pipelines to ship Canadian output to Gulf Coast refineries. And Canada’s oil sands output would also help relieve a crunch U.S. Gulf Coast refineries will face when Venezuelan crude supply contracts expire in 2014.

Whether Keystone XL is built, interest will continue to grow in exporting Canadian energy to Asia. The company pushing this forward is Enbridge Inc. (TSX: ENB, NYSE: ENB) — with the backing of Chinese investors. Its key project is a proposed $5.5 billion pipeline to bring 525,000 barrels of oil from the oil sands to the Pacific Coast for shipment to refineries in California and Asia.

There are still opponents, largely on environmental grounds. And it’s far from a sure thing Northern Gateway will be built. But the process will be far less complicated.

Obama may have doomed Keystone XL. But whether the pipeline and the President survive, demand for crude from Canada’s oil sands will continue. If America passes on Canadian oil sands altogether, it’s easy to identify the likely beneficiaries: China and India.

(This article originally appeared in Investing Daily.)

–David Dittman