Jason interviews Steve Alley about investing in dividend paying stocks.

Steve Alley is the President of Alley Company and has investment experience dating back to 1983. He founded the firm in 1998 after a 12-year career with Morgan Stanley, including five years as Managing Director of Private Client Services and the Institutional Equity Department in Chicago. He earned a bachelor’s degree in business administration and an MBA in finance from the University of Wisconsin, where he was a student in the Applied Securities Analysis Program. Steve also played hockey at Wisconsin, on the U.S. Olympic hockey team in 1976, and in the National Hockey League.

To learn more please visit www.alleycompanyllc.com

Below is the full transcript:


Announcer: Welcome back, America, to Sound Retirement Radio, where we bring you concepts, ideas and strategies designed to help you achieve clarity, confidence and freedom as you prepare for and transition through retirement.
Now, here is your host, Jason Parker.
Jason: America, welcome back to another round of Sound Retirement Radio. I’m so glad you’re joining us and you have made us your resource for expert retirement advice. You’re listening to episode 089, Investing in Dividend Paying Stocks with Steve [Alley 00:00:31]. He’s going to be our featured guest today and I’ll bring him on in just a moment.
As you know, I like to get the morning started right, so if you’re driving down the road in Seattle this morning, I think one way to do that is by renewing our minds and I’ve got a verse here from Matthew. The verse is Matthew 6:27. “Can any one of you by worrying add a single hour to your life?” Matthew 6:27. “Can any one of you by worrying add a single hour to your life?” What an amazing question Jesus asks.
I love a good question and we’re going to come back to questions in just a minute, but I know how much you guys all enjoy our jokes on Saturday mornings. I’ve got one here for you. What did the shy pebble say? I wish I was a little bit boulder. The shy pebble, a little bit boulder. I know, you guys love these jokes. Share them with the grandkids. Put a smile on their face.
Anyways, I was thinking this morning about this question. One of the things I love about the work that I do is I get to meet a lot of amazing people from all over the country, and occasionally people hire me to help them put together a retirement plan. One of my favorite questions, because a good question can be so powerful. It can inspire you. It can cause you to ponder or reflect, can cause you to change, can cause you to grow, can cause you to question maybe the reason that you’re doing certain things.
One of my favorite questions, I’m going to give it to you right now, is what is the purpose of the money? What’s the purpose of your money? You guys work hard. You’ve worked for a really long time. You’ve saved a lot of money, and I went back through several of my recent interviews with folks and I just wanted to share with you some of the answers that I heard in going through that. I think it’s really going to lead well into this interview that we’re doing today on investing in dividend-paying stocks. Here were some of the answers to that question, what’s the purpose of the money? To not be a burden; to pay the bills; not outliving our income; not be poor when retired; security; supplement social security; to live on it in retirement; to live on it until we are gone; to cover our basic needs and some extras; to be able to leave a legacy; stability; give; does not want his wife’s lifestyle to change when he’s gone.
Those are just flipping back through my notes from the last several couple of meetings I’ve had, and it really got me thinking, and I hope you guys will ask this question, what’s the purpose of your money, because I think the one thing you didn’t hear anywhere in there was anything about the amount of wealth that people had. “Jason, the purpose of this money is to grow it from 1 million to 2 million, from 2 million to 3 million.” Never heard that. I never heard “The purpose of this money is to earn a right of return of 6%.” Never heard that.
I want you think a little bit different about your money when you transition into retirement, and there’s a common theme here that I’m seeing. I’m wondering if you’re seeing the same thing. That being said, as you’re driving down the road this morning, one more time, you’re listening to 089, soundretirementradio.com. You can find these programs online.
Today it is my good fortune to bring Steve Alley onto the program. Let me tell you a little bit about Steve. Steve Alley is the President of the Alley Company and has investment experience dating back to 1983. He founded the firm in 1998 after a 12 year career with Morgan Stanley, including 5 years as Managing Director or Private Client Services and the Institutional Equity Department in Chicago. He earned a Bachelor’s degree in Business Administration and an MBA in Finance from the University of Wisconsin, where he was a student in the Applied Securities Analysis program. Steve also played hockey at Wisconsin on the US Olympic Hockey team in 1976 and in the National Hockey League.
Jason: Steve Alley, welcome back to Sound Retirement Radio.
Steve: Thank you, Jason. It’s a pleasure to be here.
Jason: Boy, I know that the program we had you one was probably a year or two ago. I know it’s been really well received, and to tie in that intro on that question, what’s the purpose of the money, the common theme that I heard there, Steve, was that people wanted lifestyle. They wanted income and they wanted to make sure it was going to last the rest of their life. Investing in dividend paying stocks is one way to do that, and that is what this show is all about today is dividend paying stocks.
The first question, just to get us down to bare basics kind of entry level here, historically, why have companies paid dividends to shareholders?
Steve: That’s a great question. That’s the way it was originally designed when common stocks were created, and in the public market where companies would access capital through the public marketplace. One of the benefits that investors, who invested in these companies, would receive would be a share of that company’s income and that’s called a dividend. Early on, companies would pay 50-60% of their earnings or more out to shareholders in the form of dividends, so that’s really the genesis. That’s when dividends were created and of course today, we can have a whole different discussion about that, but yes, that’s why dividends were created.
Jason: Just to boil this down to the bare bones, here, because some of our listeners, they really don’t have much investment experience and they’re maybe just trying to figure this all out. They’ve been good savers, maybe, but not necessarily spent a lot of time investing. Bottom line is you’re purchasing, you’re owning a portion of a company, and in exchange for buying into that company, that company is going to pay you a portion of their revenue in the form of a dividend and some form of income.
I understand that there are some companies that have paid dividends for a really long time. Has that been your experience? Do you like companies that have a long track record of paying dividends?
Steve: Yes, we do. There’s some good examples, if you’d like me to go into it. I’ll give you one of my favorite examples, would be a company like Procter & Gamble. Procter & Gamble we all know makes Tide laundry detergent, Pampers diapers, Crest toothpaste, Gillette razors and many other consumable products that are number one or number two brands worldwide. Here’s a company that, again, sells basic things that we use up every day, and so they’ve got a very consistent level of revenue growth and earnings growth and thus, a very consistent level of dividend payout to their shareholders. Procter has raised their dividend for 59 straight years, and in fact, for the past 30 years, they’ve actually grown their dividend by 10% a year on average.
Think about that. 30 years of, on average, raising their dividend level by 10% a year. It’s an astounding figure. Here you’ve got a company today whose dividend yield is approximately 3.3%, which compared to money market rates at 0 or the 10 year government bond at about 1.95% this morning, 3.3% in terms of a dividend yield is a really nice bird in the hand that shareholders from Procter & Gamble receive. It’s a tremendous example of a high quality company that, over time, has not only maintained their dividend but grown it at a very rapid rate.
Jason: Boy, I tell you, that sounds pretty attractive. 3.3% in today’s interest rate environment. Like you say, 1.95% on the 10 year treasury. They have a history of paying that dividend for 59 years, but there’s no such thing as a free lunch. We know that there’s risks associated, so do you have any examples of a company that paid a dividend for a long time and then something happened and they had to either slash the dividend or they had to stop paying the dividend altogether. Any examples like that?
Steve: That’s a great question. Back in the financial crisis of 2008-2009, a lot of banks, because of that crisis, cut their dividend entirely. In fact, most of the banks did. You’re talking about blue chip companies here. We’re talking about JP Morgan. We’re talking about Citibank, Bank of America. Some of the finest financial institutions in the country were obviously very negatively affected by the financial crisis. A lot of those banks have reinstated those dividends and are starting to grow them back again.
Another example would be the energy sector right here, today. Conoco is a tremendous oil company, but it’s 100% exploration and production. They’re taking oil out of the ground and selling it. Of course, we know the price of oil went from $110 to $30 here, over the last year and a half. Conoco recently cut their dividend by 75% to shore up their financial situation.
What I’m saying there, when you look at those two examples, whether it be banks or oil companies, these are companies that have some cyclicality to them. The financial marketplace blew up in 2008 and 2009, and now the oil economy has had a huge shock, so companies that are in that area of the economy aren’t necessarily the places where you’re going to find the most consistent dividends. Whereas a company like Procter & Gamble, just a solid, blue chip, steady-Eddie that’s selling products, even if oil goes from $110 to $30, people are still buying Crest toothpaste. If the financial-
Jason: I hope so. I hope they’re still brushing their teeth, even if-
Steve: If the bank system gets into trouble like it did in 2008, 2009, people are still buying Tide laundry detergent, Pampers diapers and Gillette razors. We look for companies, in our strategy, that are really good, solid, consistent revenue growers with really sound balance sheets. We’ll invest in the financial services sector, in blue chip companies, but we know that there’s some risk out there that we’ve got to watch very carefully. Of course, back in the crisis, I don’t need to go into the war story there, but we did manage through that pretty well.
Jason: What’s your opinion? How many stocks does somebody have to own to diversify enough that they reduce some of that individual company risk?
Steve: That’s another great question. There’s two schools of thought on that.
One school of thought is you need to own 50-100 or maybe even more names in a portfolio to get proper diversification. The second rule of thumb, or the second philosophy would be that you really should own between 25-40 names. Both are adequate diversification. Obviously, if you own 100 names in your portfolio, you really got a lot of diversification, but our question is, can you really follow all 100 companies as well as you need to?
Our philosophy is to own somewhere between 25 and 40 names. We currently own about 45 names in our dividends strategy, and we feel we can follow those names very, very closely, as well as have, 10, 15, 20 names on the on-deck circle that could become potential stocks in a portfolio. Yes, 35 names is kind of our diversification level and we feel very comfortable with that.
Jason: Before we get carried on too far here, go ahead and tell our listeners, if they want to learn more about the work you’re doing specifically on the portfolio that you oversee and manage, how can they learn more about the work that you’re doing?
Did I lose you, Steve?
Steve: Yes, we’re here. We’re here.
Jason: How can people learn more about you and the work you’re doing in your company?
Steve: We’re Alley Company, LLC. We’re a separate account manager. We manage individual accounts for our clients. You can go to www.alleycompanyllc.com and you can learn about what we do for clients.
Jason: Let me ask you this. Is there any advantage to somebody owning individual securities versus just buying a mutual fund that owns dividend paying stocks, or an ETF that owns dividend paying stocks? What’s the advantage to owning individual stocks over a mutual fund or an ETF?
Steve: There’s a lot of advantages. One is just pure tax planning. You can’t tax plan harvest losses, for example, in a difficult environment like we saw in 08-09, as effectively with mutual funds and ETFs as you can with individual stocks. There’s just way more latitude, way more flexibility and you can actually harvest more losses, if that’s what you’re trying to do if you own individual stocks.
The other thing that we’ve found is that while ETFs in particular do play a nice role, and mutual funds, too, in terms of getting exposure to various asset classes, one of the things you’ve got to be careful of is concentration in various industry groups. For example, the Dow Jones dividend index, which is used for what’s known as the DDY, which is the dividend ETF, 38% of the money is earmarked for electric utilities there. That’s terrible diversification, in our mind, to have 38% in one industry group.
If you’re even going to invest in the S&P 500 index, back in 2000-2001 technology bubble, technology got to be over 40% of that index and so when the stock market went down in total, that hurt even more so in the technology area, so people were exposed more heavily there than they needed to be. Whereas, if you had owned an individual stock portfolio like we run, we would never have 40% of our money in one sector like technology or 38% in utilities.
Jason: How much do you have-
Steve: What we’re going to have in any one industry group is probably 20, maybe 22%, but that would be high. The biggest [wing 00:16:18] that we have right now in our portfolio is health care, which is approximately 15% of the portfolio. We have broad diversification by industry group as well as by individual security, and I think that’s what you can do when you own a separate account, owning the individual stocks in that account.
Jason: Folks, if you’re just tuning in, you’re listening to episode 089. This is Sound Retirement Radio. You can find this program archived at soundretirementradio.com. I want to remind our listeners. We’ve been doing a webinar a month to teach folks about different things. This month, we’ve got a webinar coming up for the federal employees retirement system. If you are a federal employee and you’re thinking about retirement, I highly encourage you to attend. It’s a free event. You can register right at soundretirementplanning.com.
Today, I have Steve Alley on the program. We’re talking about investing in dividend paying stocks. Steve, what is the biggest mistake, in your opinion, that people make when buying dividend paying stocks?
Steve: I would say the biggest mistake people make is that they buy a stock that has a yield of, let’s say in today’s world, it would be 6 or 7% and they’re thinking, “Wow, what an upfront yield I’m getting here.” That understanding that that company is probably in some degree of financial distress and that there’s a potential for a dividend cut coming.
We are very, very careful. We’ve had one dividend cut in our almost 10 year history now, and that was during the financial crisis and the company that cut their dividend did so not because they had to but because everyone else was doing it, and about 2 quarters later, they reinstated it. We do not want what we call reach for yield and try to tack on, as they say in today’s world, a 6 or 7% dividend yielding company. Very, very high likelihood that that company is under some sort of stress and is likely to cut the dividend.
Jason: Explain to our listeners the payout ratio in 30 seconds, if you will.
Steve: Sure. Payout ratio is the percent of a company’s earnings that are paid out in dividends.
Jason: One of the companies that have been in the headlines recently is Chevron. As we talk about companies that are paying out a high percentage of their total revenue in dividends, and Chevron is one of these companies. I think they have a very long track record of paying dividends. What’s your thought with a company like that? They’ve paid dividends for a really long time. They’ve increased dividends. They’ve got a very, fairly high dividend, in today’s interest rate environment, but they’re approaching this payout ratio that says … At one point does the payout ratio dictate selling a position?
Steve: Chevron’s an interesting example. The energy industry. We’re talking about Conoco earlier, which people are worried about Chevron, that if their earnings keep going down … Remember, the payout ratio is the percent of earnings paid out in the form of a dividend, so if the earnings are going way down and their current dividend is higher than their earnings, now they’ve got to borrow money to pay their dividend. They’re putting themselves in even more financial distress.
A company like Chevron is going to have to watch and see what happens to the price of oil. They’re going to try to defend their dividend to the hilt, because it’s been part of their culture and, as you say, they’ve had a good dividend record. Big, diversified oil companies like this tend to have a good dividend paying history.
There’s no guarantee. They may have to cut their dividend at some point. It’s just, again, depending on what happens to the price of oil over the next year or two.
Jason: We talked about not chasing yield. That’s the biggest mistake people make. If somebody’s trying to find a good selection of dividend paying stocks, what is some of the criteria they should be looking for when evaluating a company?
Steve: What we look for, when we’re building our dividends portfolio, is we’re looking for companies that have wide moats. We’re talking about companies that have a competitive advantage. You look at Procter & Gamble, you’re talking about the number one consumer products company in the world. It’s hard to replicate their portfolio of products. We know that they’ve got stability in terms of their revenue and earnings stream, and therefore, that their dividend is not only going to be stable, but it’s going to be growing.
You look at electric utilities and telephone utilities, those companies were basically born to pay a dividend. They’re very slow growing. They grow at the rate of about GDP, and their dividend therefore will grow at the rate of GDP, which is 2 or 3%, but you’re getting a nice, upfront yield. 3-1/2 to 4-1/2% electric utilities. That dividend growing at 2-3%. Your total return is your dividend plus your dividend growth rate. You probably have a 6 or 7% total return potential in electric utilities. Not as sexy, so to speak, as other areas.
We’re also looking for companies who … You mentioned payout ratio, who maybe have a payout ratio of 28% or 30% and we think the payout ratio can go to 50%. Companies like CVS, the drug store company. You’ve got a duopoly in the United States between them and Walgreens, basically, and this company is raising their dividend at double digit rate right now because they see not only tremendous growth in their revenue and earnings, but very stable growth and their payout ratio is sufficiently low so they can afford to keep raising it at a double digit rate.
What we try to do is we try to find companies that are both growing their dividend at a rapid rate, as I mentioned, something like a Procter & Gamble, or a CVS, but also looking at companies that have a higher yield in the 4% range, like electric utilities. Even though they’re growing at a slower rate, it’s still a very stable aspect. Provides a lot of stability to the portfolio.
Jason: Let me ask you. Everybody loves Warren Buffet. He’s got a way with words and put a smile on everybody’s face. What do you think Warren Buffet feels about dividends, when he’s making stock selection? Have you done any research on his track record?
Steve: Yes, we have. One of his big holdings is Coca Cola. He’s owned it since the late 1980s, and he originally purchased it, I believe, it was 1988. We wrote a commentary on this. If anybody wants to go on our website, you can read our commentary called The Power of Dividend Growth. In there, we cite Warren Buffet’s investment in Coca Cola. There again, Warren Buffet owns enough Coca Cola stock that he says every time somebody buys a can of Coke, it’s putting a penny in his coffers. That’s how much he owns.
He now has basically … The dividends that have accrued to Warren Buffet’s company, Berkshire Hathaway, via Coca Cola dividends has now paid for the entire position that he owns in that company-
Jason: Steve, I hate to cut you off, but we’re out of time. Thank you for being a guest on Sound Retirement Radio today.
Steve: All right, Jason. Thank you very much.
Jason: Folks, this is Jason Parker signing out. Again, episode 089. Find us online. Soundretirementplanning.com.
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Investing involves risk. Jason Parker is the President of Parker Financial, an independent, fee-based wealth management firm located at 9057 Washington Avenue Northwest, Silverdale, Washington. For additional information, call 1-800-514-5046, or visit us online at soundretirementplanning.com.