Being a dividend investors, I am looking for companies that have potential to grow their dividends over time. I have observed that companies that grow their dividends, with good quality of earnings, the market value (or share price) also grows. This not only provides dividend cash flow, but also the capital appreciation over time.

Now, in case of concentrating the portfolio to small number of stocks will increase my risk. Assuming equal allocation in 10 companies, when any one company suspends dividends, it will reduce my dividend cash flow by 10%. That is a very large drop. Therefore, I am targeting to build my portfolio with 30 to 35 companies.

• The reason for using 30 to 35 companies is that I want to limit the risk if dividend cash flow to any single company to maximum of 5%. In one my earlier post, I have discussed the process of risk management.
• It would be a folly to expect that all companies in the portfolio would continue to pay growing dividends. 100% success rate is purely an illusion. However, I would expect that at a minimum there would always be 20 to 25 companies performing as per my initial expectation. These will continue to provide growing dividends over time. I also expect that they will continue to increase their value.
• The remaining ones may or may not perform. I will have to continue to make changes such as adding to existing ones, removing, and adding newer ones.
• In addition, I also understand my limitation of not being able to keep track of more companies.

At present, I continue to hold approximately 27 companies. One of the benefit of long term buy and hold investing is that you do not need to keep following the market daily or monthly; all of the companies that I select are not going to vanish or crash in such short period of time. Sure, some small number will have problems like 2008/2009, but I do not expect to have all of them in a same crashing bucket. If it does happen, then it was likely due to improper portfolio management process.

“The majority of corporations are in the business of doing business, producing and manufacturing, not hedging currencies,” said Paul Bramwell, a senior vice president of Treasury solutions at the AvantGard unit of SunGard in Connecticut. “A lot of companies were caught unawares by volatility.”

As of this year, the euro dropped eleven percent against the dollar.  On May 6, 2010, the euro fell to a fourteen month low of $1.2529.  The currency fluctuations are definitely having an effect on large companies as well.  For instance, the recent currency rate swings caused eBay Inc to make the announcement in 2009 that the currency fluctuations would decrease earnings by ten percent.  In addition, the currency volatility also did cause Johnson & Johnson, McDonald’s Corp and DuPont Co to state that the declining euro was having an impact on their earnings or that the declining currency rate may decrease growth.

“If you have an increase in profits but it’s wiped out by foreign-exchange loss, that’s significant,” Bramwell said. “What they should be doing, and increasingly are doing, is looking at where the exposure lies, instead of waiting for an earnings call to announce FX losses.”

That said, the ability of businesses to pay dividends depends on the businesses’ earnings, money management techniques and cash flow.  Lately, due to the recession, many people have expressed concern about the US dollar strength and status.  Many people believe that the large US debt  and/or printing more US currency will diminish the value of the US dollar .  Further, some experts believe that any US currency dollar value change will have a much larger effect on the figures.  In fact, they think that investors should look at the situation as whole and determine the long term future of these dividends.

For instance, while many people believe that printing more dollars will increase inflation numbers and then will reduce the value of the dollar, there are others that believe that governments of many other countries would use this technique as well.  Thus, the combined effect of all of the countries printing more currency and in turn reducing their country’s  currency values would be nil.

Therefore, in order for dividend investors and forex trading market investors to make sense of the current market conditions, some experts suggests that investors find dividend companies that gain their earnings from international operations.  Why?  Investing in businesses with global operations is simply the best hedge against currency fluctuations.

Other firms suggest that investors seek out a portfolio of fairly conservative, high dividend paying, non-U.S. equities.  These experts suggest this type of portfolio as:

• These types of portfolios usually pay high dividends – and many of these items qualify for a lower dividend tax that is in effect.
• As these types of dividends are paid in the companies’ local currencies, the value of these dividends – along with the value of the shares itself – rises when the dollar falls

All in all then, fluctuating exchange rates do have a significant effect on US dividend investors.

This was a guest post by Vincenzo Desroches from Forex Traders

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. The company operates in three segments viz., (1) Consumer; (2) Pharmaceutical; and (3) Medical Devices and Diagnostics. The company was founded in 1886 and is based in New Brunswick, New Jersey.

JNJ is a part of the dividend aristocrats, S&P500 index, and DJIA index. It has been raising its dividend for last 48 years. The latest increase in dividend was 9.3% in May 2010. My objective here is to analyze JNJ to determine fair price range for buying and adding to existing positions.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts are shown in image below.

• Revenue: Overall had a growing trend.
• Cash Flows: In general, a growing trend. The free cash flow is generally close to net income. Operating cash flow is always higher than net income.
• EPS from continuing operation: Overall a growing trend.
• Dividends per share: Consistently growing dividends.

Johnson and Johnson - Trend Analysis

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.29. This is a low risk category as per my 3-point risk scale for dividend sustainability.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 13% (stdev. 2.5%) is almost same as average EPS growth rate of 13%. Dividends have grown inline with earnings per share.
• Duration of dividend growth: 48 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10% for past 10 years.
• Payout factor: It has been in the less than 40%. It was at 44% in 2009.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 3.6%; and (b) MMA yield is 1.75%. Last 10 years average dividend growth rate has been 13%, and I expect JNJ dividend growth rate to be 11%. With my projected dividend growth of 11%, the dividend cash flow is twice the MMA income at the price of $130. What this means is, I could pay up to $130 and still the dividends cash flow would be twice MMA based income. Is there anything more to ask for?

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $48
• Average high yield price calculated based on past 10 years: $75
• Pricing based on past 10 year relative price-to-earnings ratio. $92
• Pricing based on price-to-earnings ratio of 12: $55
• Graham number: $44

The range of fair value is calculated as $52 to $63.

Qualitative Analysis
JNJ is one the largest and most diversified health care company. For a company, which has 250 operating/subsidiary companies it is unique in a sense that it continues to perform with such a consistency year after year.

• It is a global company with approximately 50% of its revenue outside of US. All three market segments contribute significant portion of revenue.
• Investing in JNJ is a good proxy for foreign and emerging markets.
• JNJ is highly innovative and spends close 10% of its revenue on R&D and new product development.
• For growth, it uses organic internal opportunities and inorganic through strategic acquisitions.
• It generates free cash flow, which is generally, greater than its net income.
• It remains to be seen how JNJ is affected due to new health care legislation.
• Future risks include failure of any potential patent candidate or adverse effect of any existing drugs.

Conclusion
I like JNJ’s large size, global reach, diversified revenue streams, and multiple products. JNJ is more about substance rather than panacea. It has very good balance sheet. The dividend growth follows the growth in EPS. At current yield, the dividend cash flow is almost four times the MMA interest income in 10 year time period. The stock’s current risk-to-dividend rating is 1.29 (low risk). Since the share price is my fair value buy range, I added to my existing company even though I am fully allocated.

Full Disclosure: Long on JNJ.

This article first appeared on The DIV-Net on July 1, 2010.

We investors know BRIC stands for Brazil, Russia, India, and China. This BRIC label clubs all four distinct but emerging markets into a single entity. Based on this acronym there are many different mutual funds, closed-end funds, and ETFs. Each of these countries are different in many ways such as different governance structure, different governance policies, different types of economies, different strengths, different financial markets, different values, etc., Even with these differences they are clubbed together and viewed as single entity for investing in emerging markets.

To me, it does not make sense to club BRIC together for investing purposes. Each country should be looked at individual entity. China continues to receive most attention in the press, however, I believe its India that provides a much better option for small individual investors. Following are three reasons I believe India has relatively more fundamental strength than other countries.

• Inward Consumption Based Growth: India’s economy is consumption oriented when compared to other emerging markets. India’s export contributes less than 15% to its $1.2T GDP. The IT outsourcing services and back office has garnered most of the business media coverage; however, these industries have less than 8% contribution to the GDP and employ less than 5 million people. This is an indicator of growth by internal production and consumption. It is less reliant on exports. Quite contrarily, these technology services perform better in recession, because it is all about optimizing operational cost.

• Conservative Central Bank: Its Reserve Bank (a.ka. central bank) has very conservative monetary policy, which is why we did not see failure of the banks (or banking system) during recent financial melt down. There were no widespread bank bailouts.

• Transparency: It has democratic governance which on many occasions slows down the decision making progress, but provides better transparency (relative to Russia and China). As of today, its currency is freely convertible for trading goods and services, but there are certain restrictions for international asset acquisition. However, it has a pragmatic roadmap to allow its currency to fully float with market dynamics. In 2007 and 2008, when Dollar dropped against Indian Rupee, Indian export started becoming uncompetitive.

• Government Stimulus Driven Growth is Less: The Indian market has rebounded in line with other emerging markets like China or Brazil. An earlier fear of bubble seems to be a just – a fear. It’s economy indicator suggest it is back of growth. The key in this rebound is; not much is being supported by government driven expenditure or public infrastructure projects. In fact, it continues to stumble on its infrastructure.

Finally, India can boast that its government is run by a bunch of prominent economists (with political and public support). The architect of Indian economic reforms, who laid down the path for reforms 18 years ago, is now at its helm as a prime minister. It is always good to have a non-political leader who is not only an economist, but someone who knows how to execute it in the complex state like India. Therefore, I continue to believe that on long 10+ year time horizons my dollars are (a) relatively safer; and (b) provide above average returns in Indian markets. I do not expect to be a smooth ride. There will be time period when markets will crash, but it will eventually come out stronger.

Having said that, I believe, individual investors should use ETF based investment vehicles for India (or any other emerging markets) which invest in array of companies and have less fees and commissions. Keeping with this thought process, I use Wisdom Tree India based ETF, EPI. You may read more about my reasons for selecting EPI for this objective.

Exxon Mobil Corporation engages in the exploration, production, transportation, and sale of crude oil and natural gas. It also involves in the manufacture, transportation, and sale of petroleum products. The company manufactures and markets commodity petrochemicals, including olefins, aromatics, polyethylene and polypropylene plastics, and other specialty products. XOM pretty much operates in all parts of the world such as United States, Canada, Europe, Africa, the Asia Pacific, the Middle East, Russia/Caspian region, and South America. Exxon Mobil Corporation was founded in 1870 and is based in Irving, Texas.

XOM is a part of the dividend aristocrats, S&P500 index, and DJIA index. It has been raising its dividend for last 28 years. The latest increase in dividend was 4.8% in April 2010. My objective here is to analyze XOM to determine fair price range for buying and how will it rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: Overall had a growing trend, but dropped significantly in 2009.
• Cash Flows: In general, a slow growing trend, but dropped significantly in 2009. The free cash flow is generally close to net income. Operating cash flow is always higher.
• EPS from continuing operation: In general, growing trend, but dropped in 2009.
• Dividends per share: Consistently growing dividends.

Exxon Mobil: Trend Analysis

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.86. This is a medium risk category (relatively closer low risk) as per my 3-point risk scale. The sudden drop in 2009 (EPS and gross margins) makes it a medium risk-to-dividends.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past ten years.

• Dividend growth rate: The average dividend growth of 7% (stdev. 3.6%) is almost same as average EPS growth rate of 7.6%. Dividends have grown inline with earnings per share.
• Duration of dividend growth: 28 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10% for past 10 years.
• Payout factor: It has been in the less than 30%. It was at 42% (at the end of 2009).
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 2.9%; and (b) MMA yield is 1.75%. Last 10 years average dividend growth rate has been 7.1%, and I expect XOM dividend growth rate to be 7.1%. With my projected dividend growth of 7.1%, the dividend cash flow is twice the MMA income at the price of $77.0.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

• Net present value (NPV) price based on 15 year DCF: $37
• Average high yield price calculated based on past 10 years: $63
• Pricing based on past 8 year relative price-to-earnings ratio. $87
• Pricing based on price-to-earnings ratio of 12: $72
• Graham number: $56

The range of fair value is calculated as $53 to $63.

Qualitative Analysis
XOM is one of the largest vertically integrated oil and natural gas company. It has exploration and production operations in more than 180 countries, full-to-partial ownership in 37 refineries, and high oil and gas reserves.

• The revenue distribution shows that US contributes approximately 30% of the revenue. The rest 70% comes from foreign markets and emerging markets.
• Investing in XOM can be considered as a good proxy for foreign/emerging markets
• It has taken initiatives to expand its capabilities and capacity in natural gas by proposing to acquire XTO.
• The company seems to spend more on share buybacks than on dividends. This is a drawback. The fact that it has cash for share buyback, I would argue why not increase dividends (and reduce the share buybacks). Higher dividend payout could support its prices. But for a large organization like XOM, there could be large number of options exercised that require buybacks, otherwise EPS starts getting affected.
• Contrarily, when we look at dividend growth, it has kept pace with earnings growth.

Conclusion
I like XOM’s large size, worldwide operation, presence in every international market. It has built a global operation with integrated exploration, productions, and refining. This gives it moat for economies of scale. The dividend growth seems to follow the growth in EPS. The stock’s current risk-to-dividend rating is 1.86 (medium risk). This is much closer to being a low risk. I recently added a new starter position in XOM. I will continue to build my position as per my allocation level if the stock stays within my buy price range.

Full Disclosure: Long on XOM.

This article originally appeared on The DIV-Net on May 27, 2010