Dividend Tree 2 January 2009 Commentary, Goals  Email This Post  Print This Post

In my investment process, I have mentioned about my 2020 dividend cash flow goals. I am targeting to achieve a dividend-based cash flow of $30,000 by year end 2020. In this post, I am discussing a back-of-envelope empirical exercise to demonstrate the feasibility of achieving this goal.

At end of year 2008 the dividend champion list has 128 companies. The annual dividends that these companies pay range from $2.80 to $0.20. The average dividend for all of 128 companies is $1.17 and the average price is $35.71. In addition, there are 75 companies that pay at least pay $1 annual dividend. The average dividend of these 75 companies is $1.53 annualized.

Let us assume we invest in 50 companies that will pay at a minimum $1 annual dividend. This is just an assumption for empirical calculation and has no basis.

· with my end goal of $30000, we will have to buy 600 shares per stock [30000/50].

· total funds needed = [50*600*$35.71] = $1,071,419 i.e. we can have this cash flow today with one million dollar.

Now let us do empirical optimization and make it simple.

Looking at dividend champion list, the average dividend for 75 companies (with at least $1 dividend) is $1.53 annually. Assume that the 50 companies that we have invested in has average annual dividend of $1.53. In fact I expect this average to be more – but let us be conservative and simple).

· number of shares needed per companies = [30000/(50*1.53)] = 393

· total funds needed = [50*393*$35.71] = $701,780 i.e. now need $702K.

In this calculation, we still need to include dividend growth (positive effect), dividend reinvestment (positive effect), and price appreciation (perhaps negative effect).

Let us consider that at begin of 2009; we have 50 shares of one company stock in our portfolio and each stock costs us $35.71. Each share has an average annual dividend of $1.53. Therefore, the total investment in one company is $1786.

· we will consider dividend growth rate of 8% every year;

· dividends are reinvested only once at the end of each year; and

· at the end of each year, we will appreciate the price of stock by 8%.

Let us do the math:

· at end of 2009, total dividend received $76.5, price of share $38.57

· beginning 2010, number of shares [(76.5/38.57)+50] = 51.984

· end of 2010, total dividend received $85.9, price of stock $41.65

· continuing this until end of 2020 – number of shares 76.706, total annual dividend $273.6.

· on our initial investment of $1786, we will receive dividend cash flow of $273.6

Extrapolating this for 50 shares each in 50 companies

· total invested capital [50*50*$35.71] = $89,275

· total dividend cash flow [$273.6*50] = $13,682

· we have still not reached our end goal of $30,000 dividend cash flow.

Solving this backward, to achieve $30,000 dividend cash flow, we get:

· 110 shares for each company [total 50 companies*110 shares].

· total initial investment is $196,405.

To summarize….

As of today, if we invested $196,405 in 50 companies from dividend champion’s list (and bought 110 shares for each), we should be able to reach our 2020 goal. The yield on cost would be 15.3% [30,000/196,405]. This assumes dividend growth of 8%, annual dividend reinvestment, and share price appreciation of 8%.

Our first calculation of one million dollar came down to approximately $196K. This can be further optimized by including quarterly reinvestment, stock selection, and initial buy price.

The purpose in this empirical calculation is to show (1) the significance of dividend growth and dividend reinvestment; and (2) we can use simple back-of-envelope calculation to figure out the initial feasibility of our goals. To evaluate the first pass feasibility of our objectives we do not necessarily need complicated mathematical models. Once we understand that the objective/goal is reachable (and not out of whack), then we can go to next step to understand how to execute the process and optimize it for best results.