Download now: The Downfall of Cable, and the Rise of 5G!

Sell These Dividend Stocks

Written by Briton Ryle
Posted April 25, 2016

There's a very simple formula for growing your wealth in the stock market: Buy the stock of solid companies that are raising their dividends every year, and reinvest those dividends.

When you reinvest dividends, every three months you get more stock in place of the cash dividend. Then, when the next dividend is paid, you get more, because you have more stock. And when the dividend gets raised, well, you get even more money. 

This is the power of compounding. And if you do it over a period of time, you will inevitably end up with a fortune.

One of the best examples of this is Warren Buffett's $1 billion investment in Coca-Cola from 1988. If you account for all the times Coke split its stock since then, he paid about $2.50 a share. The company was worth around $25 billion at the time, and Buffett's investment amounted to 6% of Coca-Cola. 

This was the biggest investment Warren Buffett had made. That $1 billion was 35% of his investment company Berkshire Hathaway's assets. 

Ten years later, in 1999, Coca-Cola was a $143 billion company. Buffett's $1 billion investment was now worth $12 billion. Today, Buffett's Coca-Cola stock is worth about $16 billion. Not bad for a $1 billion investment. But that's only part of the story...

Buffett's Berkshire Hathaway owns about 400,000 shares of Coca-Cola. And Coca-Cola currently pays $1.40 a year in dividends. That means Buffett collects $560,000 a year in dividend payments from Coke. Buffett makes his initial investment back every 22 months!

The Power of Compounding

Let's say you bought 1,000 shares of a $30 stock. That's a $30,000 initial investment. And let's also say that stock pays a 3% dividend and hikes that dividend by 10%. If the stock goes up just 10% a year, and you reinvest your dividends, you'll more than triple your money in 10 years — from $30k to $101,207.28. 

But the power of compounding means that your wealth grows exponentially over time. So if you hold that same investment for just another five years, you'd triple it again! In 15 years, your $30k will be worth $185,828.15. Hold it for 29 years, and you're a millionaire. 

Now, I get that we don't all have 30-year time horizons. I'm 50, and I wouldn't want to wager on my lifespan. Still, I will continue to let compounding work for me.

But my kids are in a different circumstance. They have plenty of time to let compounding work for them...

I've already taken steps to make sure that they will have financial security when they get older. And it hasn't cost me a ton of cash, either. Is there any better gift that I can give them? I don't think so.

What to Buy Now?

If you're thinking of starting to invest and letting the power of compounding work for you or your dependents or loved ones, you need just two things.

First, you need an investment account. For U.S. citizens, I always recommend Roth IRAs. Roth IRAs have contribution limits. If you're under 50 and make less than $183,000 a year, you can contribute $5,500 a year. Over 50, and the amount goes up to $6,500. 

But the benefit is that when you start taking payouts from a Roth IRA, it's all tax-free. That's right; money can multiply for decades and you won't pay a penny in taxes. That is incredibly powerful when you consider that you would be taxed 15% if you held investments in a regular investment account. 

So talk to your bank; they probably offer Roth IRAs. And you should be able to open a Roth IRA for free, with a minimum initial contribution.

Second, once you have a Roth IRA, you need something to invest in. Most banks or brokerages that offer Roth IRAs will have some funds that you can easily invest in. Personally, I don't like funds for long-term investing. They will likely have annual fees that will eat into your returns.

For example, the average annual return for the stock market is around 8%. But if you pay a 1.5% annual fee, that's nearly 20% of your gains. Not good. 

Plus, over the long haul, you won't necessarily find more safety in funds. And you will likely underperform many stocks that you could easily invest in. 

So, yeah, I prefer buying individual stocks for long-term portfolios. It's not as hard to do as you might think. You just have to find stable businesses that are profitable now and will continue to be in the future. And ones that pay dividends that are likely to rise.

I always point out Bank of America (NYSE: BAC) as a great example of this kind of investment. Do you think Bank of America is going out of business soon? No. Is the U.S. population growing? Yes it is, which means BofA is likely to improve its revenues and earnings. Is the dividend likely to rise? Yes, it is. BofA pays one of the lowest dividend rates of any U.S. bank. It's going higher.

You can ask the same questions about companies like Starbucks (NASDAQ: SBUX), Disney (NYSE: DIS), or AT&T (NYSE: T). You can also look into real estate investment trusts (REITs) like Realty Income Trust (NYSE: O). 

But watch out for the dividend sector known as "Consumer Staples." Consumer staples are companies whose products are staples — that is, people buy the products no matter what the economy is doing. This includes things like toothpaste, diapers, and food and companies like Johnson & Johnson (NYSE: JNJ), Hormel (NYSE: HRL), Kimberly-Clark (NYSE: KMB), or Procter & Gamble (NYSE: PG).

Bloomberg reports that retiring baby boomers have been buying these supposedly "safe" dividend stocks hand over fist, and they have driven the prices up very high. For instance, Kimberly-Clark has a P/E ratio of 21 — that's 35% higher than its 10-year average. And with a P/E of 31, Hormel is 65% higher than its 10-year average. Hormel is also 62% higher than the average tech stock. 

Until next time,

Until next time,

brit''s sig

Briton Ryle

follow basic@BritonRyle on Twitter

A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

Comments

Buffett's Envy: 50% Annual Returns, Guaranteed