Mannie, I don't mean to beat a dead horse, but I thought I'd complete my thoughts on why I sold my position in EXC, and why I will be moving WM and SCG out of my portfolio.
As a dividend growth investor, it is important to me that the dividend continues to grow. When I start drawing my dividend income, I want to be able to count on cost of living increases every year. This is important to me because once I start drawing that income, I won't have any other source to help me offset inflation. My pension will be fixed income and Social Security cost of living increases are not only unreliable, when they do occur, they are minimal.
It is for this reason that I mix in the type of companies I purchase. I do own some companies with a high yield, low dividend growth structure, but that yield must be around 5% or higher. It's why T will stay in the portfolio, for example.
The other part of the equation for me is holding lower yielding companies that provide high dividend growth. Hence the reasons for owning ADP, CL, PG, KO and others.
I could always take the higher yielding companies now and switch over later, but I decided I would "practice" my retirement strategy now and get it ingrained into my system over the coming years. They say "practice" makes perfect. I want to do better than that. I want it to be "perfect practice" makes perfect. So, I am practicing my dividend growth philosophy now, as if it is going to be the only thing I count on in retirement. I want to make the mistakes now, as opposed to later.
When I initially purchased EXC, is was a high yielding company that was growing the dividend. I use a simple formula to help me obtain the higher quality dividend companies. I want the current yield, plus the 5 year compounded growth rate (CAGR) to equal 12% or better. In other words, if the yield is 3%, then I need to see a 5 year CAGR of 9% or better. If the yield is 5%, the 5 year CAGR needs to be 7% or better.
I will make an exception with utility companies though, because they often times aren't allowed to grow. ... Ha!
I will accept an 8% total dividend return for utility companies and I include telecommunication companies and oil and gas companies under the utility umbrella.
I own D. It has a 4.1% yield and a 5 year CAGR of 7.66% for a dividend total return of 11.76%. If I didn't already own it, it would qualify for purchase as long as the fundamentals checked out for me.
I'm looking at buying LNT. I like how they have turned the company around and analysts, including Value Line and Morningstar, seem to think that LNT is on an upward swing. The current yield is 4.0% and the 5 year CAGR is 7.24% for a dividend total number of 11.24%. It qualifies for purchase. Both Value Line and Morning star are predicting that LNT will grow their dividends in the 7% range going out to 2015 and beyond.
The formula I use to help assure acceptable results is:
High Quality + High Current Yield + High Growth Of Yield = High Total Return.
When I look at EXC, on the surface it would look like it qualifies for purchase under the total dividend return formula. It has a yield of 7.0% and a 5 year CAGR of 3.75% for a total dividend return of 10.75%.
This is misleading. We know that the dividend is no longer increasing, which is why the 5 year CAGR keeps dropping. Six months ago, the dividend was safe according to the CEO. A lot of things had to change in such a short period of time for him to reverse course and warn that the dividend may need to be cut.
Thus, EXC know longer supports the formula above. We no longer have High Growth Of Yield.
In addition to low power prices, and the fact that the hedges due now are being locked in at lower prices, thus creating lower margins down the road, the company has put off capital investment and they are concerned about their credit rating.
In my swing trading days, I looked for high probability set up points to enter, and high probability set ups for selling. That high probability concept has been ingrained in my thick skull. When the company stops capital investment, is concerned about their credit rating, and warns that there may be a dividend cut six months from now, the high probability set up is that this would be a short in the world of trading, not a long. Those who shorted the company off the conference call made money.
What are some of the high probability set up situations to go long on EXC? First of all, how about the fundamentals? Are the fundamentals in place for the company to continue paying and increasing the dividend?
I am making an assumption here, and maybe I shouldn't, but aren't utility companies usually purchased for their dividend income safety? Utility companies are regulated as to how much earnings growth they are allowed to have. Since earnings are restricted, then the entry point is even more important when buying utility companies. In my opinion, I want to own a utility as its future looks like it is rising, not falling.
People are being attracted to the high yield and justifying ownership. They think the dividend cut is already priced in. What isn't priced in yet, in my opinion, are the lower hedges that will be renewed in the coming months. I think the high probability set up we need to see is improving power pricing.
Roger Conrad, Editor of The Utility Forecaster newsletter, is on record as saying that in the history of electricity, of the hundreds of mergers that have taken place, every single one of them saw the acquiring company come out financially stronger. Every single one of them! The key was being patient.
Now, this is where the waters get muddy. If you were already a shareowner, and have been for years, you saw EXC at $90 plus just a few years ago. EXC would now have to increase 200% just to get you back to even. You'd have to be real patient in order for that to happen.
My entry was lower, but it comes to a point where you must have a draw down point with utilities, I think. I decided I wouldn't accept a loss of more than 20% below my entry. I took a 19.34% loss in EXC. When you put that loss in proper perspective, and look at how it affected the total portfolio value, the loss represented less than 1/2 of a percentage point due to the number of positions I own and the way they are weighted. The loss means nothing other than I'm practicing retirement income strategies. EXC had to go.
I do think that EXC will eventually present a scenario where it will be advantageous to own it. I think if one were to purchase it here, trying to lock in the high yield, I think I would make it a partial position until the fundamentals turn around. I think it's a speculation play at this time and that takes a different set of rules, and a different set of objectives, when monitoring your position.
To make a long story short, it depends on what side of the fence you sit on as to how you approach a company like EXC. It boils down to what your objectives are. |
