The Main Street Investor

    Union Pacific (UNP) traded ex-dividend today with a payout of $0.60 per share. This is a 26.32% increase over the $0.475 dividend paid in the same quarter last year. Based on an annualized dividend payout of $2.40 my yield on cost is currently 2.27% at my average share purchase price of $105.94.
    Union Pacific's dividend compound annual growth rate has been accelerating over the last 10 years with the expected payout in 2012 increasing at a compound rate of 24.35% over 2011. This is lower than the 3 and 5 year dividend CAGR, but very respectable nonetheless. The following table outlines the annual dividends paid since 2002 along with the 10, 5, 3, and 1 year dividend CAGR.

    *Indicated dividend for 2012.

    Since 2002, annual dividends increased 8 times and remained unchanged in 2005 and 2006.  Despite not growing dividend payouts for two years, UNP has delivered an impressive dividend growth rate of 19.04% over the last decade. The current payout ratio is a comfortable 28% based on the 2012 analyst EPS mean estimate of $8.59.
    Union Pacific has also exhibited strong earnings growth over the last 5 years at a compound annual rate of 19.95%. Analyst estimates for growth over the next 5 years is 16.30%, which is a decline of roughly 18.30%. Taking the 10 year dividend CAGR as a basis, the following table estimates the yield on initial investment and EPS through the next 20 years. An 18.30% reduction is made in EPS estimates for years 1-5, with each 5 years after year 5 receiving an additional 18.30% reduction. Dividend growth rates are reduced at a similar rate with a 5 year lag behind EPS decline. 

    The analysis shows an investor may expect a yield on cost of 33.26% at year 20. This certainly seems reasonable as UNP's estimated payout ratio is only 40.22%. An investor can also expect to receive $300 per share in total dividends paid out over the 20 year period. This is 2.83 times the initial share price paid for the investment. Also note that UNP hits a 10 year target many dividend growth investors use of 10% yield on cost. The calculated 20 year dividend CAGR is 14.38% for this analysis. A similar analysis can be performed at the more aggressive 5 year dividend CAGR of 26.19%. The results are shown in the following table.

    Using the more aggressive historical 5 year dividend CAGR of 26.19% we can expect a yield on cost of 83.40%, but the payout ratio hits 100%. It is unlikely Union Pacific will be in a state of business that allows them to payout 100% of earnings as dividends in 20 years. The calculated 20 year dividend CAGR is 19.76% for this analysis. Some value may be found in this analysis at the 10 year mark. If UNP were to double it's payout ratio over the next decade an investor could expect to receive a yield on cost of 19.11%. This may be about as reasonable an assessment we can make for this analysis as the estimates quickly start breaking down after year 10. Needless to say, estimating future cash flows when starting out at an increased level of dividend growth is extremely difficult.
    With a strong dividend CAGR over the last decade, a most recent quarter over quarter dividend increase of 26%, and strong earnings growth, Union Pacific passes the dividend test and will continue to be a core position is my dividend growth portfolio.

    CEO trades ex-dividend today with a payout of $3.2456 per share. This is an 12.28% increase over the $2.8907 paid in the same quarter last year. Based on an annualized dividend payout of $6.49 my yield on investment for CEO is currently 3.26%.

Full analysis can be found here.
   

    For those of you who have never dealt with options before, the idea of using a covered call on a stock position you own may seem like a foreign concept. Let's first explain what an option is. In the most basic sense an option either gives you the right to buy (call) or sell (put) an equity at a determined strike price within a certain period of time.
    Options chains are displayed on just about every financial quoting website out there such as Yahoo and CNBC. An options chain displays the current ask/bid prices for options at different expiration dates and strike prices.
    Let's take an example. Looking at the options chain for MCD, we can see that the Jun 12 $92.50 call option's ask price is at $89 at the time of writing. If you were to buy this option it would cost you $89 plus commissions. Owning this option gives you the right to buy shares of MCD at $92.50 at any time before or on the third Friday of June 2012. Say MCD goes up to $100 the first week of June. You can exercise your option and buy the shares at $92.50 even though they are trading at $100. You'll have an immediate gain of $7.50.
    Many traders use options for leverage. You essentially control 100 shares of an underlying equity for a fraction of the cost. If someone were to believe a short term spike in the price of MCD stock they could buy shares outright on the market at say $92 a share. Or they could buy call options for MCD and control a much larger quantity of MCD stock for a fraction of the capital required for the position. There are numerous ways to trade options and if you are interested I suggest you get a good book because it can get complicated in a hurry. For now, though, we are only interested in selling call options on positions we own in our long term growth portfolio.
    A covered call option is an option that is "covered" by owning 100 shares of the underlying equity. It is considered covered because we already own the shares and if the call option is exercised there shouldn't be any problem in delivering those shares to the owner of the call option.
    Selling covered call options is a great way to increase returns and supply a little more capital through selling to buy more stock in great dividend growth companies. Let's take another example.
    Say you own 200 shares of POT at an average price of $39. We could sell 2 x Jul 12 $43 call options at the bid price at the time of this writing of $81. We would immediately pocket $162 minus commissions that we get to keep. That's 2.08% return for about a two month period or an extra 12% annually if you could pull it off 6 times in a year. A couple of different outcomes can happen now. The price of POT goes above the $43 strike price and the call is exercised. If this happens you get a decent capital gain of $800 plus the $162 premium you got from selling the calls. Now, we as long term investors don't necessarily want to sell our shares. We could at any time buy back the options we sold, possibly at a loss, to prevent having to sell our shares. The other outcome is the price of POT stays below $43 before expiring on the third Friday of July. The option expires worthless, you keep your 100 shares of POT, and get $162 in covered call premium for your trouble.
    Given the example, you can start to understand how covered calls can provide a steady stream of capital to help finance additional dividend growth stock positions. It's not without risks however. You have to be willing to sell your shares and you need to understand how writing covered calls can affect your qualified dividend status as well as your stock holding period that is used for long or short term capital gains tax. In short, as long as you sell out of the money calls with more than 30 days to expiration but less than a year to expiration, the covered call positions should not impact either your holding time for determining long versus short term capital gains or your qualified dividend status on the underlying shares. An out of the money call option is an option with a strike price higher than the current share price of the underlying shares.
   
   
   
   

    ABC trades ex-dividend today with a payout of $0.13 per share. This is a 13% increase over the same $0.115 paid in the same quarter last year. This is a lot below the 34.42% dividend CAGR over the last 10 years so I'll be keeping a close eye on the dividend increase for 2013. Based on an annualized dividend payout of $0.52 my yield on investment for ABC is currently 1.41%.

    CMI trades ex-dividend today with a payout of $0.40 per share. This is a 52% increase over the same $0.263 paid in the same quarter last year. Based on an annualized dividend payout of $1.60 my yield on investment for CMI is currently 1.46%. Keep those dividend increases coming!

    UTX trades ex-dividend today with a payout of $0.48 per share. This is a 0% increase over the same $0.48 paid in the same quarter last year. Based on an annualized dividend payout of $1.20 my yield on investment for UTX is currently 2.41%. Ok UTX, you get a pass for now...but need to kick it in gear or you're getting the boot!
    United Technologies has been subjected to a quickly deteriorating dividend CAGR with it's current projected 1 year CAGR a dismal 2.67%. The 5 and 3 year dividend CAGRs are well below the 10 year CAGR. This is cause for concern. Let's see if we can find anything to ease our fears about UTX dividend growth prospects. The following table lists the dividend compound annual growth rates for the last 10, 5, and 3 year periods along with the annual dividends paid since 2002.

    *Indicated dividend for 2012.

    United Technologies has increased it's payout to shareholders every year for the last 10 years but it's glaringly apparent from the table above the dividend growth rate has slowed down dramatically. Is UTX having a slowdown in earnings growth or having a difficult time generating cash flow? The following chart shows the annual dividends paid, earnings per share, cash flow per share, and payout ratio for United Technologies since 2002.

    The graph shows EPS and cash flow per share in a nice upward trend (2012 estimate for cash flow per share is my own and 2012 EPS estimate is analyst mean estimate).
    While UTX's earnings and cash flow growth remain good, they have really slowed down in the dividend growth department and, as a dividend growth investor, I am not pleased by this. UTX fails the dividend test and may be sold in favor of a faster dividend growth company if the opportunity presents itself. If UTX fails to increase it's dividend by a decent amount in 2013 it will definitely be unloaded. At least I am getting a 2.41% current yield on investment. This is better than the 10 year albeit at a much larger risk.

    MSFT trades ex-dividend today with a payout of $0.20 per share. This is an increase of 25% over the $0.16 paid in the same quarter last year. Based on an annualized dividend payout of $0.80 my yield on investment for MSFT is currently 2.63%. Pretty good for a large tech stock. Imagine what they could do with a new operating system that doesn't crash every couple of hours...

Full analysis can be found here.
  

Today's buy:
HLF - added to position at $43.02 with RSI slightly under 20. The downward spiral for this stock continues but the company is making major efforts to stand behind their stock. The company announced shortly after this past quarter's earnings call a $428 million stock repurchase effort. Moreover, insiders bought some $650,000 worth of Herbalife stock this past Friday, giving a strong signal of support for the business. It would appear to be HLF vs. David Einhorn for the time being and I am betting in the long term on HLF. May 16th will mark an important day for HLF as Einhorn is set to speak at the Sohn Investment Capital conference on the 16th and there is some speculation he will have a prepared analysis, assumingly negative, on HLF. I am a continued buyer at these levels for the time being.

    HLF trades ex-dividend today with a payout of $0.30 per share. This is an increase of 50% over the $0.20 paid in the same quarter last year. Based on an annualized dividend payout of $1.20 my yield on investment for HLF is currently 2.31%. Let's keep it going Herbalife!
    Herbalife is a relative newcomer to paying dividends with it's first annual dividend payment made in 2007. During this short period of time, HLF's dividend CAGR has been accelerating at a high pace. Many choices in my portfolio are companies like Herbalife that do not have the 50 year dividend paying history that Dividend Aristocrats do, but have a great chance of becoming a future Dividend Aristocrat. That's where the really high initial yield on cost can be found when you can get invested in a companies high dividend growth rate phase. The following table shows the dividend CAGR for 1, 3, and 5 years along with the annual dividend payments made since 2007.

    *Indicated dividend for 2012.

    While HLF has only been paying dividends for about 5 years now, it's growth rate is impressive. The most recent increase beat out the 3 and 5 year dividend compound annual growth rates by a substantial margin at 2.05:1 and 1.48:1 ratio respectively. Herbalife has also increased dividends 4 of the last 5 years.
    Estimating future cash flow 20 years from now that can be excepted from a company in a high dividend CAGR is challenging. These high growth rates will eventually decline to more mature levels of growth, say around 15% annually, but the problem is we do not know exactly when that will happen. The following table attempts to estimate what the initial yield on cost and cumulative dividend return might look like with a modified CAGR analysis. The dividend growth rate for 5 and 3 years is reduced by 10% of the historical rates of 31.95% and 44.22% respectively every two years up to year 11. Starting at year 11 the dividend CAGR is set to 15% annually. My initial cost is my averaged in price of $48.59 a share.

    As stated before it becomes more difficult performing a long term future cash flow analysis when a company is exhibiting a high dividend CAGR phase. The heightened level of dividend increases cannot be expected to continue indefinitely. In the case of HLF, I used a gradual decrease in the dividend growth rate until a reasonable level of 15% annually was reached in year 11. As shown in the table, the anticipated yield on cost is something to get excited about.
    Herbalife passes the dividend test and will continue to be held in my dividend growth portfolio. Despite some timidness in accumulating more shares in the wake of the recent David Einhorn earnings call incident, I will be looking to add to my position if the opportunity presents itself.

    GWW trades ex-dividend today with a payout of $0.80 per share. This is an increase of 21.21% over the $0.66 paid in the same quarter last year. Nice increase over the 10 year CAGR of 15.56% hopefully indicating a continued ramp up in dividend growth. Based on an annualized dividend payout of $3.20 my yield on investment for GWW is currently 1.53%.

Full analysis can be found here.