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Berko: A different investment philosophy

By Malcolm Berko

Published: December 1, 2018, 6:00am

Dear Mr. Berko: This market frightens the heck out of me, and I’m scared my $263,000 individual retirement account will go up in smoke. I’m 42. Is there any way to avoid scary downturns?

— SS, Springfield, Ill.

Dear SS: No!

I don’t stress capital gains, because I can’t spend them unless I sell something, because they’re difficult to predict and because they’re often fleeting. I don’t value my portfolio the way most investors do. Most investors measure gains as a percentage of their cost basis, hoping to grow wealth via capital gains. That’s the old-fashioned way. My definition of wealth is “how much money you can spend while leaving your capital alone and maintaining enough funds for important life events.” We don’t spend wealth; we spend the income that wealth produces. So the best measure of investing success is the income your portfolio earns. An investor with a $3 million portfolio generating $70,000 in income is less successful than an investor with a $2 million portfolio generating $100,000 in income. When the Dow Jones industrial average becomes a wrecking ball, the latter’s stress level doesn’t provoke the needle as much as the former’s.

Assume you invested $10,000 in AT&T 10 years ago and bought 410 shares at $24.40. The dividend then was $1.60 a share, yielding 6.5 percent, and the annual dividend income was $656. If you reinvested the dividends every quarter, you’d have 731 shares today, worth $30 each. Because AT&T’s dividend increases each year, those 731 shares would now pay a $2 dividend, or $1,462 a year — and that would be a 14.6 percent cash-on-cash return on your $10,000 investment. That $806 dividend growth represents about a 125 percent gain in 10 years, an average income boost of about 8.3 percent each year. And each year, your income should increase because AT&T’s board may continue growing its dividend.

If you’d done the same with Omega Healthcare Investors, your initial dividend on a $10,000 investment would’ve been $1,117 10 years ago. However, after reinvesting each quarterly payout, you’d own 1,701 shares with a $2.58 dividend paying $4,388 a year today. That’s a 43 percent cash-on-cash return on a $10,000 investment.

If you’d done the same with Verizon Communications, your dividend would’ve grown from $687 on 394 shares in 2008 to a tad over $1,530 on 635 shares today. And no matter how you slice the salami, Sammy, that’s a 15.3 percent cash-on-cash return that’ll increase a bit each year as Verizon grows earnings.

Note that some business development companies, such as Main Street Capital and BlackRock Capital Investment Corp., have impressive 10-year income growth records. Ten years ago, $10,000 invested in BlackRock Capital Investment Corp. would’ve purchased 80 shares paying $240 in annual income. If you reinvested all of BlackRock’s payouts for a decade, you’d have accumulated 134 shares paying $12.02 a share, totaling $1,610 in annual income. That’s a 16.1 percent cash-on-cash return. And BlackRock’s dividend increases a little each year because its growing business enables management to raise the dividend annually.

There are hundreds of stocks with attractive records of annual dividend increases. Your stockbroker should be able to compile a list of good dividend growers.

Finally, I can’t, with a high to modest degree of certainty, tell you the stock price of Johnson & Johnson will grow from $142 this year to $157 next year. But that 15-point gain represents the consensus of 24 of Wall Street’s analysts. I can tell you with a significantly higher degree of certainty that Johnson & Johnson will increase its dividend from $3.60 in 2018 to $3.85 in 2019. And when the Dow takes these extended 600- and 800-point falls, I’m less uncomfortable than you because I know that Johnson & Johnson’s growing dividend will purchase new shares at lower prices. You might consider changing your investment philosophy.

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