=== Fourth Quarter 2010 === Connolly Report ideas

Here's what dividend growth investing is all about. Our son bought some BCE in August 2009 for $25.09 per share. The dividend is now $1.97 per. His yield is 1.97 / 25.09 = 7.85%. That 7.8% includes the gains in the dividend since he bought the shares. It does not include the gain in price (currently $35.) He's up $10 per share and he's getting 7.8% on his money now. That $10 is his margin of safety. The stock can fall $10 and he's still breaking even. The margin of safety would not be as great with a current purchase at $35, of course. But if BCE rises to the price Teachers' was willing to pay for it, $42 or so, there would be some margin of safety for the current purchaser.

• “One of the key themes of this book (The Ultimate Dividend Playbook by Josh Peters) is the idea that dividends, through both yield and growth, enable investors to meet real-world financial needs directly with their portfolios. Fickle capital gains (green today, red tomorrow, endlessly unpredictable) do not“. TC: This is a terrific book on dividend growth - Peters knows his stuff and has Morningstar data [unfortunately, American] to back it up. This sentence also points dramatically to the great weakness of mutual funds when it comes to providing income…capital gains are fickle. Read the sentence again. Peters nails it down beautifully.
• In the letter accompanying his renewal cheque (It's that time of year) a long-time (since 1991) subscriber, told me he bought 1000 Interprovincial Pipe in 1995 at $28 a share. After the name change and two, two for 1, splits² in May of 1999 and 2005, he now owns 4000 Enbridge. He calculates the yield on his investment to be 24.3% now and he says “I am up 8 times.” TC: This person bought when Enbridge was value priced, and had the patience to hold, this good dividend growing common stock. Fifteen years is a long time, but his wealth was building over that entire period. The dividend, split-adjusted, went from .50 in 1995 to $1.70 now. And his wealth is still building. (4000 shares times the current price is $228,000; up $200,000 from 1000 shares at $28 = $28,000). Dividend growth investors believe share price growth is driven by dividend growth. Enbridge's dividend rose 14.9% in 2010 (up 12.1% in 2009, 7.3% in 2008, 7% in 2007, 10.6% the year before, 13.7% in 2005, 10.2% before that. This is the essence of dividend growth investing. Did he care about the market crash of 2008? NO! His cost price is $7 ( $28 / 4 ). (Read Peters' sentence at the top of this page again.) Does he care about the currently low interest rates? NO!. The yield on his investment is now 24.3%. Is he going to sell? NO! His asset produces income, a growing income. This is what you want in your retirement portfolio*¹: a cluth of common stocks that produce a growing income. Dividends on all the non-financial stocks in my list increased in 2010. Every one. The financial stocks, with one exception, however, became like bonds: fixed income…no dividend increases. But none decreased.

Dividend Growth Investing: Have you read Stephen Jarislowsky's The Investment Zoo yet? Have you bought Josh Peter's The Ultimate Dividend Playbook yet? You can do dividend growth investing too. It's easy. Get rid of your funds while the market is high, and your broker too (he/she'll lead you astray by suggesting over-priced, non-dividend stocks, and maybe even bonds). But don't buy Enbridge. Not now. ENB is currently on the very bottom of my list sorted by yield difference: it's expensive ³. The question, remember, is not whether Enbridge is a good company, it is, it's whether ENB is a good buy now. ♣ Instead now, I'd buy the highest non-financial in my list, sorted by difference from its average yield, except that my wife and son already own it. The list evolves. Expensive ones, over time, sink to the bottom, cheaper stocks rise to the top. I have used yield to sort for value since I started nearly 30 years ago. Others use price to book or price/earning to measure value. It does not really matter which metric is used as long as you do not buy an expensive stock. Generally, as I key this in November 2010, that market is expensive. WAIT. Or, if you can't, select carefully. And remember it is a financial crisis we are in (present tense…it's not over). And know your history. For instance, the stock market peaked in 1929. The bottom was reached in 1932. In between, there was a great rally (we are in that type of rally now) I don't think we've seen the bottom yet. If you want to buy stock cheaply, hope the bottom has not yet been reached. If you already own good dividend-paying common (never preferred*, they are not) stock, hold for the dividend increases as my subscriber is doing with his Enbridge.

* That preferred stock was not even mentioned in The Investment Zoo is telling. From where I am typing this, I can touch this great book by Jarislowsky.

♣ ³ I was curious about Enbridge's position in my list in 1995 and looked it up (Connolly Report page 329, February 1995). Interestingly, when this person bought Enbridge (IPL then) it was on top of my list, then sorted by yield, at 7.1%. There had been no recent dividend increase. It was somewhat of a risky move, back then. But the purchase paid off. Value priced stocks, over the long haul, perform better than expensive stocks. Actually, the front page headline of my February 1995 issue was the very rare “Time to Buy” and I had six yield charts in that issue: Quebec Tel, BCE, Fortis, TransCanada, BC Gas and, at the opposite end of the spectre, BNS: the banks, and Nova, were at the bottom of the list. ² Expect fewer stock splits in the years ahead: there's a 'new normal'. But with dividend growth, wealth will build. After holding a dividend-growing common stock for five years, some 80% of you return will be from the dividend and its growth (James Montier of GMO). If you buy a stock that does not pay a dividend, you're behind the eight ball from the start.

*¹ For more examples of dividend growth stocks (no bonds in the portfolio), seek out Rob Carrick's Report on Business column of Saturday November 20th 2010: 'The 'blazingly simple,' must-have portfolio” - seven dividend growing common stocks which have beaten (not 'beat' as No-Frills says) the TSX average over the last decade. All but one are in my list. Tom Connolly

• Alexandre, a trifleuvien, writes from G9A: “I'm 31 years old and plan on retiring at 55. Your reports are a great help. After a few dividend increases, I'm making 4 1/4% on ENB and I'm already quite excited! I cannot wait to be making 10…20…30% on my original capital. Thanks for sharing the dividend growth technique.”
• AW writes from N9H: “Dividend growth investing is very difficult in that it requires considerable discipline both in terms of buying dividend stocks at a discount to the 'Graham number' which is likely when everyone else is selling, and in holding the stock over a long period of time, even when the stock price may be moving up and down as much as 30 percent. I find reading your material really helps me to maintain that long term perspective.”