The last chapter told us how to find the dividend growth rate so that we may select stocks that fit our portfolio criteria of growing their dividends approximately 8 percent per year.
This chapter will help us determine the future growth rate of a stock after dividends are accounted for. We need the growth rate of a stock in order to achieve our goal of selecting stocks that not only have an 8 percent dividend growth rate, but also have a 7 percent price growth rate as well.
We want to strive to select stocks that will double in value (price) over the next 10 years. Just a note here: Price does not always follow value in the short term; however, price does indeed follow value over the long term. Value is the worth or the profitable projects a company builds (or buys) over the years. Price, which can change every minute of every day, is in the minds of the beholders, but value is something very real and it is something that good companies build over the long term.
During the market crash of 1987, the market (Dow) fell 22 percent in one day. Actually, the price of stocks in the Dow on average fell 22 percent, but the value of those stocks did not fall except in the minds of those large money managers who felt they needed to stay liquid. Eventually, price caught back up to the intrinsic (basic) value of those companies. As a matter of fact, the market actually closed the year (1987) higher than it began. Those who sold at the bottom were very sad puppies indeed. The market is now 950 percent higher today than the end of the day of October 19, 1987.
Using the rule of 72, we want to find the growth rate needed in a portfolio of stocks in order to double in value within our 10-year time frame. Thus, 72/10 = 7.2 percent. This means we must select stocks that are growing in value (and thus price) at 7.2 percent per year. If we can accomplish this, then we will see a doubling of our portfolio value in 10 years. We are not counting dividends in this chapter. We are just looking at the value (price) of our stock portfolio, and we are trying to select stocks that will double in value over the next 10 years.
The growth of a company is dependent on the value of the projects or investments that a company makes over time. The money for these projects comes from earnings reinvested back into the company or from the money a company borrows. We can measure the success of these investments by calculating a return on equity (ROE) in a Clean Surplus condition. If a company continues to generate a high ROE, then we know that the company is earning a high rate of return on its investments and projects.
We have learned in this book that a method of measuring earnings efficiency is using the Clean Surplus ROE.
We have also learned that the Clean Surplus ROE has a very good correlation with the future growth (price) of a company.
Let’s look at an example. If the average stock in the S&P 500 Index has a Clean Surplus ROE of 14 percent and a growth stock we select has an ROE of 28 percent, we would expect to see our growth stock double the returns of the market as measured by the S&P 500 Index. Yes, it is that simple. Well almost.
Let’s say that our growth stock pays out half of its earnings in the form of dividends. This means that if the stock has an ROE of 28 percent and pays half of the earnings out to shareholders in the form of dividends, then it is putting just half of the earnings back into the company in order to grow.
Putting it another way, the company is retaining half or 50 percent of its earnings in order to grow the company. If the ROE is 28 percent and the retention rate of its earnings (retained earnings) is 50 percent, then we are left with a projected 14 percent per year rate of future price growth.
We want to be able to measure the stock growth rate so we can compare one stock against another stock for portfolio selection.
The first stock we looked at in the last chapter relative to dividend growth rate was Philip Morris International. Table 23.1 shows what we saw.
Table 23.1 Philip Morris International NYSE - PM 4.4%
| Year | CS Owners’ Equity | Net Income | Dividends Paid | Dividend Growth |
| 2015 | $13.06 | $5.60 | $4.24 | 8.7% |
| 2014 | $11.86 | $5.10 | $3.90 | 8.9% |
| 2013 | $10.18 | $5.26 | $3.58 | 10.5% |
| 2012 | $8.25 | $5.17 | $3.24 | 14.9% |
| 2011 | $6.22 | $4.85 | $2.82 | 15.6% |
| 2010 | $4.74 | $3.92 | $2.44 | 8.9% |
| 2009 | $3.74 | $3.24 | $2.24 | 124.0% |
| 2008 | $1.42 | $3.32 | $1.00 |
Let’s now look at some more statistics in Table 23.2
Table 23.2 Philip Morris International - PM 4.4%
| Year | Net Income | Dividends Paid | Retained Earnings | Return on Equity | Retention Rate | Stock Growth |
| 2015 | $5.60 | $4.24 | $1.36 | 43% | 24% | 10% |
| 2014 | $5.10 | $3.90 | $1.20 | 43% | 24% | 10% |
| 2013 | $5.26 | $3.58 | $1.68 | 52% | 32% | 17% |
| 2012 | $5.17 | $3.24 | $1.93 | 63% | 37% | 23% |
| 2011 | $4.85 | $2.82 | $2.03 | 78% | 42% | 33% |
| 2010 | $3.92 | $2.44 | $1.48 | 83% | 38% | 31% |
| 2009 | $3.24 | $2.24 | $1.00 | 87% | 31% | 27% |
In Table 23.2 we see the ROE of 43 percent for 2015. We also see the retention rate of 24 percent for this same year. This means that out of the $5.60 of net income, the dividends are $4.24 and the retained earnings then must be $1.36. This $1.36 of retained earnings (earnings put back into the company) divided by the net income of $5.60 is the retention rate of 24 percent.
We know that if this company did not pay out any dividends, then the ROE is a very good indicator of future growth (price). In this case, we would expect a stock growth rate of almost 43 percent. Whew, right? However, we must take into consideration the dividends. The dividends for Philip Morris represent about 76 percent of the earnings. How did I calculate that? The percentage of dividends paid (76 percent) subtracted from 100 percent is the retention rate.
What isn’t put back into the company is paid out in the form of dividends. The percentage of dividends plus the percentage of retained earnings must equal 100 percent.
But, we are concerned with the growth rate of the stock. For 2015, we merely take the Clean Surplus ROE (43 percent) and multiply it by the retention rate (24 percent), and this equals the last column for 2015 of 10 percent. Thus, we can expect this stock to grow in price about 10 percent per year.
For Philip Morris International we have a dividend of 4.2 percent, which is growing at a dividend growth rate of 8.7 percent and a projected stock growth (price) rate of 10.4 percent. I don’t know about you, but this stock is going into our dividend income and growth portfolio.
We saw earlier that AT&T had a nice high dividend of 5.3 percent. However, we also saw that the dividend growth rate was a mere 2.2 percent, which is certainly not good enough for our portfolio (see Table 23.3).
Table 23.3 AT&T, Inc. NYSE - T Div. 5.3%
| Year | CS Owners’ Equity | Net Income | Dividends Paid | Dividend Growth |
| 2015 | $42.28 | $2.80 | $1.88 | 2.2% |
| 2014 | $41.52 | $2.60 | $1.84 | 2.2% |
| 2013 | $40.82 | $2.50 | $1.80 | 2.3% |
| 2012 | $40.25 | $2.33 | $1.76 | 2.3% |
| 2011 | $39.77 | $2.20 | $1.72 | 2.4% |
| 2010 | $39.16 | $2.29 | $1.68 | 2.4% |
| 2009 | $38.68 | $2.12 | $1.64 | 2.5% |
| 2008 | $38.12 | $2.16 | $1.60 | 12.7% |
| 2007 | $36.78 | $2.76 | $1.42 |
But maybe, just maybe, the stock growth rate (price) might be high enough to justify the low dividend growth rate. NOT! See Table 23.4.
Table 23.4 AT&T, Inc. NYSE - T
| Year | Net Income | Dividends Paid | Retained Earnings | Return on Equity | Retention Rate | Stock Growth |
| 2015 | $2.80 | $1.88 | $0.92 | 7% | 33% | 2% |
| 2014 | $2.60 | $1.84 | $0.76 | 6% | 29% | 2% |
| 2013 | $2.50 | $1.80 | $0.70 | 6% | 28% | 2% |
| 2012 | $2.33 | $1.76 | $0.57 | 6% | 24% | 1% |
| 2011 | $2.20 | $1.72 | $0.48 | 6% | 22% | 1% |
| 2010 | $2.29 | $1.68 | $0.56 | 6% | 26% | 1% |
| 2009 | $2.12 | $1.64 | $1.34 | 8% | 49% | 4% |
Remember how this is done. We take the ROE, which is a good indication of the future total return of a stock and multiply it by the retention rate. The retention rate is how much money the company puts back into itself in order to grow.
The ROE (7 percent) times retention rate (33 percent), or 0.7 times 0.33, gives us the anticipated stock growth rate listed in Table 23.4 for 2015 of just 2 percent.
Let’s analyze. The dividend is very good at 5.3 percent. The dividend growth of 2.2 percent does not meet our criteria of a 7–8 percent growth rate. The stock growth of 2 percent does not meet our criteria of a 7 percent stock growth rate. Bottom line with AT&T: This company will just not get us to where we want to be in 10 years.
I was looking through stocks for a seminar I was presenting to about 100 CPAs. Clean Surplus is approved by various accounting agencies as certification for continuing education credits. When I am asked to present, I try and find new examples and in doing so for this presentation, I came across Tupperware. Yes, you all remember Tupperware. We went over this stock just in part so let’s continue on with it. First, let’s recheck the dividend and dividend growth shown in Table 23.5.
Table 23.5 Tupperware - TUP 3.3%
| Year | Dividends Paid | Dividend Growth |
| 2015 | $3.00 | 10% |
| 2014 | $2.72 | 10% |
| 2013 | $2.48 | 72% |
| 2012 | $1.44 | 20% |
| 2011 | $1.20 | 20% |
| 2010 | $1.00 | 10% |
| 2009 | $0.91 | 3% |
We see the dividend is 3.3 percent, which is pretty close to our desired overall portfolio requirement of 3.5 percent. Also from Table 23.5 we see the dividend growth rate of 10 percent, which is above our requirement of dividend growth.
From Table 23.6 we are able to calculate the stock growth rate for 2015. Using the 2015 row, we see the net income to be $6.10. From that amount, Tupperware is retaining or putting back into the company 51 percent in order to continue to grow.
Table 23.6 Tupperware Brands NYSE - TUP Div. 3.3%
| Year | Net Income | Dividends Paid | Retained Earnings | Return on Equity | Retention Rate | Stock Growth |
| 2015 | $6.10 | $3.00 | $3.10 | 29% | 51% | 15% |
| 2014 | $5.00 | $2.72 | $2.28 | 27% | 46% | 12% |
| 2013 | $5.17 | $2.48 | $2.69 | 32% | 52% | 17% |
| 2012 | $3.42 | $1.44 | $1.98 | 24% | 58% | 14% |
| 2011 | $3.55 | $1.20 | $2.35 | 30% | 66% | 20% |
| 2010 | $3.53 | $1.00 | $2.53 | 38% | 72% | 27% |
| 2009 | $2.75 | $0.91 | $1.84 | 37% | 67% | 25% |
In order to determine the potential stock growth rate, we take the ROE (29 percent) and multiply it by the retention rate (51 percent), or 0.29 times 0.51, which gives us an expected stock growth rate (last column for 2015) of 0.15 or 15 percent, which is pretty darn good.
Let’s analyze. The dividend is good at 3.3 percent. The dividend growth of 10 percent is above our criteria of 7–8 percent. The stock growth of 15 percent is above our criteria of 7 percent. Bottom line: If Tupperware can continue to earn enough money in order to fund both the dividend growth and the company growth, this company is a wonderful candidate for our dividend and growth portfolio.
One thing to notice is the Clean Surplus ROE (see Table 23.7).
Table 23.7 Tupperware - ROE
| Year | ROE |
| 2015 | 29% |
| 2014 | 27% |
| 2013 | 32% |
| 2012 | 24% |
| 2011 | 30% |
| 2010 | 38% |
| 2009 | 37% |
Since 2011, the ROE has remained around 30 percent. Always remember that the ROE means the company is earning a 29 percent (for 2015) return on the money it reinvested not only in the distant past, but also on the money it reinvested back into the company last year. The more consistent the Clean Surplus ROE, the better we can be assured that Tupperware will continue to earn a good return for shareholders going into the future. This is a very good thing.
We’ve learned to look for the growth in the dividend and the growth in the stock in order to meet our 10-year objectives. However, there is something else we like to add to our portfolio in order to make it a stellar performing portfolio that will grow and create income far and above all the other portfolios out there in Investment Land without taking on undue risk. You are about to enter the world of “enhanced income.” If we haven’t knocked your socks off yet, read on.