David Evanson and Oliver Pursche
Minyanville.com, Spring, 2013
How can investors keep ahead of inflation?
In 1900, the life expectancy for Americans was 49 years. When the Social Security Act was passed in 1935 , the life expectancy was less than 63 years. This is an interesting data point considering the fact that Social Security more or less codified the retirement age at 65. Taken literally then, the expected duration of retirement was negative two years.
This made retirement planning, from a financial perspective, rather easy. Technically, no planning was required.
Today, with life expectancies pushing 80 years (higher for females, lower for males), planning is trickier. Specifically two burning questions have emerged: How can a retiree not outlive his or her money? And how can a retiree keep ahead of inflation? This questions speaks to the latter concern.
Inflation is not the raging topic it was in the 1970s and early 1980s. But even at today’s somewhat mild rates — 1.5% over the last 12 months ended March 2013, according to the Bureau of Labor Statistics — inflation can hurt and undermine your standard of living. Over a span of 20 years, inflation of 1.5% will reduce the purchasing power of $1.00 to $0.74.
There are many ways to skin a cat when trying to outstrip inflation, but one that I like is investing in stocks that grow their dividend at rates faster than inflation. Here are eight such stocks that I really like. As you can tell from the growth in the dividends, they all handily beat the undermining effects of inflation.
But wait — there’s more.
There are lots of companies that grow their dividends — not that I am dismissing such an admirable feat out of hand. But these eight companies have grown their dividends while simultaneously reducing the percentage of their profits allocated to dividend payments. Now that’s a trick, my friends.
Within the context of our discussion, however, it’s an important one. Specifically, growing a dividend is fine, but a retiree has to consider the following question: What is the likelihood that the dividend will be cut or eliminated?
Companies that grow dividends simply by increasing the percentage of profits allocated to dividends (known as the dividend payout ratio) are overly risky in this regard. Mathematically, they are going to run out of room to raise the dividend. Companies that raise their dividends by allocating approximately the same percentage of profits to dividends, but also consistently grow their profits are less risky, but dividends might be cut if profits shrink due to competitive pressures or a lackluster economy.
But companies that year after year are able to shrink their dividend payout ratio present the least risk to your dividend income. Why? Because even if profits decline for several years in a row (think financial crisis circa 2008-2010), these companies have the most flexibility to keep their dividend payment intact. Note the rate at which these companies have been able to shrink their dividend payout ratios over the past 10 years.
There may be other companies you know of that have grown dividends while simultaneously shrinking the portion of profits allocated to dividends. Mergers, acquisitions, and divestitures all cloud the picture, making some superstars hard to find.