Lazy Man and Money

The 3 Top Chowder Rule Stocks Now

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Today’s article comes from Jonathan Weber of Sure Dividend. Sure Dividend has been a great partner with us for years. I’m just now starting to get into dividend investing and I’ll be looking to implementing a lot of their insight. I had never heard of the chowder rule before, so I suspect that many of you haven’t either.

Many investors want to invest in stocks that offer income, especially retirees and other that live off the dividends they receive. Others prefer to invest in income stocks for the ability to reinvest cash flow consistently, even during market downturns.

No matter why one invests in income stocks, one way to evaluate potential picks is the so-called “The Chowder Rule“. The framework can be summarized like this:

The Chowder Rule is a rule-based system used to identify dividend growth stocks with strong total return potential by combining dividend yield and dividend growth.

It states that stocks are attractive when they offer a good combination of dividend yield and dividend growth — it does not make sense to look at only one of these. A 5% yield with no or negative growth isn’t particularly attractive, and neither is a company that grows its dividend reliably but that offers a yield of just 0.5%. The right combination makes for an attractive dividend growth investment, however. The Chowder Number is calculated by adding the stock’s current yield and its 5-year dividend growth rate.

The three rules popularized by Chowder that can be used when the Chowder Number has been calculated look like this:

Rule 1: If a stock has a dividend yield greater than 3%, its Chowder Number must be greater than 12%.

Rule 2: If a stock has a dividend yield of less than 3%, its Chowder Number must be greater than 15%.

Rule 3: If a stock is a utility, its 5-year dividend growth rate plus its dividend yield must be greater than 8%.

Some use the 5-year trailing dividend growth rate for the calculation, but we prefer to use the (expected/forecasted) 5-year forward dividend growth rate. After all, a company that has raised the payout considerably by expanding the payout ratio without growing its earnings and cash flows will most likely not continue to grow the dividend at the same pace. We thus believe that looking at expected earnings or cash flow growth paints a more realistic picture about a company’s long-term dividend growth potential.

Using this framework, we have identified three companies that look like attractive dividend growth investments according to the Chowder Rules.

1: Baker Hughes Corporation

Baker Hughes Corporation (BKH) is an oilfield services and equipment company that also is active in some other, less important areas, such as digital solutions for monitoring the health of machinery, etc. Its main businesses are oil and gas exploration, drilling, production, and other energy-related services.

Like oil and gas companies, its business outlook depends on the macro environment. High oil and gas prices mean that energy companies are inclined to expand production, which means that companies such as Baker Hughes get more orders and contracts and have the ability to grow their revenue and profit. On the other hand, Baker Hughes’ services will be in less demand when oil and gas prices are low and energy companies are cutting their exploration budgets.

Luckily, the macro environment is very beneficial for Baker Hughes right now, as energy companies are very profitable, and since the ongoing global energy crisis means that the production of hydrocarbons needs to be expanded. That’s why the growth outlook for Baker Hughes over the coming years is excellent. We believe that the company has the ability to grow its earnings-per-share at a mid-teens rate going forward, which should allow the company to grow its dividend at a similar pace.

Since Baker Hughes is currently trading with a dividend yield of 3.1%, its Chowder Number is somewhere in the 18% range — which is pretty attractive.

2: National Storage Affiliates Trust

National Storage Affiliates Trust (NSA) is a real estate investment trust that primarily owns self-storage properties in metropolitan areas throughout the United States. With around 800 such properties, National Storage Affiliates Trust is one of the largest players in this space.

Demand for self-storage space has been growing for many years, and so far, that trend has not broken. As consumers have been expanding their purchases of all kinds of material goods for many years, it seems likely that this trend will hold, and that consumers will continue to own more and more “stuff”. This stuff needs to be stored, and that’s where NSA and its peers come in.

The real asset nature of its business model also provides solid inflation protection, as property values and rents are increasing meaningfully in a high-inflation world, while debt gets inflated away over time.

Between rent increases for existing properties and acquisitions, NSA has delivered highly compelling growth in the past, roughly doubling its funds from operations-per-share between 2017 and 2021, i.e. in just four years. We believe that growth will slow down somewhat, but FFO-per-share growth should remain north of 10%, we assume. When that is combined with a dividend yield of 5.0%, the Chowder Number is in the 15 range, making for an attractive dividend growth pick.

3: ASML Holding NV

ASML Holding NV (ASML) is an industrial company that manufactures so-called lithography machines that are used to produce chips. It is the absolute market leader in this space, both from a market share perspective as well as when it comes to technological leadership. The Dutch company just has no competitor that is able to produce lithography machines that are as advanced as those from ASML.

The semiconductor industry has experienced rapid growth over the last decade, and growth should also be attractive going forward. Although there will be some ups and downs in the short run, megatrends such as digitalization, autonomous driving, virtual and augmented reality, and many more will lead to increases in both the number and the power of chips going forward. The industry should thus continue to expand, and chip manufacturers will continue to buy the lithography machines they need from ASML.

ASML thus has a compelling long-term growth outlook when it comes to revenues and profits. Its yield isn’t overly high today, at 1.7% (based on the payout over the last twelve months), but that’s at least slightly north of the broad market’s dividend yield. The dividend has grown at a rate of 32% over the last five years.

We believe that dividend growth will slow down going forward, but a mid-to-high-teens dividend growth rate seems very achievable based on the lowish dividend payout ratio of around 30% and when we consider the strong earnings growth outlook. We thus estimate ASML’s Chowder Number at around 18, making it a compelling dividend growth pick.

Stocks vs. Real Estate

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Back in 2007, I covered an article in Money Magazine that was interesting to me – Stocks vs. Real Estate. It’s fifteen years later now, and I thought it was worth revisiting now that we sold an investment property. Now it’s time to invest that money in the stock market.

Before I get to that new stuff, let’s review what Money Magazine and 2007 Lazy Man thoughts were:

May’s Money Magazine tries to answer the Stocks vs. Real Estate question. I had thought that real estate would come out as the big winner. I know that real estate has been trendy of late, but I had it as the favorite due to the value of leverage.

Money Magazine declared stocks the winner, but I think they glossed over the leverage factor. For one, they took a two-year timeline for the real estate and deducted many one-time costs. That didn’t seem fair to me. So to the right, you’ll see my attempt at running the numbers in my spreadsheet.

For this example, I assume the investor has $40K to put to work. I assume a 10% (for better or worse) gain for stock picks. I also took a cue from my early physics classes and ignored friction – in this case; it’s the cost of buying stocks. The “Real Estate” column assumes the investor puts 20% down, allowing them to buy a $200K home and pays 10K in closing costs (closing costs from the article). The “Real Estate AC (after costs)” factors in a 6% sales commission (though I believe this can be less), paying off the mortgage, $3,600 in preparing the house for the sale (sourced from Money Magazine), plus the original 40K investment.

I’m not sure that my chart is accurate. I’ve edited it several times, realizing a couple of errors. However, each of the charts showed the same trend. Real estate seems to outperform in the short term, but at some point in the 25-30 year mark, the 10% return of stocks takes over the leverage of real estate. However, if one were to lock in real estate gains at year 8 (around $125K), the person could use the profits to buy three more $200K homes, getting more and more leverage. Leverage can be dangerous as a loss can spiral just as much in the negative direction. Nonetheless, it still makes me think that there are a lot of general gains in real estate.

If you plan to go this route, remember that it’s not a get-rich-quick scheme. In today’s real estate market, I believe you should be prepared to hold onto a home for a minimum of 6 years (while being prepared to hold for ten years). Trying to fix up and flip a home within a year opens you up to short-term price pressures and fixed costs. You should also be aware of other factors mentioned in the Money Magazine article apply. One important thing to remember is that a home is not a very diverse investment. Another is that real estate investing takes a lot of work while investing in stocks is relatively quick and easy.

That was the whole article. I miss the pithy 2007 style of blogging. For the most part, it seems to stand-up well today. Of course, it might be more challenging to buy a $200,000 home than it was back then.

With fifteen years of wisdom, I’d say I should have put more attention into the last few lines of that article.

  1. Investment property is NOT a diverse investment
    There are ways to make investing in real estate more diversified. You can buy a REIT, which trades like a stock. Or you can do crowdfunded real estate like Crowdstreet and Fundrise. Those weren’t around in 2007.

    We all know what happened in the next 12-24 after I wrote that in 2007. The market crashed, and the property I bought for around $275,000 suddenly became worth $175,000. It took years for it to recover. In 2012, we purchased another property for $95,000 and sold it for $200,000. We used that money and did a 1031 exchange into another property now worth $300,000.

    One condo lost nearly a hundred thousand in a few years. Another gained a couple hundred thousand in a decade. Those are extreme examples, but they are two of the properties we owned.

  2. Owning stocks is a LOT easier than managing a rental property
    About 97% of the time, managing a rental property is easy. It’s the other 3% that’s tough.

    The real estate approach is more difficult, but I feel that you have more control over the results. I’d like my kids to have the life skills to be able to fix up an old dump and flip it for profit. I never learned those skills, making being a landlord more difficult. My friend, Carl at 1500days.com has executed some excellent live-in home flipping profits. It’s amazing to take one of your biggest expenses (your home) and turn it into a profit.

Let’s take the case of the property we just sold. We sold the property for $385,000 – close to the Zillow Zestimate. The Zillow Zestimate said that we should be able to get $2375/mo. in rent. We would need to do some updates, but that’s a reasonable number. That’s an annual income number of $28,500. Let’s assume that there was no mortgage on the property. All we have for expenses are property tax, insurance, condo fee, and maintenance. If it wasn’t a condo the condo fee and maintenance would be combined. All those numbers add up very close to $1,000 – so we’ll keep things simple and say that expenses are $12,000 a year.

The profit on a $385,000 investment is $16,500 or about 4.2%. That’s not a great return. It’s better than I can get with most dividend stocks, but the stock market usually grows more than 4.2%, and I don’t need to be a landlord. While I never ran these numbers specifically when I sold, I knew I wasn’t getting great value. Our situation was a little more complicated because we still had a mortgage, so our monthly gain was building the equity towards owning 100% of that $385,000 property.

There are likely better properties out there that would return more. Perhaps there’s a property that’s $250,000 and rents for $2,000, making the numbers more favorable for investors.

I think it’s hard (maybe impossible) to answer the stocks vs. real estate question because the specific details matter. If you do real estate poorly (pay too much, can’t maintain the property, pick lousy tenants, etc.), you would be better off with some index funds. If you can do real estate right (live-in flip, buy at a low market, have a tremendous price-to-rent ratio, etc.), it will probably beat the stock market. And it should, especially if you are putting in the extra work.

I’m left with the same conclusion that I had before. It seems that real estate is great if you are young and can put in the work. As you get older, maybe it’s best to cash out the equity and let the passive income from the stock market work its magic.

(Original version of this article published on: Apr 19, 2007 at 05:55)

We Sold a Condo. Here’s the Investment Plan.

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Sometimes I think this blog is too often a reflection of my money journey. I should focus on things that other people can relate to more. However, that will have to wait for another day. Remember a couple of months ago when I wrote We’re Selling a Condo!

Well…

WE SOLD A CONDO

Ever had a day where there are a couple hundred thousand dollars changed hands? That’s what we had last week. I have to write about a big financial move like that, right?

We had sold a condo a couple of years ago, but we did a 1031 exchange and bought a new investment property. A 1031 exchange is a tax code sale where we avoid paying taxes because the money is going to a new property. We had decided to get out of landlording in Massachusetts – it’s easier to be a landlord in Rhode Island.

I initially thought of doing a 1031 exchange again, but my wife changed my mind. She usually doesn’t weigh in on the financial decisions, but I’m so happy she did. We had an opportunity to sell at the market highs. It was rare timing that the tenant’s lease had ended in the window where prices were high, and everyone was trying to buy because they wanted to lock in a low mortgage.

If we wanted to do a 1031 exchange, it meant buying at market highs. That’s not something that makes me comfortable. Why not cash out, pay the taxes, and see where life takes us for a bit? Perhaps there will be a crash like in 2010, and we’ll buy in low. If not, that’s okay too.

For years we’ve lived almost paycheck-to-paycheck. We were saving money but in retirement accounts. A small part of our income went into the investment properties because they had 15-year mortgages, and the rents weren’t covering expenses. All of this was great for our net worth, but at the end of the month, I’d look and see that we had 90% of our money in retirement and real estate accounts – not very liquid. In fact, among other investments, only about 3% of our money was liquid. It can be dangerous not to have enough liquid cash, but my wife’s government job is relatively secure, and all my income streams are diverse enough to withstand a lot.

Suddenly we have a couple of years of expenses in cash. Finally, we have a true emergency fund.

Where Do We Go From Here?

Having that cash is great, but my wife and I are afraid of spending it. After we pay off the taxes, we’ll invest the money. I hope that the investments throw off enough cash to supplement what we make from our jobs. Perhaps we reinvest that money. Perhaps we use it for fun. Perhaps it goes into home improvements or something like that.

I wasn’t sure how to invest this, so I went back through my archives and found my income investing article. There are some good ideas in that article, but this is how I am planning to invest the money:

Income$250,000  
InvestmentPercentageYieldTotal
VYM (High Dividend)25%3.04%$1,900.00
VNQ (REIT)25%3.00%$1,875.00
BND (Bonds)25%3.32%$2,075.00
VTI (Total Market Index)25%1.56%$975.00
Annual100%2.73%$6,825.00
Monthly$568.75

These are all Vanguard ETFs. We have enough money to get Admiral shares of the mutual funds, but I’m more comfortable with the ETFs. From what I read, it doesn’t seem like it would make a big difference. If you think otherwise, please let me know in the comments.

The dollar amounts are a reasonable sample. I’m not sure if we’ll have $250,000 exactly, but I found it helpful to put in an estimate. We have to pay some taxes, but we also have some existing money to contribute to this.

We’ve got two goals that we’re working on:

  1. Preserve the Money

    The hope is that these asset classes are diverse enough to do well in a recession. Here’s how they did in the 2009 crash:
    VYM dropped about 50%
    VNQ dropped about 66%
    BND dropped about 10%
    VTI dropped about 40%

    In total, they combined to drop 40%. That’s… not great. That recession hit real estate and banks hard. Banks usually pay good dividends, so it’s understandable why VYM was hurt badly. In some down markets, like the 20% drop in the broad indexes this year, VYM has done well. Bonds haven’t done well in this environment, but they are only down about 12% compared to those broad markets.

    Since the markets are already down, hopefully, we won’t see anything like 2009. If we do, we’ll try not to sell anything until it recovers. We’ll also try to reinvest at those lower prices.

  2. Getting a Check
    Most of these pay dividends every three months, so the “monthly” number in the chart above isn’t accurate. However, it’s an average. We’ll get more money in some months and less money in others. After the first few months, we’ll have cash in there that we can start to use.

    It’s disappointing that we wouldn’t even get $7,000 in cash. However, the ETFs prices have also gone up over time. There’s a lot more value than just the dividends.

I was curious to see how this portfolio of investments would perform over an extended period. However, I didn’t know of a good tool to help me model and backtest it. Fortunately, the awesome Mike Piper had an answer – the just-as-awesome PortfolioVisualizer.com.

Here’s what it looks like:

(Click for larger version in a new tab.)

I could only model this portfolio back to 2008, as not all these ETFs were around before that. Looking at the bottom of the image, it seems this portfolio has returned 7.60% since the start of 2008. So with a $250,000 portfolio, I could expect average returns of $19,000 per year. I’d have to sell a few shares, but that’s the kind of return that I’m happy with, especially while I try to reduce risk.

I’m still exploring this Portfolio Performance tool and coming across some great information. For example, they publish the maximum negative periods so that you can get an idea of the worst-case scenario (historically):

As you can see, the worst it did was that 40% I estimated above. After that, there was a brief period when COVID first started spreading, and there are the last six months where inflation has been high. That’s not too many downturns of 10%, and that’s still very safe. To put it another way, if it had an average year of making 7.6%, we would be in the positive almost always after that first year.

Introducing the Lazy Man Rule of 20

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At the start of 2020, I took a fresh look at the stock market and realized that it was up about four times from 2010. Many people who had $250,000 in the markets in 2010 are now millionaires. My wife and I started working before 2000, so we had already saved up a lot in our 401ks and Roth IRAs before 2010.

I was excited by all this progress. The plan was working to perfection. I had a fear… I didn’t want to lose all these gains. However, we weren’t 45 years old, so we still had a decade or two before we started to access these retirement accounts. I wanted to stay invested, but I didn’t want to take the big risks that I did when I was 25. At that time, not only was I young, but the market had collapsed with the Dot Com bust of 2000. It was the perfect time to buy growth stocks.

In 2020, it looked like technology dominated the stock market. The world’s biggest companies were not GE, Walmart, Citibank, and Exxon like they were back in 2000. Instead, we have GAMAF: Google, Apple, Microsoft, Amazon, and Facebook. (I’m substituting Microsoft for Netflix in the popular FAANG acronym.) To reduce tech risk I replaced much of the major total market index ETF I had (VTI) with a high-dividend index ETF (HDV).

I may have lost out on some gains as the pandemic was great for tech stocks. Alternatively, many companies cut their dividends. However, vaccines came out and the boring companies that are in the high-dividend index are thriving. Those boring consumer staples and energy companies are in-demand as they are generally inflation-proof.

There was one other way that I tried to protect our money in 2020. I added more bonds. I haven’t been a big fan of bonds because historically, the best returns come from stocks. I’d rather have 60 years of 10-12% returns than 60 years of 4-6% returns. However, with stocks in a 10-year bull market, I felt it was best to move some money to bonds to diversify with a lower-risk asset. I slowly started to buy Vanguard’s major bond ETF (NASDAQ: BND).

Fast-forward to today and I was either smart or very lucky. I think maybe it was a little of both. HDV is only down about 5% from its highs. VTI is down around 20%. The tech-heavy NASDAQ index has been off of its highs by about 30%. Bonds haven’t been great as they’ve been down about 11% – but they are at least better than VTI.

One of my good friends has an Investment Policy Statement (IPS) that she loves. An IPS puts down in writing how you are going to invest in advance of any market conditions. The beauty is that once you have your philosophy in black and white you simply have to just execute it. I’ve been thinking about creating one for some time, but I’ve been living up to my Lazy Man moniker on that one.

With the market going down and possibly heading further down, I’ve started to think more seriously about what might be in my IPS. One thing I know for sure would be a valuation-based asset allocation. I know a lot of people stick to one asset allocation and change it to be more conservative as they grow older. One old rule of thumb is that you should subtract your age from 100 and have that percentage in stocks. Thus, at age 45 now, I would have 55% in stocks (100-45). I’m an aggressive investor so that rule of thumb doesn’t sound great to me. (It may work beautifully for you though.)

While I do believe that age should be important in asset allocation, I also believe that the market’s valuation should be considered. Here’s a chart of the Shiller P/E:

The Shiller P/E is an indicator of how expensive the market is. The higher the number, the higher the price you are paying for the earnings. One thing that you’ll notice is that for 125 years until the last decade, when the P/E is above 25 there’s been a crash. It can stay up there for a little while. It almost always crashes at 30 until the last ten years or so. It’s crashed down a bit from 37, but could still have some way to go.

That’s why I came up with…

Lazy Man Rule of 20

The Lazy Man Rule of 20 says that my bonds should be around the Shiller P/E minus 20. When the Shiller P/E was 37, I should have had 17% in bonds. In reality, I had around 15% of my money in bonds. (This is a new rule that I’m implementing now, but it would have been nice to have been at 17% bonds.) Now that the Shiller P/E is at 30, I should have around 10% in bonds. I have been selling off bonds and buying stocks (including the NASDAQ at 30% off), but I still have about 11.25% of my money in bonds. The next day that stocks go down, I may sell 1% of my bonds and buy stocks.

Let’s look at how this may have worked in big market bubbles and crashes in the past. I’ll start with my first year out of college in 1998:

  • Bubble of 1998

    At the top of the market in 1999, the Shiller PE hit about 45. Using my rule of 20, I should have 25% of my money in bonds (45-20=25). In hindsight, it should be 100%, but 25% bonds for an aggressive investor at age 25 is a lot. I may have missed the run-up in 1997 and 1998 as I sold stocks to buy that 25% in bonds.

  • Crash of 2000

    As the market starts to crash in 2000, I allow myself to sell the bonds to buy stocks. Bonds performed well from 2000 to 2003, but the stock market was down 9% in 2000, 12% in 2001, and 23% in 2002. By the time it recovers in 2003 the Shiller PE was 23, which means that I only 3% bonds and 97% stocks. That goes to about 7% bonds (Shiller P/E of 27) until we get to 2008.

  • Crash of 2008

    When the crash of 2008 hits, the Shiller P/E goes to 15%. Suddenly, I was allowed to have -5% bonds. Realistically, I can’t do that, so I get to 100% stocks while the market recovers.

  • Bull Run from 2010 to 2020

    During this time, I’m gradually selling stocks and buying bonds. In 2013, I only have 2% bonds. By 2014, I’m up to 5% bonds. In 2015, I’m up to 6.50% bonds. This continues… in 2017 I had 8%, in 2018, I had 13%, in 2019, I have 8%. Finally, in 2000, I’d be back up to 11%.

One of the keys to my Lazy Man Rule of 20 is that I stay invested. I’m not pulling money in and out of the market. Some people claim that you can’t time the market. Is valuation-based asset allocation timing the market? I think it depends on who you ask. I think it is, but I’m using the market itself to tell me what to do.

Make Your Own Rule

I picked my Rule of 20 out of thin air. It was based on my gut feel and I’ve acted when the stock market is up and down. It was only recently that I made the connection that I tend to have bonds that are Shiller P/E minus 20.

If you are a more conservative investor you might want to choose to keep bonds that are equal to Shiller P/E. Or maybe if you are in retirement, you want to have twice the Shiller P/E in bonds. As I get older, I may move from my Rule of 20 to go through all these valuations.

What do you think? Are you going to explore valuation-based asset allocation? If so, let me know what your rules might be in the comments.

Portfolio Potential – One Trick To Keep Your Head in a Down Market

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Portfolio Potential

How are you doing with this stock market lately? Have you looked at it? Most experts recommend not paying attention if you hear bad news about the markets. I look at the markets a few times almost every day. It doesn’t matter if things are going well or very poorly. It’s a combination of a habit and a hobby.

If you are like me and look at your portfolio often maybe this trick I use will help you.

One of the numbers I keep track of is what I call Portfolio Potenial.

What is Portfolio Potential?

Portfolio Potential is not about what your portfolio value is today, but what it could potentially be… if the Vanguard Total Market Index matches its all-time high. I picked Vanguard’s VTI ETF as my market benchmark. I suppose you could choose something different if you like – I simply wanted a broad index that is well-accepted as a sound investment benchmark.

Let me give an example to illustrate.

Let’s pretend that I have a $10,000 portfolio of stocks, bonds, mutual funds, ETFs, REITs – whatever is in your brokerage account. If that portfolio drops 15% it is only worth $8,500. However, instead of looking at that $8,500 number, I take that number and divide it by how much VTI is off of its all-time high. As I’m writing this on the morning of May 12, 2022, VTI is down 20% from its all-time high… or it has retained 80% of its value. The Portfolio Potential number I look at is $8,500 divided by 0.8… or $10,625.

Essentially, I’m celebrating that my portfolio has “beat” VTI by not losing as much. How did I do that? I had bought more bonds than I would normally have and removed some tech risk from my portfolio a couple of years back. I might have given up some potential gains then, but I slept well and I was still fully invested in the market. In fact, my high-dividend ETF (HDV) is only down 6% from its all-time highs. Since it has been paying me dividends during the last couple of years, it has held its ground in the latest sell-off.

Over the last few days, I’ve seen my Portfolio Potential go up about 5%. Diversification is paying off. Psychologically it’s very calming. It also helps that this money is in a retirement account that I don’t plan on touching for quite a while. If I needed to draw down from this account, I would be more concerned about the portfolio’s actual value than its potential.

I keep track of this in my Google Spreadsheet. It automates all the math, so I just have to know which cell to look at for the Portfolio Potential.

Bonus Trick

I know I promised one trick, but here’s a bonus one. This is a good time to focus on accumulating shares of stock.

Over the last couple of days, I’ve been selling off very small amounts of bond allocation and my high-dividend ETF (HDV). I’ve been able to buy shares of QQQ (Nasdaq Cubes) at an average of $300 a share. At the start of the year, a share of QQQ would have cost me $400. If I have $4000 to invest back then I would have been able to buy 10 shares. Now, I’m getting 13 shares with an extra $100 to spare.

I’m not trying to call a bottom of the market. I have no idea where that is. I will just dollar-cost average as it goes lower. I have a lot of confidence in companies like Apple, Microsoft, Amazon, and Google. I know that they’ve gotten very expensive over the last decade. That’s one of the reasons why I removed some tech risk from my portfolio a couple of years ago. Now is a chance to buy tech at a discount.