How You Start A Dividend Stock Portfolio

Far and away the most common question I receive through e-mail from readers could be paraphrased as this, “Okay, I’ve finally reached a point in my life where I got a little money set aside, and I want to start putting together a collection of individual dividend stocks. Where should I begin?”

Because I do not know the future, there’s no right way to answer that. And plus, there are so many different answers that would to you putting together something that will result in permanent wealth down the road. Someone opens a DRIP account that puts $200 per month each into Johnson & Johnson and Procter & Gamble, allowing it to benefit from dividend growth, reinvestment, and cash additions through the upcoming years? Yeah, that’s going to work out.

Someone decides to put a few hundred each month into a collection of Exxon, Chevron, and Conoco? Yeah, that’s going to work out, although if history is going to be our tour guide, it is worth noting that oil investing is volatile investing, and you need to at least brace yourself for the notion that there will be at least one 40% downward price swing each decade, and if it doesn’t come, you were mentally prepared for something that very well could have happened (at some point, though, there is a maturation process where you realize that falling stock prices are actually something to get excited provided that the actual business remains sound, but that doesn’t come to that many people intuitively—it happens when you look back at a decade of monthly Exxon purchases and realize that the additional shares purchased and reinvested in 2009 when the stock was at $60 per share is where the real seeds of wealth creation were sown).

So accept, from the beginning, that there are a lot of successful ways to do this. But for my money, I would want to start with the “Big Three” in beverages: Pepsi, Coca Cola, and Dr. Pepper (you could easily include Nestle here and life would work out just fine).

There’s a common notion on the investing internet that Dr. Pepper doesn’t belong in the same conversation with Pepsi and Coca Cola because of its smaller size—what’s funny, though, is that its corporate history is just as rich, if not richer, than Coca-Cola’s if you are viewing through the lens of a long-term shareholder. For example, on page 258 of Jeremy Siegel’s excellent work “The Future For Investors”, he notes the absolute best investments that you could have made from 1957-2003.

Pepsi, which compounded at an excellent 13.8% rate during that period, did not make the “Top Twenty” cut. Coca-Cola, meanwhile, compounded at 16.02% annually during that period, making it the fifteenth best stock in the world that anyone could have purchased in 1957 and then hold for five decades (what is extra interesting is that, at the start of this measuring period, Coca-Cola was already well over 50+ years old and becoming established as a significant presence in corporate America, but people have a long-term tendency to discount its ability to grow into the future. Hint: Look to the 27% returns on equity to figure out why Coca-Cola is able to keep doing what it is doing).

And then, there is Dr. Pepper. Although it gets treated like the dog flying in cargo on the airplane, its treatment in the investor community is decidedly undeserved because Dr. Pepper was the fourth most wealth-creative company you could have purchased in 1957, as it went on to compound at a rate of 18.07% from 1957 through 2003. That qualifies Dr. Pepper for inclusion on the list of one-time investments that could have completely and totally changed the trajectory of your financial life on earth, as a $2,000 investment in 1957, if you stuck with it through 2003, would have become $7.6 million eleven years ago.

Why don’t people talk about this? Because Ted Forstmann (aside: probably the most interesting dude who never quite made it to household name—he coined terms like “barbarians at the gate”, “junk bonds”, and dated Princess Diana for a bit) took Dr. Pepper private for a short period in 1984, meaning it doesn’t have that smooth long-term history that investors can appreciate. With General Mills and Procter & Gamble, you can say things like, “These stocks haven’t lowered their dividends in the past one hundred years.” The ownership changes in Dr. Pepper make such a statement impossible, and because it’s seen as the second-fiddle John Mellencamp to Coca-Cola’s Bruce Springsteen, it quietly goes unnoticed by most long-term investors.

But I would seriously consider making Pepsi, Dr. Pepper, and Coca-Cola the foundational components of a portfolio for three reasons: they have extraordinary economies of scale that lead to low-cost production so it is almost impossible for any competitor to sell colored beverages at a lower price (the only exception I’ve seen in my lifetime is when Wal-Mart has flirted with creating its own store brand sodas and such. Sometimes, local grocery marts try to start their own soda brands, but because they run at a loss and don’t catch hold with the public, they don’t usually last).

Secondly, they sell products that don’t run the risk of technological obsolescence. The reason we saw Kodak go down is because the whole smart phone revolution happened and using cameras became akin to wearing watches, something done as more of a social statement or comfort rather than an actual necessity to accomplish a particular objective (photo-taking or telling time). Sure, there is the concern that soda demand will decline (although the truth is this—soda demand only goes down in North America by 2% in especially bad years, as population growth takes care of gradual declines in the soda consumption rates), but there is also the fact that whatever product you switch from drinking soda towards also inevitably ends up being owned by the Coca-Cola, PepsiCo, and Dr. Pepper umbrella. Seriously, look up who owns Dasani, Aquafina, Gatorade, and Powerade.

And then, lastly, there is the fact that they fall into the category of cheap, repeatable, affordable goods so that (1) drinks are purchased regularly, (2) they are purchased during times of recession because it’s not that hard to find $1.50 in your pocket, (3) and there is a significant gap between what it costs to create soda and what it sells for. In a way, carbonated beverages have been the savior of gas stations and restaurants across the country, as they provide fat profit margins that pad the owner’s bank accounts. The real money at the restaurant isn’t made when a family of four orders hamburgers with fries, but rather, when they shell out $9 for sodas that cost the restauranteur about $0.25 on a bulk basis.

There is a reason why Pepsi, Dr. Pepper, and Coca-Cola have been around for a century. There’s a reason why the dividends keep going up, and you never see any of these companies go three years in a row without increasing profits. They have name brand equity, low costs of production, sell products that people buy regularly through all conditions, great product line diversity, and huge gaps between what the product costs and what it eventually sells for. For someone that wants to make a decision today that will still be paying out dividends in 2044, I can’t think of better fertile soil to start the search.