Dividend Portfolio Strategy

1. Dividend Portfolio Strategy

2. The Power of Compound Interest "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it." Albert Einstein Albert Einstein when asked what he considered to be the most powerful force in the universe answered: “Compound interest! What you have become is the price you paid to get what you used to want.” Mignon McLaughlin, American Journalist

3. The Power of Compound Interest Interest Rates Really Are Interesting "Yeah, interest. It's an amazing thing. You make money without doing anything..." "Y'know, I have friends who try to base their whole life on that principle." "Really? Who?" "Nobody you know...“ Jerry and George - Seinfeld TV Show

4. What is more powerful than Compound Interest? Compound Dividends! “Compound Dividends are like compound interest on steroids, figuratively speaking” “Good dividend stocks’ yield, tends to stay within a given range, so if dividends are increasing each year, the only way to keep a consistent yield is for the price of the stock to go up.” Source: Dividendvalue.com

5. Historical Comparison: * Represents 5th and 4th quintiles respectively **Compound Annual Return Source: Grant’s Interest Rate Observer (October 2010)

6. Picture this Assuming Buy & Hold over the entire period: Source: Grant’s Interest Rate Observer (October 2010)

7. The General Pros of Paying Dividends 1.Dividends may appeal to investors who desire stable cash flow but do not want to incur the transaction costs from periodically selling shares of stocks. 2.Behavioral finance argues that investors with limited self-control can meet current consumption needs with high-dividend stocks while adhering to the policy of never dipping into principal. 3. Managers, acting on behalf of the stockholders, can pay dividends in order to keep cash from bondholders. 4.The board of directors, acting on behalf of the stockholders, can use dividends in order to reduce cash available to spendthrift managers. 6.Dividends have long been a signal to investors. A constant dividend assures investors the company is doing well, and views future potential to be equally as sound. 7.The dividend approach gives a greater opportunity to beat inflation, over time, than a bond-only portfolio. Ross,Westerfield,Jaffe (2008) Corporate Finance

8. Dividends and Taxes • Favorable tax treatment recently has hedged dividend returns. • For most of the last 80 years, dividends have been taxed at the individual marginal income tax rate. * • *Tax facts 2009 Addition Source: Grant’s Interest Rate Observer (October 2010)

9. Process of Capital Allocation • Dividend paying stocks will often help an individual hold onto a stock that he/she may come to believe they over paid for when originally bought. EXAMPLE: Source: Grant’s Interest Rate Observer (October 2010)

10. Abbott Example Continuation… Source: Grant’s Interest Rate Observer (October 2010) "Investing in dividend stocks is one of the top strategies to survive market instability" Lawrence Carrel, journalist of The Wall Street Journal

11. Building a Portfolio for Income: • In July 2004, Microsoft had a cash hoard of nearly $60 billion. It used cash to: • Increase the annual dividend $.32 per share • Repurchase about $30 billion of the company’s stock over the next 4 years • Make a special dividend payment of $3 per share to shareholders With 10 billion shares outstanding – the special dividend payment totaled $32.6 billion – the largest corporate cash disbursement in history! The total dividends paid by all the companies in the S&P500 for the year totaled $213.6 billion – Special dividend represented about 15% of all dividends paid by 500 of the largest companies of the year! When the dividend was sent to investors in December, personal income in the United States rose 3.7%. Without dividend, personal income only rose .3%. This special dividend payment accounted for over 3% of all personal income in the U.S. for the month of December, 2004! Ross,Westerfield,Jaffe (2008) Corporate Finance

12. Dividend Portfolio Strategy Goal: • To concentrate on higher current dividend yields that have also a history of annual dividend increases in order to increase portfolio performance while reducing risk Reason: • Tangible confirmation of management’s confidence in future earnings growth • Generation of higher levels of income over a long period of time if reinvesting dividends

13. Screening Methodology Objective: To apply quantitative criteria to the wide universe of dividend stocks in order to narrow it down to few companies. This will allow us to concentrate on a more promising group of dividend stocks, our high probability dividend stocks!

14. Master List (250 stocks) Popular List Current List Screen Based List Scoring Process Stock Universe Top 25 Dividend Stocks

15. Screening Process STOCK UNIVERSE Screen Based List DRPs High Yield Dividend Growth Dividend Yield High Div & Growth Dividend Yield & Profitability Master List Scoring Process TOP 25 DIVIDEND STOCKS

16. Description of the Screens • DRPs High Yield Screen: DRPs companies with high relative yields, reasonable dividend payout ratios and high growth • Dividend Growth: Looking for stable companies that are in the maturity stage of their life cycle, above-average dividend growth rates. • Dividend Yield: Screen that looks for undervalued stocks using the dividend-yield approach (companies with secure dividends – example: specifying a maximum level of dividend payout ratio of less than 50%) • High Div&Growth: Screen that focuses on high-quality growth stocks that have higher dividends and lower price volatility • Dividend Yield & Profitability: Screen that looks for companies with increasing profitability and reasonable dividend yield • Current List: List that comes from our experienced advisors.

17. Dividend Screens* *The formulas have been alteredto protect Proprietary Information

18. Screen 1: DRPs with High Yield • Provides DRP plan • Yield >= 3 • Dividend 12m >= Dividend Y1 • Dividend Y1> Dividend Y2 • Dividend Y2>Dividend Y3 • Dividend Y3 > Dividend Y4 • Dividend Y4>Dividend Y5 • Dividend Y5>Dividend Y6 • Dividend Y6>Dividend Y7 • Dividend Gr. 5Y> Industry Div-Gr. 5Y • Yield > Yield-Avg. 5 Y • Payout ratio 12 <= 60% • EPS-Gr. 5 Yr >= Industry EPS-Gr.5Y • ADR/ADS Stock is false

19. Screen 1: DRPs with High Yield 17 companies passed the screen!

20. Master List Top 250 Dividend Stocks

21. Master List Top 250 Dividend Stocks Scoring Process • Criteria for scoring: • Consistent Growth • Increasing Profitability • Good Financial Health • High Dividend Yield TOP 25 DIVIDEND STOCKS

22. * Yield Score and Growth Score as of July 1, 2012 - from 3rd Quarter Screener

23. Capital asset pricing model (capm) • A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. • General idea behind CAPM: investors need to be compensated in two ways: time value of money and risk. • The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. • The risk is represented by beta and calculates the amount of compensation the investor needs for taking on additional risk (risk premium) • The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. Investopedia, January 2011

24. Expected Return on Dividend Portfolio August1, 2012

25. Dividend ScoringQ3 2012

26. Deep Thinking in the Scoring Process • 36 variables in the Scoring Process, including: • Dividend Growth • Free Cash Flow • Return on Equity • Sales Growth…

27. Dividend Scoring Snapshot

28. Dividend Scoring • Based on Fundamental Data • In-Depth Dividend Analysis: • Dividend Yield • Dividend Growth • Margin of Safety • Dividend Valuation • Based on a combination of dividend strategies • Provides Ex-Dividend date

29. Dividend Analysis

30. Dividend Analysis • Yield Growth: Combination of dividend yield and dividend growth rate analysis. High value on this category indicates stocks with above average yield and long-term growth. • Dividend Analysis: In-depth analysis of dividend stocks considering payout ratio, P/E ratio, earnings yield and dividend yield. • Dividend Growth: Concentrates on sustainable growth rate, the maximum growth rate that a firm can sustain without having to increase financial leverage. • Strong Dividend Valuation: Focuses on strong dividend stocks: a record of dividend increases over time. • Margin of Safety: Determines the margin of safety of the stock based on dividend valuation approach.

31. Dividend Strategies STRATEGY 1: Combination of high yield stock with low dividend growth. This strategy concentrates on INCOME – High risk and short term benefits STRATEGY 2: Combination of low yield with high dividend growth. This strategy concentrates on GROWTH – Long term benefits due to compounding nature of the growing dividend. STRATEGY 3: Combination of low yield and low dividend growth with high risk due to high divided payout ratio. STRATEGY 4: Combination of high yield stock with high dividend growth. STRATEGY 5: Mature companies with low but stable dividend. The strategy with the lowest risk and lowest income.

33. Importance of Ex-Dividend Date • Investment term related to the payment of dividend. • Defined by the IRS as “the first date following the declaration of a dividend on which the buyer of a stock is not entitled to receive the next dividend payment.“ • Theoretically, the closer to the ex-dividend date, the higher the stock price. On the ex-dividend date the stock will drop the amount by the dividend amount.

34. Dividend Strategy • Long-term Strategy. • Looking for strong financial quality firms: • Growth • Profitability • Financial Health • Relative Strength • Involves a cyclical rotation of the dividend strategies • Combinations of the dividend strategies will reduce risk.

35. Dividend Buy Signals

36. Dividend Sell Signals • Sell signals will be based on: • Dividend picking process • News on fundamentals • Drastic drop of dividend

37. Lee Johnson Capital Management does not promise, guarantee or imply that you will improve your operation, or increase your revenues. As with any business, earnings potential and successful or unsuccessful use of LJCM products and materials will widely vary among our customers depending on many factors, including but not limited to, the customer’s finances, knowledge and skill set, creativity, motivation, level of effort, individual expertise and as such we do not guarantee your success or income level. The information conveyed by LJCM, as well as the information otherwise conveyed in these materials is intended to provide you with basic instruction regarding your business or operation. LJCM does not guarantee any results or returns based on the information you receive. Past performance or examples of other’s performance is no indication or guarantee of your anticipated future results, and individual results may vary. We are not responsible for any success or failure of your business if you implement the information you receive from us. We provide a tool that you can use to try to improve the operations of your business. All information contained or received through the use of our materials is provided “as is” without warranty of any kind. We hereby disclaim all warranties with regard to the information contained in our materials including without limitation all expenses, statutory and implied warranties of merchantability and fitness for a particular purpose.