Upon first glance, it would appear that crazy gyrations in the stock market are bad news for folks looking to save toward an early retirement.
I’d argue the exact opposite, however. Today is a fantastic opportunity to put cash toward buying cheap stocks. That’ll make your early retirement happen all the sooner, assuming you put that cash to work in a smart way. You’ll want to pick solid stocks and avoid those with a risk of a dividend cut, for example.
Let’s take a closer look at why this selloff is a gift to prospective early retirement folks and how you can fully seize this opportunity.
Early retirement — closer than ever
Many financial independence retire early (FIRE) devotees are big advocates of academic safe withdrawal studies. This research states that it’s safe to withdraw 4% of your portfolio every year to weather an extra-long retirement.
But now that markets have melted down some 25% in just a few weeks, many are questioning this logic. While the 4% withdrawal rate has worked well in the past, that doesn’t guarantee success in the future. They’re beginning to have serious doubts about a previously solid early retirement plan.
I would go in a different direction, however. I firmly believe the easiest way for the average Canadian to secure an early retirement is to live as cheaply as possible and direct the cash saved toward our nation’s top dividend growth stocks.
That plan won’t be perfect either — after all, dividends are hardly guaranteed — but investors can take much of the risk out of play by focusing on high-quality names.
Investing in dividend growth stocks also offers a compelling hedge against dividend cuts. In a portfolio of 25-30 stocks, you’re bound to pick a dud or two.
But the majority of the portfolio should continue humming along, and regular dividend increases help protect it against one of the biggest risks of early retirement: inflation.
One stock can help you get there
Canada is filled with excellent dividend growth stocks. Many investors have made these names the core of their portfolios. And thanks to the recent market sell-off, you’ll get to lock in some impressive yields if you buy today.
One great dividend grower that also offers a fantastic yield — a great combination for early retirement — is Capital Power (TSX:CPX). Capital Power owns power plants across North America — assets that use everything from coal to wind as fuel sources. Don’t sweat the coal exposure: Capital Power is converting these plants to natural gas.
The company is taking advantage of its balance sheet flexibility to acquire new power plants and build others from scratch. It spent some $1 billion on acquisitions in 2019 and expects another $450 million worth of new builds to come online in 2020.
Capital Power should also announce other growth projects later in the year as well, likely when markets settle down a bit.
Despite all the chaos in the market today, however, Capital Power has consistently stuck to its financial targets for the year. It has told investors to expect adjusted funds from operations of approximately $500 to $550 million, which is in the range of $5 to $5.30 per share. To put that valuation into perspective, shares trade hands at around $27 each as I type this.
That’s right. Capital Power stock trades hands for just over five times expected adjusted funds from operations, a metric companies use because it approximates free cash flow.
This cheap valuation also translates into a succulent dividend yield. The current payout is $1.92 per share, which converts into a 7.3% dividend yield.
While you might think such a high payout isn’t sustainable, that’s not the case here. The payout ratio is under 40% of adjusted funds from operations.
In fact, Capital Power has hiked its dividend each year since 2014 and has already told investors to expect 7% increases in both 2020 and 2021.
The bottom line
The ideal strategy for an early retirement is simple. Save as much as you can and then put that cash into dividend growth stocks like Capital Power.
Today is an especially powerful time to put money to work. In fact, if you’re aggressive enough, you could save yourself countless hours of work and retire years sooner.
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Fool contributor Nelson Smith owns shares of CAPITAL POWER CORPORATION.