This article is the first of a series on meeting your investment goals. Part 2 is located here.
Meeting Your Investment Goals
Your holdings should be a result of good planning, of discipline and patience, which are very important keys to success. This article will enable you to look at your stocks in a way that may increase your investing success. We work with a core portfolio of large cap, blue chip dividend growth stocks and build on that foundation. Other investments will be in different categories of equities, which increase the yield of the total portfolio. We seek a balance of risk and return, of income and income growth, of stability with high returns.
The objective is to create the income needed for someone in early retirement so that they might meet their current living expenses from the resources available. In addition, this income should grow on an annual basis at least at a rate that will outpace inflation. Investable savings total $300,000 and the initial income goal is $15,000.
Portfolio Core Holdings
These 11 stocks represent $120,000 and provide a 3.4% return and a dividend growth rate of 10.9%. They make a significant contribution to the inflation abatement goal.
The core is the heart of your dividend growth portfolio. The companies, which make up the core, should be the most solid and reliable engines of capitalism: Large cap and low-levered blue chip companies with long and great histories, which give every indication of equally bright futures. This core is the powerful and perpetual money machine around which you build your portfolio. A well-designed core adds huge stability to your portfolio. These stocks come from seven different sectors. These are companies with significant economic moats; they dominate their markets. These companies are your best ideas; you know these companies well and why you own them.
All of these stocks are Dividend Champions, Challengers and Contenders, from David Fish's CCC lists, and have paid increasing dividends annually for 8 to 56 years, with an average of 29 years. They have a low beta, on average 0.63. These long term holdings will help you sleep well at night.
We note that 40% of the available money is only providing 26.1% of the required income. Next, let us move forward and invest in High Yield Core Stocks.
These stocks do not have the credentials of the previous stocks, but they are all very sound and prosperous companies. In the case of the Canadian Banks, they froze dividends during the worst of the 2008 -2009 financial crisis; therefore, they do not qualify for the CCC lists. Canadian banks, however, are among the strongest in the world.
Intel (NASDAQ:INTC) is a top tech company with an awesome cash flow. However, they are currently out of favor with Mr. Market and their stock has declined in price, driving up the yield percentage (yield = dividend/stock price).
While the stocks in this collection come from different countries, they will not cause you any tax problems. If held in an IRA the Canadian stocks are exempt from withholding and taxes. Royal Dutch Shell (NYSE:RDS.B) is the London offering of that dual listed company; the UK does not tax foreign dividends. Australia's Westpac Bank (NYSE:WBK) issues a fully franked dividend on its ADR so there are no taxes involved.
Once we cross the 5% yield mark, the dividend growth rates average a little lower. Cash rich Royal Dutch Shell is one of the top 5 integrated oils, and the outlook for this stock is good. Morningstar rates it 4 stars, for example, and sees the stocks selling 10% below its fair value. BCE (NYSE:BCE) is the former Bell Canada and it is chalking up a great dividend growth record. LNCO (LNCO) is a C Corporation (a regular company) which serves only to hold Linn Energy (LINE), an oil exploration MLP. AT&T (NYSE:T) is an American institution, with, however, a slowing dividend growth rate. Westpac Bank (WBK) is an one of six big banks in a country renowned for its sound banking.
The above High Yield Core Stocks contribute a proportionate share of the portfolio income in relation to the amount invested.
We put this utility into a separate class, as utilities are unique in several ways. They typically have high yields and many pay 4% or more. However, they have lower Dividend Growth Rates due to their geographic constraints and regulations that limit their expansion capabilities. PPL Corp (NYSE:PPL) has a 5-year beta of 0.41 and it is decreasing, with a 3-year beta of 0.14. Some utilities are almost bond like. The utility investment here is 5% of the portfolio, although some retirees put more emphasis on these stable cash generators. PPL Corp. and the one REIT are each 5% of the portfolio, the portfolio limit for a single holding. The average holding size of the 30 stocks is 3.3% of the portfolio.
At this point, we have invested 75% of our resources in the above dividend growth corporations. Now we will look outside of conventional companies for even higher yields. This is akin to adding a tactical allocation to a strategic portfolio, a core and satellite approach.
Special Tax Considerations Equal Higher Yields
We move now from standard corporations to entities that conform to certain statutory and regulatory rules and as a result pass most of their income on to investors. Many equate higher yield with higher risk. However, this investor believes that, "risk is not having enough money when you need it." Therefore, from that perspective these high yielding holdings are risk reducing in nature.
From this potpourri of special equities, we derive nearly 40% of our income from 25% of our capital.
National Retail Properties (NYSE:NNN) leases stand-alone buildings on a triple net basis and has raised dividends annually for over 20 years.
The three MLPs are primarily pipeline companies, which collect a "toll" on the volume of gas and oil they transport. They do not own, nor are they subject to, the price volatility of the products. They provide predictable incomes and have betas in the 0.50 range.
Business development companies are like venture capitalists for smaller firms. By the nature of their business, they take risks by investing in startup companies and others that need infusions of money. PennantPark (NASDAQ:PNNT) is no exception and its stock rises and falls on the fate of its holdings. It has a beta in the 1.50 range.
Mortgage REITS are deemed by some to be in a precarious situation because of the current federal interest rate policy. Annaly Capital (NYSE:NLY) and American Capital Agency (NASDAQ:AGNC) are no exception and they garner much attention because of their very high yields. I believe that these are two of the best, and see more reward than risk in getting 14% of the income from only 5% of the assets.
Characteristics of Stock Types
We see a pattern in the kind of stocks we find at each level of dividend yield. In broad terms, the first group we labeled Core, the foundational core, are the most consistent, top quality companies and long-term dividend payers. The next group, High Yield Core, have a little less in the way of long-term dividend growth streaks, though they are all solid companies. Utilities, Master Limited Partnerships, MLPs, Business Development Companies, BDCs, Real Estate Investment Trusts, REITs, and Mortgage REITS, mREITS, have their own characteristics. Usually, higher yields accompany lower dividend growth rates. Note: These yields and DGRs are for the stocks above, and are not industry averages.
With an understanding of the different types of equities available and their characteristics, we can design a dividend growth portfolio to meet an investment goal, in this case a 5% yield to provide income and a high dividend growth rate to counter inflation.
Your goals may be very different from these. It all depends on your circumstances and your outlook on the future. Each stock has its particular characteristics. The investor must select those, the aggregate of which, best suits his goals. I wish you luck.
Disclosure: I am long WBK, TU, RY, RDS.B, PPL, PNNT, PG, PEP, NLY, MSFT, MMP, MCD, LNCO, KMB, K, JNJ, INTC, EPD, CVX, COP, BPL, AZN, AGNC, ABT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.