Revising My Portfolio Business Plan

by: Bob Wells

At the end of 2011, I read my first article by David Van Knapp on Dividend Growth Investing. If you are just now starting to explore this concept of investing during retirement, I urge you to start by reading some of Dave's articles. One that affected my thinking the most suggested simply that a portfolio be treated like a business and have a formal business plan.

Each plan needs to be written by you to reflect your goals, investment preferences and volatility tolerance. If you're retired or near retirement, getting a good night's sleep may be hard enough. You shouldn't have a portfolio that keeps you awake at night.

I took this task seriously, and what followed was the development of a business plan that would guide our actions moving forward. I believe that our plan helps take a good bit of emotion out of the business of buying, selling or even trimming positions. Our business plan helped to provide guidance during our first quarterly portfolio review following the third quarter. For those that missed it, that review is available here.

Besides providing guidance, our plan helps to provide increased safety and an overall sense of security. It assists in taking emotions out of the decision making process. I believe there is nothing more important any investor can do than spend time carefully crafting a business plan for their portfolio, and then actually adhere to the plan you developed.

I've been writing on this issue and others for Seeking Alpha for just under a year now. Writing is something I've enjoyed for years. One thing I learned about my writing, when I revisited what I wrote a year later, I always felt that now I could improve it. With earnings season in full swing next week, it was clearly time to revisit my Dividend Growth Portfolio Business Plan with an eye toward making meaning improvements.

After a careful review, I made considerable changes to my original plan. The revised plan is presented below:

Business Name: Wells Family Income Stream Portfolio

Goal: Generate a steadily increasing stream of income paid solely from the growing dividends generated by low-risk companies with a track record of providing safe and growing dividends. Target is to deliver a 4.5% percent plus yield during 2012 with no loss in overall portfolio capital.

Business Model Strategies:

Stock Selection:

Use the current Champion, Challengers and Contender (NYSE:CCC) Lists as my principle shopping list when considering new equity purchases.

Alternative: Select stocks from Safe Dividend Stock document generated from my back testing of Dividend stocks from 2002-2011.

Give priority to stocks that meet both standards.

Require the following from any stock selected:

  • Price at least $5 per share. Minimum projected yield 3.0% at time of purchase.
  • Total Portfolio Dividend growth rate (DGR) over past 5 years at least 7% annually.
  • Positive annual total returns in four of past five years (2007-2011).
  • Annualized average total return of at least 5% over past five years.
  • Increased dividend payout in each of past 5 years.
  • An understandable and sustainable business model with meaningful competitive advantages, also called a "moat."
  • Good fundamental business metrics. Low debt. Low payout ratio, or one below average for that sector. Strong credit rating.

Stock Valuation:

Buy only stocks with "Fair" or better valuations as determined by average PE for past five years. Seek an overall portfolio PE of 15 or below. Be cautious of buying a stock at a point where it is at its 52 week high.

Consider multiple sources of value assessment when seeking to determine value. Sources include, but are not limited to the following:

  • Merrill Lynch
  • Morningstar
  • Fast Graphs
  • Select SA Contributors

Buy stocks with a current payout ratio of under 70% or one in line with its peers.

Buy stocks that meet the "chowder rule," requiring a yield plus 5 year Dividend Growth Rate (DGR) total of 12% or more. In the case of utilities and REITs, the total is 8% or more.

To help insure capital preservation, est. 5 year growth figures will be examined and compared for all stocks under consideration. As a minimum standard, only stocks with growth equal to inflation will be considered.

A watch list of stocks meeting the above standards with a minimum yield of 2.75% shall be maintained at all times and revised quarterly. A full year by year performance back test for each stock will be conducted going back to 2002. Results will be maintained and used when considering new holdings.

Portfolio Construction:

Aim for well-roundedness in the portfolio. Diversify across sectors, industries, geographies, and different ranges of yields and growth rates.

The number of stocks owned will be a minimum of 50.

The portfolio should maintain an overall beta of less than 0 .7.

Be alert to position sizing. Investing an equal initial amount in each stock is the norm. Adjustments may be considered as prices change, yields decline and perceptions of risk and reward change.

Hold no more than 3 percent of the portfolio's value in a single stock, with 2% being the norm. If a position exceeds 3 percent, sell the excess and re-deploy the proceeds.

Make opportunistic switches from one stock to another if such a swap will upgrade the portfolio. The expected frequency of such exchanges is low.

The major focus is dividends and not share prices, the portfolio will usually be 95% or more invested. Generating a steady and growing income stream from dividends remains job one.

Dividend Reinvestment:

Consider reinvesting dividend income in excess of 5%.

When reinvesting dividends, consider new positions designed to improve the portfolio in one or more of the following dimensions: yield, dividend growth, or diversification.

Selling Guidelines:

Investigate and seriously consider selling any stock for these reasons:

  • It cuts, freezes, or suspends its dividend.
  • It becomes seriously overvalued as determined by a dividend of under 2.5% or an evaluation by Fast Graphs. Re-capture and re-investment of gains will likely be the first step.
  • It underperforms stocks in its sector in total returns (price + dividends) for two years running.
  • It incurs a loss in excess of 10% and maintains such a loss for a quarter, and where such a percentage represents a loss significantly greater than similar stocks in that sector or industry. If losses increase into the next quarter, suitable replacements will be carefully evaluated.

Portfolio Review:

Conduct a thorough quarterly Portfolio Review.

As part of each review, measure the Portfolio's overall progress toward the overall goal of maintaining stable growing income and capital preservation.

Review performance by sector or group. No longer use either the Dow or the S&P 500 as a measure of the success of the portfolio. Instead use performance of appropriate sector ETFs such as XLU as a gauge. For example: How was the average performance of portfolio utilities vs. the performance of the XLU that quarter? Serious under performance will be closely examined to see if an exchange for other DG equities within that sector have the potential to further strengthen income stream and capital preservation.

Measure final success against the "Chowder Index." Check to see if this quarter's income from dividends exceeds that of the same quarter last year. If it does, celebrate with a cold one or two. If it doesn't, make appropriate adjustments based on stated guidelines and portfolio objectives.

Well folks, there it is, our new and improved portfolio business plan. We're proud of i, but would sure like to hear from you about how we might further define and improve it. I hope it generates thinking and comment, but most of all I hope it generates action. If you're a few years out or all ready retired, no matter what investment vehicle or mix of vehicles you choose, whether you are a self-directed investor or work with an advisor, take the time to develop your plan.

I want to encourage each of you to continue to share your insights on the issue of portfolio business development, particularly those who of you who are retired and those who have yet to comment. It is from comments and questions that I learned so much from those generous enough to share their experiences

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.