Old-School DGI Method: Leveling The Income Stream

by: Land Locked

In the early '90s, I engaged the services of a full-service broker to help me solve the (enviable) problem of having too much cash sitting idly in checking and savings accounts. This marked the real beginning of my investing education, and I owe much of my success to the lessons I learned under Ebenezer "Ebie" Grier's tutelage. When I followed Ebie's investing philosophy, I almost inevitably profited. When I strayed into speculative trading, I generally lost. It's worth noting that since the mid-nineties a marriage and a child has done more to solve the problem of idle cash than Ebie's best efforts.

Ebie taught me the tenets of DGI before I even knew that the methodology had a name, and the last lesson I learned since joining the DGI readership here at Seeking Alpha - one that I wish Ebie had smacked his desktop repeatedly to drill into my head a few more times - is that DGI is not about making money over the course of a year, or a few years, and taking profits - it's about making money work for you repeatedly over a lifetime to accumulate enough capital gains and dividend income to fund your retirement and leave a legacy for your heirs.

Ebie's investing and advising style was conservative - emphasizing safety and long-term vision investing versus the quick-fix / fast-buck trading style that would define the marketplace just a few years later. I too got caught up in the craze, and badly burned for straying off the path. Ebie introduced me to stodgy old tools like Value Line(tm), and later the Morningstar advisory service, and to sound concepts like "core and explore" - Ebie's Investing Tenets were these (color commentary is my own):

  • Start with a Strong Core: Your portfolio should be built around a core of defensive, dividend paying, slow-growth stocks with long and stable records of earnings and distribution growth. Stock / Industry selection is a bit beyond the scope of this article, but be sure every core stock is blue-chip class - or nearly so, be ready to pay a premium for that distinction and the stability that comes with it, and consider one or more issues from Industry groups such as Food, Healthcare, Basic Materials, Utilities, Oil & Gas, Cyclicals, and Financials.
  • Reinvest Dividends: Until you have a more urgent use for the income - e.g. retirement, you should reinvest ALL dividends in the firm that pays them. Ebie believed, and led me to believe, in the power of compounded growth over time.
  • Target Monthly Income: As you build your portfolio's core during the accumulation phase, every stock you add requires due diligence, research, and in Ebie's opinion, consideration of distribution payment schedule. More on this concept follows...but to paraphrase Ebie's description of the method: select high-quality dividend stocks with staggered payment schedules. That way over the course of your accumulation, and when you're ready to retire on that income, you'll have dividend income coming in every month.

As you start seeing the dividend entries show up in your brokerage account transaction history - for the small, but increasing distributions and re-investments each quarter, if you DON'T make it a point to add payment schedule to your stock selection criteria, you may notice a pattern emerging: most stocks distribute dividends in March, June, September, and December.

Whether you're in the accumulation / reinvestment phase, or in retirement when you're more likely to be tapping the income from your stocks to cover living expenses, this phenomenon makes for a rather lumpy and erratic stream of recurring investments, or distributions to your cash account. So when you're starting out, it's important to pro-actively seek balance by doing what you can to smooth out the income stream from something that month-to-month, may look like a saw tooth pattern to something more closely resembling a straight line.

Please note that the intent of this article is not to promote or encourage investment in stocks or funds that distribute dividends monthly, though there are doubtless some such issues that merit consideration. My intent is to provide a high level view of how to select stocks that pay quarterly dividends on varying schedules in order to create a portfolio that generates monthly dividend distributions.

That said, if you compare monthly-pay versus quarterly-pay stocks and funds with otherwise equal dividend rates and yields; the "Mo Pay's" offer a slightly higher compounded growth rate on reinvested dividends than the quarterly-pay issues. Over many years, the advantage adds up. For example, consider the love that REIT investors have for Realty Income (NYSE:O).

Monthly dividend reinvestment versus quarterly may also be a means to enhance DCA or "Dollar Cost Averaging" performance over time. I'm sure there's a plethora of well-documented evidence that proves beyond a doubt both the validity and fallacy of this argument.

In my opinion though, the crux of DCA is beta - capturing the normal ups and downs of a stock price over time to reduce the cost basis of a stock or fund you intend to accumulate for an extended period.

Assuming your portfolio does not consist entirely of stocks or funds that pay monthly distributions, take a portfolio-centric perspective versus the individual stock perspective. Twelve instances of beta should be 'better' than exposure to four beta instances in reducing the cost basis of an entire portfolio, or collection of DGI stocks in your portfolio if you're not a pure-play DGI investor. I am not, but I'm weighted heavily towards DGI. I've not done the math or the back testing on this yet - perhaps that's content for a future article.

On the subject of math, I'm over-simplifying in my references to beta instances here. It's highly likely your portfolio will include several stocks on schedule A, B, & C. Odds are they won't all distribute or execute reinvestments on the same date, even if their schedule is on the same month.

David Fish's excellent Excel spreadsheet (updated monthly) listing his pre-screened and well-researched Dividend Champions, Contenders, and Challengers (which you can find here) includes payment schedule data for the approximately 465 stocks that make up the 3-C's of David's DGI universe. (Note - this applies to the 30 April 2013 revision to Mr. Fish's workbook. The number of stocks is likely to change as stocks are added or disqualified over time.)

Of these 465 stocks, Mr. Fish primarily characterizes payment schedules as A, B, C: (note that these designations apply to schedules only, and in no way reflect on the quality or 'rating' of a particular stock)

  • 116 "A" stocks distribute dividends in Jan, Apr, Jul, and Oct (25%)
  • 122 "B" stocks distribute dividends in Feb, May, Aug, and Nov (26%)
  • 195 "C" stocks distribute dividends in Mar, Jun, Sep, and Dec (42%)
  • 32 "other" stocks distribute Monthly, Semi-Annually, or Annually (7%)

So - this distribution of distribution schedules (sorry) makes it pretty obvious that if you're not screening on payment schedules, and you're using the entire CCC universe as your list of eligible stocks, you're 42% likely to pick a stock that pays in accordance with schedule "C".

Granted - it's not always possible, or advisable, to discard a stock you've screened as an eligible "buy" for your portfolio simply because the payment schedule is inconvenient. As well, it's somewhat unlikely, given the spread, that you'd be able to achieve an equal weighting of "A", "B", and "C" schedule stocks without making significant compromises in your stock screening and selection process.

It is certain however, that simply including a handful of schedule "A" and "B" stocks in your DGI portfolio will smooth out the choppiness of your dividend payments and reinvestments in the stocks you intend to hold for many years. Getting back to Ebie's credo, when you start tapping those dividends to put gas in the motor home or pay the country club dues, there's a great deal of peace of mind that must come with knowing that you've only got to wait a few weeks - versus a couple of months - for your next retirement paycheck.

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.