Choosing the best system to allocate funds within a Dividend Growth Investing portfolio is a frequent topic in this corner of Seeking Alpha. Although I have used a tiered method instead of equally weighting all positions, I hadn't really delved into the reasons for my decision ... until now.
For this study, I use tables to illustrate three different methods to weight a $600,000 portfolio of 30 companies. I have not cherry-picked these names to strengthen any particular point of view; they are my actual holdings as listed in the wrap-up of my recent four-part series on DGI portfolio construction. I even use the terminology from that series again in this article to describe my three tiers of quality: DGI Superstars, Role Players and Prospects.
In my actual portfolio, I combine Kinder Morgan Management (NYSE:KMR) and Kinder Morgan Inc. (NYSE:KMI) to form one position but have chosen KMR for this study because of its higher yield. I also eliminated 3M (NYSE:MMM), my lowest yielder, to give this exercise an even 30 companies for ease of computations. Finally, for the sake of privacy, I have not used dollar figures from my real portfolio.
|Procter & Gamble (NYSE:PG)||20000||77.70||257||2.406||$618|
|Philip Morris (NYSE:PM)||20000||83.44||240||3.40||$816|
|Johnson & Johnson (NYSE:JNJ)||20000||86.41||231||2.64||$610|
|General Mills (NYSE:GIS)||20000||49.32||406||1.52||$617|
|DGI Superstars TOTAL||180000||$5666|
|Kinder Morgan Mgt||20000||79.84||125||5.28||$660|
|Royal Dutch Shell (NYSE:RDS.A)||20000||64.59||310||3.60||$1116|
|Southern Company (NYSE:SO)||20000||41.62||481||2.03||$976|
|Realty Income (NYSE:O)||20000||39.50||506||2.178||$1102|
|Wisconsin Electric (NYSE:WEC)||20000||41.04||487||1.53||$745|
|Role Players TOTAL||240000||$8842|
|Health Care REIT (NYSE:HCN)||20000||61.44||326||3.06||$998|
|Omega Healthcare (NYSE:OHI)||20000||28.40||704||1.88||$1324|
|National Health (NYSE:NHI)||20000||54.90||364||2.94||$1070|
|National Retail (NYSE:NNN)||20000||30.63||653||1.62||$1058|
|Main Street (NYSE:MAIN)||20000||29.12||687||1.86||$1278|
|General Electric (NYSE:GE)||20000||23.14||864||0.76||$657|
|Waste Management (NYSE:WM)||20000||40.44||495||1.46||$723|
(Key -- Cost: size, in dollars, of each position. Price: per-share price as of Aug. 30 market close. Shares: number of shares purchased for each position; Div/Sh: annual per-share dividend. Div Pd: annual dividends paid for the number of shares held in each position.)
This is the preferred method of many investors I deeply respect. It also happens to be one I do not favor.
As DGI practitioners, we want to own high-quality companies with long histories of inflation-beating dividend growth. We have made our choices carefully because we are understandably demanding; in addition to being great businesses, we insist that these companies increase income payments to us for decades to come.
Why, then, would an investor assign the same cash value to a dependable heavyweight such as General Mills and a borderline speculative company such as Omega Healthcare? The former is a blue chip that has paid dividends for 114 consecutive years. The latter has been highly sensitive to Fed activity and has been called a "lower quality" company posing potentially dangerous risks by Seeking Alpha REIT expert Brad Thomas.
Equally weighting Omega Healthcare and General Mills smacks of paying an unproven kid the same salary as a multiple MVP-winner in the prime of his career.
I'm not saying, "Forget the unproven kid." I'm saying, "I'm OK with him being part of my team ... but I won't pay him MVP money until he proves himself worthy."
My DGI Superstars aren't exactly top-secret names I unearthed through years of detective work. There's a reason these brands are investors' favorites: They are the creme de la creme. So why would I want to count on nine third-stringers -- companies I literally might sell tomorrow -- to generate 38% more in annual dividends than nine companies I expect to be core positions for decades?
I wouldn't, which is where the next table comes in.
WEIGHTINGS BY "QUALITY TIER"
|Procter & Gamble||30000||77.70||386||2.406||$929|
|Johnson & Johnson||30000||86.41||347||2.64||$916|
|DGI Superstars TOTAL||270000||$8501|
|Kinder Morgan Mgt||20000||79.84||125||5.28||$660|
|Royal Dutch Shell||20000||64.59||310||3.60||$1116|
|Role Players TOTAL||240000||$9289|
|Health Care REIT||10000||61.44||163||3.06||$499|
Equal-weighting proponents say their method "protects" their portfolio by preventing one or two bad apples from spoiling the whole bunch.
Well, I'd rather protect my portfolio by allocating more money to the companies in which I have the most confidence -- both as businesses and dividend-growers. I am willing to buy some higher-yielding, arguably less "blue-chippy" stocks, but I'd rather not have oversized percentages of my dividends come from them. So I'll buy considerably more McDonald's than Main Street Capital, thank you.
The above 30-20-10 breakdown approximates what I'm trying to do with my portfolio, but I prefer ranges to absolutes. In other words, when I'm fully invested, my DGI Superstars might range from 25k-35k and my Role Players from 15k-20k. That way, I don't feel I have to buy $20,000 worth of low-yielders such as Aflac and Deere to have "full positions." It also paves the way for the Kinder Morgans and Altrias to earn promotions to Superstar status eventually.
One important thing I must keep reminding myself: It's not about the dollars for each position, it's about the dividends and their growth over time. Which brings us to an interesting third option.
WEIGHTED BY QUALITY TIER & DIVIDENDS PAID
|Procter & Gamble||30692||77.70||395||2.406||$950|
|Johnson & Johnson||31108||86.41||360||2.64||$950|
|DGI Superstars TOTAL||275111||$8550|
|Kinder Morgan Mgt||10619||79.84||133||5.28||$702|
|Royal Dutch Shell||12530||64.59||194||3.60||$699|
|Role Players TOTAL||237084||$8402|
|Health Care REIT||10015||61.44||163||3.06||$499|
In the third portfolio, I strive to produce $950 in annual dividends from each top-tier company, $700 from each member of the second group and $500 from each third-stringer. As is the case in the other options presented, those would just be the starting figures. We'd expect these dividends to grow significantly over time, requiring occasional portfolio rebalancing.
I like this concept because I'm all about dividend growth and about maximizing investments in top-tier companies. However, there are enough quirks to make me uncomfortable with this plan. Do I really want to spend $36,245 to create $950 in Walgreen divvies and $27,145 just to reach the $700 mark for Wal-Mart? Again, going to ranges -- say, $800-$1100 for the Superstars and $600-$800 for Role Players -- would create more flexibility.
Still, even as I always, always, always keep an eye on dividends and their growth, my plan for now is to stick with variable dollar weightings by tier. Using ranges instead of absolutes, it is a fairly simple way to put more faith in my best ideas while being open-minded about other possibilities.