We all spend so much time building our portfolio and checking the positions and researching the positions every month. One thing I believe most people fail to do is stress test their portfolio. By stress testing your portfolio, what I mean is to look at it from where it currently stands and assume we go into a recession tomorrow. How will a recession and everything that comes with a recession affect your portfolio value and income? How a recession affects these two things will help you determine, for example, when you may be able to retire and be ok with the current structure and amount of your portfolio.
For example, for anyone that has been following me for some time I'm a big income investor. I hope to be able to retire and live off the dividends only and not have to sell any shares. In order to retire, I want to ensure that the dividends I'm going to receive surpass my retirement expenses. It would be catastrophic if we went into a recession soon after retiring and dividends were cut. Now I have to go and find a job and get back to work.
In order to prevent the above catastrophe, I stress test my portfolio with likely, but conservative estimates of what could happen if we had a moderate economic recession. This is subjective by all measures because no one, maybe not even the corporate management of my stock picks, knows exactly what they would do if something happened. It would likely depend on severity, exact form or cause of recession and so many factors that this is a rough estimate.
I'll try to explain as many assumptions going in but again there are so many factors at play a lot of this is guess work with some estimation. If anyone has any inputs or thoughts to improve my estimations I'll take it because I by no means am accounting for everything I'm sure.
Many of the things I look at:
Recent price movement (52 week perf, 10d sma, 50d sma, 200d sma)
Price valuation (P/E, P/B)
Dividends (Payout ratio, dividend history, dividend increase/decrease willingness)
Assumption: 30% broad market price decline in one year, dividend is a one year projection
My Portfolio (as of 25 Oct.)
Kinder Morgan Energy Partners (NYSE:KMP)
Vanguard Natural Resources LLC (NASDAQ:VNR)
General Electric (NYSE:GE)
Philip Morris (NYSE:PM)
Procter & Gamble (NYSE:PG)
Leggett & Platt Inc. (NYSE:LEG)
Triangle Capital (NYSE:TCAP)
Wells Fargo (NYSE:WFC)
American Capital Mortgage Investment Corp (NASDAQ:MTGE)
Annaly Capital Management, Inc (NYSE:NLY)
American Capital Agency Corp (NASDAQ:AGNC)
Dynex Capital Inc (NYSE:DX)
Realty Income Corp (NYSE:O)
UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT (NYSEARCA:MORL)
HCP, Inc (NYSE:HCP)
Healthcare REIT, Inc (NYSE:HCN)
Johnson & Johnson (NYSE:JNJ)
Illinois Tool Works (NYSE:ITW)
Target Corporation (NYSE:TGT)
Textainer Group Holdings Limited (NYSE:TGH)
McDonald's Corporation (NYSE:MCD)
StoneMor Partners (NYSE:STON)
Emerson Electric Co (NYSE:EMR)
NTT DoCoMo, Inc (NYSE:DCM)
AT&T Inc (NYSE:T)
American State Water Co (NYSE:AWR)
AmeriGas Partners LP (NYSE:APU)
The portfolio performance should be pretty decent during a recession if one were to happen soon. 24 out of the 32 stocks are on Dave Fish's spreadsheet of Dividend Challengers, Contenders, and Champions meaning they have increased dividends for at least 5 years. One stock has the cash and seems to have the willingness to make it on the list soon (Apple (AAPL)) and two other stocks have been on the list in the past and could soon be back on there (GE (GE) and Wells Fargo (WFC)).
I'm projecting an overall dividend increase of just over 1% and a drop in value of 17%. The drop in value is less than that of the broad marke,t because many of the stocks are defensive and are not necessarily reliant on consumers or the economic cycle. The portfolio beta is roughly 0.75 so it is less volatile than the market. Many of the stocks, mainly the mREITs could actually stay flat or improve if the economy fell into a recession due to the potential for rates to stay lower longer.
The increase in dividends is due to the nature of these stocks and that most have raised their dividends for many years already regardless of the economy. Of those that I assumed would still raise their dividend I used a rate below the 1-yr, 5-yr, and 10-yr dividend growth rate of the company to be more conservative and account for maybe one or two actually not raising their dividend. There was also a large group of stocks I assumed didn't raise their dividend even though it is possible some of them would but I did this to again be on the conservative side.
Overall, the actual results could vary if a recession hit us tomorrow but based on recent performance and this analysis I'm comfortable with the portfolio make-up and portfolio performance if a recession is upon us. I'm far from retirement and will continue to monitor the portfolio via stress testing as I get closer and prior to entering retirement full time.
Disclosure: I am long COP, KMP, GE, JNJ, WFC, VNR, MMM, AGNC, MTGE, KO, PM, PG, LEG, TCAP, NLY, DX, O, MORL, HCN, HCP, ITW, TGT, TGH, MCD, STON, EMR, DCM, AAPL, T, AWR, APU. 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.