How One Retiree Is Muddling Through Dividend Investing: Part IX - My Dividend Investment Business Plan

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 |  Includes: APU, AVA, AZN, BBL, BGS, CA, COP, CSCO, DPS, EFC, GIS, GSK, INTC, KHC, KMP, KO, LXP, MAT, MO, MRK, O, PETS, PPL, RCI, ROIC, RTN, SO, STAG, T, TGT, TOT, TRTN, VOD, VZ, WMT, WPZ
by: Martin Rice

Summary

In spite of knowing better and saying I would, I never made an investment business plan.

Drawing upon advice from Bob Wells, Chowder, David Van Knapp, and other S.A. contributors, I have constructed a plan specific to our goals and needs.

The plan is spelled out in this article and our current portfolio is presented.

I Never Did It

On February 10, 2013, I published Part IV of this series. Bob Wells, in one of his many helpful comments, said: "Develop a business plan for your portfolio clearly defining your criteria for buying, selling or trimming a position. Here's the link to mine"

Additionally, over time, I got the same suggestion from chowder, David Van Knapp, and several other S.A. contributors. Naturally I agreed that this was sound and important advice and I mentioned many times throughout the series that I would be developing a plan specific to the needs of my wife and me based on the examples and suggestions provided in the comments.

I never did it. Not because I didn't think it was a great idea and the right thing to do. I was convinced that it was a necessary step in becoming a successful dividend investor. But, as so often happens, I didn't see the forest for the trees. I got so busy trying to learn about investing and trying to adjust my portfolio so that it would be successful and consistent that I never actually got around to creating the plan (yes, I know that's what the business plan would have helped me achieve).

After I published Part VIII of this series a little more than 2 weeks ago, I decided that before doing anything else (other than making a couple of important changes in my portfolio, which you can see below) I would focus entirely on creating a dividend investment business plan for my wife and me that would take full advantage of all I had learned since January, 2013 when I began writing this series.

First Considerations

I began by generally following Bob Wells's outline, which he published in his article, "Revising My Business Portfolio Plan" (linked to above). His outline consists of the following headings:

  • Business Name
  • Goal
  • Stock Selection
  • Stock Valuation
  • Portfolio Construction
  • Dividend Reinvestment
  • Selling Guidelines
  • Portfolio Review

Using his outline, which he so generously made available, here is what I've decided to do:

Business Name

I decided that we didn't really need a name for our business.

Goal

The goal is extremely important, of course. I had always had a goal in mind, namely: attaining the maximum dividend income with the least amount of risk.

In a sense, that is pretty much the goal of all dividend investors, regardless of whether they're already using the income stream as we are; or whether they're reinvesting all of it as do so many who are still in the accumulation stage; or whether they're doing both, as Bob seemed to be doing.

But now that I was creating a plan for real, it was time to become more specific in expressing the plan's goals.

In my Part VIII (linked to above) I said that we only needed an income stream from dividends of 4%-5% based on YOC to allow us to continue living the life we're accustomed to. Upon reviewing our income and expenses (we just filed our taxes), I still feel that this is the appropriate figure. As far as inflation is concerned, I'll address that when I discuss stock selection. Fortunately, as is evident in our portfolio below, we're currently doing better than 5% YOC.

Stock Selection

I look for stocks to consider adding to my portfolio from the following sources:

  • Recommendations and articles by Josh Peters and his staff on Morningstar's Dividend Investor, to which I subscribe.
  • The top-ranked dividend stocks on dividend.com, where I am a premium member.
  • Articles on morningstar.com where I am a premium member - especially those about stocks that achieve new four and five star ratings.
  • Articles by Seeking Alpha contributors and the comments made on those articles
  • Screenings I do on morningstar.com
  • Screenings I do on fidelity.com, which is our brokerage firm

I don't pay too much attention to the stock's price, but I don't own any under $10.00. I rarely see anything under $10.00 show up in my screenings or reading anyway.

Additionally, any stock that I want to continue researching must have the following attributes:

  • Yield must be at least 3.0% at time of purchase.
  • Dividend growth over the last four years must average at least 4% and have increased in each of the past 4 years. I came up with this figure in order to keep up with an assumed 3% inflation rate plus to have a little more to spend above inflation. I get this information mostly from FASTGraphs and dividend.com

The stock must be doing as well as or better than its industry average in the following key metrics:

  • Revenue Growth (3 yr. avg.)
  • Net Income Growth (3 yr. avg.)
  • Return on Assets
  • Return on Equity
  • Debt/Equity
  • I want my stocks to have a P/E ratio lower than the average for it's industry.

This information is easy to find on morningstar.com. I have learned that metrics vary widely by industry and having them available compared to their industry is, I think, a great help in stock selection

Stock Valuation

Generally I use FASTGraphs to check valuation. It's the best tool I know of. But I also take a look at Morningstar's valuation. I frequently find differences between it and FASTGraphs; in that case I tend to rely more on the latter. In a sense valuation is a chief focus of their business.

That said, I prefer to only consider stocks that are either at fair value or undervalued according to FASTGraphs and Morningstar.

As mentioned above, I want a stock that has a P/E ratio lower than it's industry average.

Portfolio Construction

I've grown more aware over the past year and a half of how important the relationship is between a portfolio's sectors and industries on the one hand and our goals on the other.

For example, in a comment chowder made in a previous part of this series, he said he felt we were probably light on the Consumer Defensive sector in regard to our goals of income and our relatively short investing horizon, both of which require a greater degree of defensiveness. I certain agree with him and have made some changes already in that direction, which you can see in the portfolio below.

Consequently, after I've selected a stock using the criteria outlined above, I then check to make sure that it will work in my portfolio in relation to my sector/industry weightings. That is, if a purchase will make me overweight in the stock's sector/industry, I'll probably pass.

I want to emphasize, however, that just as I do not have a set percentage for the weight of each stock in the portfolio (see below), neither do I have a set percentage for each of the sectors. Some sectors, such as Consumer Defensive, as mentioned above, are more suitable to our situation than others.

I don't have any fixed number of stocks in mind as a minimum or maximum number for the portfolio. I expect the number will hover between about 35 and 45. I believe that number is sufficient for me to gain the diversity I require. If I need more stocks than that to gain the diversity, I have no problem having more.

Currently the portfolio's beta is 0.67 and that falls within the range of 0.5-0.7 that I'd like to maintain. Given how heavy we are in large caps, utilities, and other stable sectors, it should not be much of a problem to keep the portfolio's volatility down, something I feel is important for us given our goals, needs, and investing horizon.

I know that many investors feel a need for strict sizing balance in their portfolios. For example, Bob Wells say he does not want any single position in his portfolio to be greater than 3% of the portfolio's value and that 2% would be the norm.

I recently read a comment on S.A. where the writer said he was ok with 5%. I haven't been able to bring myself to a strict definition of single position sizes.

Right now the biggest position in our portfolio is AT&T (NYSE:T) at 9.67%. That's not due to appreciation so much (though it has appreciated better than 15%) as it is to our having additional purchases several times.

AT&T has a 29-year run of dividend growth; it's dividend is over 5%. T is not going to go out of business in my lifetime. It has a beta of 0.34. I can't see any reason in the world, given our needs and goals, to cut this position back to 5% or 3% or 2%.

I know that cutting it back would give us "opportunity funds," but we currently have funds left to take advantage of opportunities that might arise. Additionally it would be a rare opportunity for our particular portfolio that would be as good or better than this.

That said, Astrazeneca (NYSE:AZN) is currently at 4.88% of our portfolio. It has appreciated 38.64% since we acquired it. Its dividend is 4.35% (lower than AT&T) and, most notable, there was no dividend growth last year, in fact it went down. It's clearly time to sell at least that 38.64% appreciation and buy something else with the proceeds.

To sum up, I'm just going to judge, stock-by-stock, whether its percentage of the total portfolio value needs to be changed; then I'll act accordingly. I'll do this formally with a quarterly review. At the same time, because I keep close track of the portfolio, there's a chance that we might make changes during the quarter as well.

I will stick with about 5% of the portfolio value in cash to be able to take advantage of any good opportunities that arise.

Dividend Reinvestment

We don't do any dividend reinvestment in any formal way. If at the end of the year it turns out that we have unspent dividend income, then there's certainly the chance we'd use that money to buy more stock. Why just leave it in cash, especially at today's interest rates? But there's also the very good chance that I, total car freak that I am, might just use that money on a new trade-in.

Selling Guidelines

I agree completely with Bob's criteria for selling, which I'd like to quote here:

  • 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.

I expect to adhere to these guidelines, too. Of course because I have not yet used them, I'll have to add the qualification that if they don't seem to work for us I'll make appropriate changes for our situation.

Portfolio Review

This will be relatively simple, I think. Essentially, at the beginning of each new calendar quarter, I will look at each holding and review it in relation to all the criteria listed above. If I find any specific stock lacking or significantly changed, I will make appropriate adjustments.

Additionally, during the course of the quarter, I'll have collected a watch list of stocks that look interesting to me and which I think would work well in our portfolio. I'll look at these during the review and determine whether it would be better for the portfolio to replace one of the existing holdings with one on the watch list, or even add from the watch list without replacing one of the existing names.

Where We Are Now

After last publishing our portfolio we effected several changes based on comments made by readers and our own reconsideration of our situation.

The first changes were sales:

  1. Sold 5 Equity REITs: Excel Trust, Inc. (NYSE:EXL), Healthcare Trust of America, Inc. (NYSE:HTA), Inland Real Estate (NYSE:IRC), Monmouth Real Estate Investment Corp. (NYSE:MNR), and Medical Properties Trust (NYSE:MPW)
  2. Sold 3 BCDs: Medley Capital Corp. (NYSE:MCC), Prospect Capital Corporation (NASDAQ:PSEC), and THL Credit, Inc. (NASDAQ:TCRD)
  3. Sold 4 municipal bonds. We are now 100% in stocks with no fixed income investments
  4. Sold about a third of our AZN shares today as I mentioned I would above
  5. Sold Eaton Vance Risk-Managed Diversified Equity Income Fund (NYSE:ETJ), the last of the funds we held.

The second set of changes were purchases:

Bought Avista Corp. (NYSE:AVA), AmeriGas Partners L.P. (NYSE:APU), added to CA Inc. (NASDAQ:CA), Cisco Systems (NASDAQ:CSCO), Dr. Pepper Snapple Group (NYSE:DPS), General Mills (NYSE:GIS), Kinder Morgan Energy Partners L.P. (NYSE:KMP), Kraft Foods Group, Inc. (KRFT), Mattel (NASDAQ:MAT), PetSmart (NASDAQ:PETS), Rogers Communications (NYSE:RCI), added to T, TAL International Group (TAL), Target (NYSE:TGT), added to Verizon (NYSE:VZ), Wal-Mart Stores (NYSE:WMT), and Williams Partners L.P. (NYSE:WPZ)

Here is what our portfolio looks like as of April 7, 2014. (Note that I'm using the Morningstar Sector/Industry classification scheme.)

Symbol

Description and Sector

Industry

Yield on Cost

Portfolio value %

Portfolio value % by Sector

Consumer Defensive

17.51%

BGS

B & G FOODS INC

Packaged Foods

4.51%

3.40%

DPS

Dr Pepper Snapple Group

Beverages - Soft Drinks

3.02%

1.08%

GIS

General Mills

Packaged Foods

3.20%

1.03%

KO

COCA COLA CO

Beverages - Soft Drinks

3.11%

3.17%

KRFT

KRAFT FOODS

Packaged Foods

3.69%

1.44%

MO

ALTRIA GROUP INC

Tobacco

5.61%

3.61%

PETS

PetMed Express, Inc.

Pharmaceutical Retailers

5.21%

1.04%

TGT

Target Corp.

Discount Stores

2.87%

1.21%

WMT

Wal-Mart Stores

Discount Stores

2.50%

1.54%

Consumer Cyclical

0.80%

MAT

Mattel, Inc

Leisure

3.85%

0.80%

Energy

12.25%

COP

CONOCOPHILLIPS

Oil & Gas - Exploration & Production

4.70%

4.05%

KMP

KINDER MORGAN ENERGY PARTNER

MLP - Energy - Oil & Gas Midstream

7.37%

3.02%

TOT

TOTAL SA SPON ADR

Oil & Gas - Exploration & Production

7.47%

1.98%

WPZ

WILLIAMS PARTNERS L.P.

MLP - Energy - Oil & Gas Midstream

6.76%

3.19%

Financial Services

0.68%

EFC

ELLINGTON FINL LLC

MLP - Specialty Finance

13.83%

0.68%

Real Estate

12.56%

LXP

LEXINGTON REALTY TR

REIT - Diversified

6.48%

1.08%

O

REALTY INCOME CORP

REIT - Retail

5.48%

3.29%

Non-traded REIT CPA17

Corp Property Assoc.17 - Global Inc.

REIT - Diversified

6.90%

5.34%

ROIC

RETAIL OPPORTUNITY INVTS CORP

REIT - Retail

4.99%

0.82%

STAG

STAG INDL INC

REIT - Industrial

5.84%

2.04%

Healthcare

8.74%

AZN

ASTRAZENECA ADR

Healthcare-Drug Manufacturers - Major

6.03%

3.56%

GSK

GLAXOSMITHKLINE ADR

Healthcare-Drug Manufacturers - Major

5.37%

1.47%

MRK

MERCK & CO INC

Healthcare-Drug Manufacturers - Major

3.95%

3.71%

Industrials

3.34%

TAL

Tal International Group, Inc.

Rental and Leasing Services

6.92%

3.34%

Technology

6.34%

CA

CA INC COM

Software Infrastructure

3.77%

2.25%

CSCO

Cisco Systems, Inc.

Communication Equipment

3.42%

0.44%

INTC

INTEL CORP

Semiconductors

3.96%

3.65%

Basic Materials

1.29%

BBL

BHP BILLITON PLC SPONS ADR

Industrial Metals & Materials

3.74%

1.29%

Communication Services

18.75%

T

AT&T INC

Telecom Services

5.60%

9.88%

RCI

Rogers Communications, Inc.

Telecom Services

4.56%

3.27%

VZ

VERIZON COMMUNICATIONS

Telecom Services

4.49%

4.53%

VOD

VODAFONE GROUP SPON ADR

Telecom Services

11.18%

1.07%

Utilities

11.26%

AEP

American Electric Power Company

Regulated Electric

3.94%

1.02%

APU

AMERIGAS PARTNERS L.P.

MLP - Utilities - Utilities Regulated Gas

7.96%

3.11%

AVA

Avista Corp.

Diversified

4.25%

2.41%

PPL

PPL CORP

Diversified

4.89%

1.39%

SO

SOUTHERN CO

Diversified

4.68%

3.33%

CSH

Cash

6.47%

6.47%

Average YOC

5.30%

Click to enlarge

At this point I feel that our portfolio is closer than ever to where it ought to be. Our yield is above our target level. With a beta of 0.67 we should not encounter a great deal of volatility.

All positions other than T are under 5% of the portfolio's value (the average size is 2.63%). We are heavy in the Consumer Defensive sector, but that's the way it should be. Communication Services are heavy, too, but that is due mostly to T, which is a good value and safe.

Our next step is to redeploy the rest of the funds from the sales we made. We'll use those purchases to reinforce a proper balancing of sectors and industries.

I'm looking forward to hearing your thoughts and comments about where we're at now in our plan. As usual, your suggestions are eagerly solicited.

Disclosure: I am long APU, AVA, AZN, BBL, BGS, CA, COP, CSCO, DPS, EFC, GIS, GSK, INTC, KMP, KO, KRFT, LXP, MAT, MO, MRK, O, PETS, PPL, RCI, ROIC, RTN, SO, STAG, T, TAL, TGT, TOT, VOD, VZ, WMT, WPZ. 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.