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Dividend growth investing, retirement
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Summary

  • This Dividend Growth Portfolio was created six years ago to demonstrate dividend growth investing.
  • The portfolio has a long-term income goal - to generate 10% yield on cost within 10 years. Through six years, the portfolio is on pace to meet that goal.
  • Strategies, practices, and specific portfolio moves are discussed, along with total return and lessons learned.

Background

Six years ago, on June 1, 2008, I established a real-time, real-money dividend growth portfolio to demonstrate dividend growth principles. There is no trickery, cherry picking, or back-testing involved. It is a real portfolio, run with real money at E-Trade since its inception.

On June 1 of this year, my Dividend Growth Portfolio [DGP] celebrated its 6th birthday. I have been the sole manager of the DGP since its creation. I publish a monthly report card about the DGP on my Web site. It can be found here.

At inception, the value of the portfolio was $46,783. No new money has been added to or removed from the portfolio since it was created. Dividends are received into the portfolio and reinvested.

Why Does This Portfolio Exist?

I created the Dividend Growth Portfolio to demonstrate the results that can be achieved through the principles of dividend growth investing. I have never held this portfolio out as the best or the only way to execute a dividend growth strategy. It is simply an example of me doing it in real time with real money. I hope that it has educational value.

Dividend growth is certainly not the only way to invest, but it is suitable for certain goals.

I strongly believe that the good investing starts with goals. The main goal of the DGP is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies. That goal is clearly stated in the DGP's "Constitution," which I will discuss more below.

That main objective is being accomplished. The dividend stream has increased each year since the portfolio was created in 2008.

At the current time, it appears that 2014's dividends will exceed 2013's by about 12%. That projection probably understates the actual increase for 2014. For example, at the time of last year's 5th birthday report, the projection was for a 13% increase in 2013. The actual total increase for the whole year was 18%. I will discuss the reasons for this later.

A secondary goal of the DGP is to generate acceptable total returns. The Portfolio is up 63% in total value since inception, which is more than the S&P 500 with dividends reinvested.

Good Governance: The DGP's Business Plan

The Dividend Growth Portfolio is governed by a Constitution that spells out its goals, strategies, and tactics. I wrote the first constitution in 2008 and amend it annually. The complete document can be found here.

Highlights of the DGP's constitution include:

Goal Statement. The goal of the Dividend Growth Portfolio is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies. Numerically, the target is for the portfolio to deliver 10 percent yield on cost within 10 years (that is, $4678 by 2018).

The metric yield on cost gets a lot of criticism as a backwards-looking "feel good" number. But as you can see, I used it from the beginning as way to look forward, to express an aspiration. I found it exciting to think that I could create a dividend stream that, by itself, would match the historical total return of the stock market. I still do.

I manage the portfolio for income optimization. Total returns happen as a byproduct of that central focus.

Strategies. The constitution lays out the strategies by which I try to achieve the goal. Here are the most important ones.

  • Use the current Top 40 Dividend Growth Stocks as my shopping list.
  • Buy only stocks with "Fair" or better valuations.
  • Reinvest dividends without dripping them. Reinvest when the incoming cash accumulates to $1000.
  • Shoot for an eventual total of 20 to 25 stocks. Aim for well-roundedness. Hold no more than 15 percent of the portfolio's value in a single stock.
  • Make opportunistic switches from one stock to another if such a swap will upgrade the portfolio. The expected frequency of such exchanges is low.
  • Seriously consider selling any stock if:
    (1) It cuts, freezes, or suspends its dividend.
    (2) It bubbles or becomes seriously overvalued.
    (3) Significant fundamental changes impact the company.
    (4) It is going to be acquired.
    (5) It announces plans to split or to spin off a separate company.
    (6) Its current yield rises above 9 percent or drops below 2.7 percent.
    (7) Its size increases beyond 15 percent of the portfolio.

Performance: Steadily Rising Dividends

The DGP's goal of steadily rising dividends has been met splendidly so far. This table shows actual dividends received 2008-2013 plus a projection for 2014.

Year

Dividends

Received

Yield on Cost

Increase from

Prior Year (%)

2008 (7 Months)

$998

2.1%

2009

1568

3.4

57%

2010

1799

3.8

15

2011

1960

4.2

9

2012

2179

4.7

11

2013

2582

5.5

18

2014 (Est.)

2898

6.2

12

Let's look at that in graphical form.

The numbers for 2008-2013 are actual dividends received.

The estimate for 2014 (full year) comes from E-Trade's Income Estimator. That tool annualizes the most recent dividend for each stock and projects it forward, taking into account any upcoming dividend increases that have been announced. Thus it understates dividends that will be increased during the rest of the year, and of course it does not know about dividends from shares that I will purchase with incoming dividends. By the same token, it overstates dividends if any of the stocks cuts or suspends its dividend.

I derive the estimate for 2014 by adding the dividends already received to the Estimator's projection for the rest of the year.

The DGP has a current yield of 3.8%. That figure has held pretty steady for most of the portfolio's life. (It varies up and down a little as dividend payments change and as the total value of the portfolio varies within the market.) For comparison, the S&P 500's current yield is 1.9%, according to multpl.com. So my portfolio is generating cash twice as fast as an equivalent investment in the S&P 500.

The numeric goal for the DGP is to achieve 10% yield on cost within 10 years. That means that I want the portfolio to be yielding an "APR" of $4678 by June 1, 2018. The following graph shows my progress towards that goal. The red line is the goal line and the blue line is the actual run-rate as of June 1 of each year.

Because dividends are reinvested, they compound. That is why the red goal line is not simply a straight-line projection from the portfolio's inception date to its goal in 2018. Instead, the goal line curves upwards, reflecting the compounding.

Comparing the red and blue lines tells me that I am on track to meet my goal.

Portfolio Holdings

At the moment, the portfolio holds 18 stocks. Here is the portfolio as it exists today, with each stock's date of entry into the portfolio and the percentage it comprises of the whole portfolio. Some stocks have been purchased more than once; the entry date is the year of first purchase. The right-hand column shows 2014's actual or expected dividend increases.

Company

Entered Portfolio

% of Portfolio

2014 Dividend Increase

Alliant Energy (NYSE:LNT)

2010

10

January: 9%

AT&T (NYSE:T)

2009

3

January: 2%.

BHP Billiton (NYSE:BBL)

2012

3

September: TBD.

Chevron (NYSE:CVX)

2008

5

May: 7%.

Coca-Cola (NYSE:KO)

2014

5

March: 9%.

Hasbro (NASDAQ:HAS)

2012

4

April: 8%.

Johnson & Johnson (NYSE:JNJ)

2010

13

May: 6%.

Kinder Morgan Energy Partners (NYSE:KMP)

2008

6

January: 1%. April: 1%. July & October: TBD.

Lorillard (NYSE:LO)

2013

2

February: 12%.

McDonald's (NYSE:MCD)

2008

10

November: TBD.

Microsoft (NASDAQ:MSFT)

2014

1

November: TBD.

Omega Healthcare (NYSE:OHI)

2013

6

January: 2%. April: 2%. July & October: TBD.

PepsiCo (NYSE:PEP)

2008

12

June: 15%.

Philip Morris Int'l. (NYSE:PM)

2013

4

September: TBD.

Procter & Gamble (NYSE:PG)

2014

3

April: 7%.

Realty Income (NYSE:O)

2008

10

March: <1%. June, September & December: TBD.

Shaw Communications (NYSE:SJR)

2012

3

March: 8%.

Ventas (NYSE:VTR)

2014

1

December: TBD

I pay no attention to payment or increase schedules when selecting stocks. For example, I make no effort to have a payment every month. When I am in purchasing mode, I always look for the best addition to the portfolio; I can cope with different payment schedules.

The DGP currently has $232 in cash (less than 1% of the portfolio). That represents dividends that have arrived since the most recent reinvestment in May. When the sum reaches $1000, I will reinvest it, either to start a new position or add to an existing one.

I have already made two reinvestments in 2013, using accumulated dividends to start positions in Microsoft and Ventas. I expect to make one more purchase with accumulated dividends in 2014.

Turnover

The DGP has never been a buy-and-forget portfolio. I have made transactions and changes from time to time, always keeping my eye on the principal goal - increasing the dividend stream.

Since the beginning of the year, I have made 8 transactions.

  • Bought Microsoft. In January, I started a position in MSFT with accumulated dividends.
  • Sold Intel. Intel failed to raise its dividend last year and still hasn't. That is grounds for considering a sale, and I sold the stock in January. I made a slight profit and used the proceeds to fund the following two purchases.
  • Bought Coca-Cola. This was a new stock for the DGP. The purchase is discussed in this article.
  • Bought more Philip Morris. This added to a position begun last year.
  • Sold Darden. In March, I became concerned about DRI's overall business results (see this article). I sold the stock at a profit and used it to fund the following two purchases.
  • Bought more Coca-Cola.
  • Bought Procter & Gamble. This brought another new stock into the portfolio. (See this article).
  • Bought Ventas. In May, I made my second dividend reinvestment of the year. VTR is a new position, bringing the total number of holdings to 18. (See this article.)

Right now, I have one stock under special watch. Reynolds American (NYSE:RAI) has floated a proposal to purchase Lorillard. I am sitting on a 57% paper profit in LO (it is a small position). RAI has never been a Top 40 stock, so I may sell LO at some point, although I will investigate RAI with the idea of just keeping it if and when they acquire LO.

There is plenty of time to make this decision. LO's price ran up on the first announcement of the possible acquisition, then fell back, and then regained its high at the end of May. I may stick a sell-stop under it to preserve the paper profit in case the deal falls through or the market changes its mind while I am researching RAI.

Performance: Total Return

As stated earlier, total return is not the main goal of the DGP, and I do not manage it for total return. Nevertheless, total return happens. The following chart compares the DGP's total return to the S&P 500's total return (with dividends reinvested). The DGP has never trailed the index since inception.

Starting from its initial value of $46,783, the portfolio has increased in total value by 63% to $76,225. That gives it an average annual growth rate of 10.5% per year and a CAGR (compound annual growth rate) of 8.5% per year.

For comparison, the S&P 500 (represented by (NYSEARCA:SPY)), with dividends reinvested, has increased 56% in total value over the same time frame. That would be an annual average growth rate of 9.3% and a CAGR of 7.7%.

Principles Reinforced and Lessons Learned

Most of the original concepts behind this portfolio have remained in place since the beginning.

Income Focus. From the beginning, the emphasis on dividends and dividend growth has served me well. I intend eventually to live off the dividends along with other sources of income. My hope is to do this without liquidating assets if possible. So accumulating what I call dividend rights makes sense.

I reinvest dividends now. At some point in the future I will start taking them as a cash paycheck.

I believe that the income focus helps lead me to more intelligent long-range investment decisions. As my portfolio continues to churn out increasing dividends, focusing on the growing income stream has become more interesting than focusing on price. Short term price swings have become of little interest.

Value Focus. I try to purchase stocks only at favorable, or at least fair, valuations. This helps in two ways.

First, the better the price on a purchase, the better the yield. Assuming the stock never cuts its dividend, the initial yield that you get when you purchase it is the worst yield on cost that you will ever have for that block of stock. In a sense, that yield is locked in.

Second, you reduce the probability of paper price losses. While price is a secondary consideration in this portfolio, I am not in love with paper losses any more than most investors. While some unrealized losses are almost inevitable, their likelihood and magnitude tends to be diminished if stocks are purchased at reasonable valuations.

Behavioral Finance. I believe that focusing on the income stream helps to insulate me from some of the behavioral finance mistakes that have been identified.

  • I don't anchor on recent prices nor pay much heed to short-term price movements. Instead, I focus on company fundamentals, dividend characteristics, and value.
  • Herd mentality is virtually eliminated. I pay scant attention to hot investment trends or to what many investors consider to be daily doses of must-know news. Dividend growth investing is about as opposite from faddish investing as you can get. I understand that some critics of dividend growth investing think that dividend growth investors are themselves a herd. But my own interpretation of what I read from dividend growth investors is that there are a lot of independent thinkers willing to challenge or ignore conventional Wall Street wisdom. One obvious example of rejecting convention is the central focus on income performance rather than total returns.
  • I don't think that I overreact to market events, as I don't follow the market much. I do tote things up in round numbers at the end of each week. I write my monthly report card for my website which goes into detail on income and total performance of this portfolio. I don't think this has ever led me to react to anything the market was doing. (I do, of course, react to things that companies are doing.)
  • I don't believe that I suffer much from loss aversion. I don't regret total-return losses more than I appreciate gains. Those would be price-related emotions, and I hardly pay attention to price other than when looking for bargains. Valuation - which takes into account earnings and earnings growth, plus a collection of other judgments about each company's business - has replaced price in almost all of my thinking about stock prices. Of course, if a loss or potential loss involves dividends, I take actions to correct, as described earlier. My goal is to keep the income stream climbing.

While most of my initial principles and strategies have held up, I think that I have learned a few valuable lessons since 2008, and that I am therefore a better investor now than I was then.

Diversification. I think the biggest shift in my behavior has come in the area of diversification, a lesson that I learned both from studying Modern Portfolio Theory but more importantly from Seeking Alpha writers and commenters.

When I began the Dividend Growth Portfolio, my intent was to hold its size down to what I thought were my absolute best ideas. The original portfolio held 11 companies, and its target was 10-15.

But I became convinced that in the income realm, spreading your bets is the better course. There are many dividend growth companies with essentially similar characteristics, so there seems to be no downside to owning more companies provided that you can keep your portfolio's yield and dividend growth where you want it.

Accordingly, last year I amended my constitution to increase the target number of positions and decrease the maximum allowable size of any one position. In the past 18 months, I have increased the number of positions in the DGP from 10 to 18, and the maximum size of the largest has been reduced from about 19% of the portfolio to about 13%. As stated earlier, my new target for number of positions is now 20-25. I could see myself further reducing the maximum position size to 10%.

Selling Guidelines. Since I wrote my first constitution in 2008, I have made my selling guidelines more comprehensive but also allow for situational judgments. These are the guidelines as they stand now:

Investigate and seriously consider selling any stock for these reasons:

(1) It cuts, freezes, or suspends its dividend.
(2) It bubbles or becomes seriously overvalued.
(3) You receive news of significant changes impacting the company.
(4) It is going to be acquired.
(5) It announces plans to split itself or spin off a separate company.
(6) Its current yield rises above 9 percent or drops below 2.5 percent.
(7) It underperforms the market in total returns (price + dividends) for three years running.
(8) Its size increases beyond 15 percent of the portfolio.

Many of the guidelines interact. For example, if a stock becomes seriously overvalued, it is probably because its price has shot up. And therefore its current yield has probably dropped. So whichever way you look at it, the stock becomes a candidate for investigation and possible trimming or elimination. The objective is always to improve the chances of the portfolio meeting its goals.

Source: My Dividend Growth Portfolio's 6th Birthday Report