Second Quarter Portfolio Review: Building Dividend Growth And Quality

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 |  Includes: ARLP, AVA, BCE, BMO, BNS, COP, CVX, DLR, DX, EPD, ESV, ETP, HAS, HCN, KHC, KMB, KMP, KO, LMT, LO, MCD, MMP, MO, NHI, OHI, PAA, PAYX, PEP, PG, RAI, RCI, SDRL, SO, SXL, T, TCAP, VNR, VZ, WPC
by: Bob Wells

Summary

As a retiree in the "Distribution Stage," it's important to have a portfolio business plan to guide decision making.

Our plan calls for us to conduct quarterly portfolio reviews.

This quarter's plan outlines our increased emphasis on both dividend growth and quality.

I am pleased to present my Second Quarter 2014 portfolio review. This review helps clarify one investor's approach to dividend growth investing. It should not be read that I am in any way suggesting it is the single best approach to investing or the approach that will always amass the largest amount of capital gain. Instead it is the approach that best matches our risk tolerance. One that helps both my wife and I sleep well at night when the market is turbulent.

My portfolio finished the quarter with 48 holdings and yields roughly 5% at today's cost. Each of my holdings represents less than 3% of the overall portfolio with most positions under 2%.

My portfolio was constructed starting in 2011 from the lists of Dividend Champions, Challengers and Contenders (CCCs) maintained by Seeking Alpha Contributor David Fish and available here. Nearly every stock selected from this list has the distinction of not only maintaining its dividend during the bear market of 2008 but growing it each year, with most growing at a rate greater than inflation. In addition to core CCC holdings, there are additional stocks from the "Frozen Angel List" and others from the "Near Challengers List" also complied by David.

As a retiree, my goal from the start has been to construct and maintain a portfolio that would substitute for the traditional concept of selling holdings each month to provide necessary retirement income. Our portfolio acts as a substitute for the 4% withdrawal of capital gain plus an additional withdrawal each year equal to inflation, the rule recommended by our former advisers. We rely instead on income generated from dividends growing at a rate greater than inflation. I have two major goals for our dividend growth investments: increased annual income through dividend growth greater than inflation and capital preservation.

I believe our continuing success as investors lies in having our portfolio business plan that sets out specific guidelines for buying, selling and on occasion trimming portfolio positions. Our plan, recently revised and available here, was developed over a period of nearly a year after first defining our retirement income requirements and our personal risk profile. Our plan defines our principal investment goals and sets out the clear performance benchmarks upon which success will be measured. What follows is the comprehensive quarterly review we conduct at the end of each quarter as required by our plan.

It remains exciting to experience firsthand the direct results of strong consistent dividend growth. Since our portfolio is designed to produce growing dividend income, applying a key metric, referred to by many as the "chowder rule," at the time of purchase has proven instrumental in our success.

Dividend Growth slowed a bit the first quarter with growth in the range of 6.5% for the stocks announced during that quarter. This is an area I examined closely when making our new purchases this quarter. As risk averse investors we sought a low beta portfolio. Our overall portfolio beta remains under .70 as required by our plan. It is currently registered at .63.

There were no dividend cuts or freezes among our holdings this quarter. During the quarter Digital Realty (NYSE:DLR) was removed from the bench, enjoying a period of greater price stability and performance.

In my recent two-part series, I discuss the renewed emphasis I plan to place on Dividend Growth. Last quarter I began that emphasis in the new purchases made to the portfolios of my wife and I.

This quarter I continued our renewed emphasis on dividend growth and quality. We have increase the number of holdings with investment grade credit of BBB or higher. Only five holdings listed below fail to qualify under that criteria.

Last quarter I began a position in SeaDrill (NYSE:SDRL). This quarter Ensco (NYSE:ESV) and Bank of Nova Scotia (NYSE:BNS) were added after I made the decision to sell Dynex Capital (NYSE:DX) and Paychex (NASDAQ:PAYX) because of factors like quality and dividend growth.

Capital preservation, a key objective for our portfolio, continues to exceed expectations, particularly for a portfolio with 35% less risk than the S&P 500 Index. We are pleased that since starting in February of 2011, our return on capital is 58.54% compared to 52.54% for the S&P 500. Now that's what I call capital preservation!

Capital gains help ensure our holdings maintain their dividends and hopefully increase their growth. Remember it is primarily through dividend growth, not capital growth, that our monthly income increases. We like to think of the process as TDR - Total Dividend Return - yield plus dividend growth. During the same period, February of 2011 and today, our income from dividends has increased over 30%. Now that's what I call Total Dividend Return.

We expect the income to pull back just a bit as we scale back risk and reduce "low conviction" holdings.

Below are the current holdings making up my portfolio. They were purchased at fair value or better between 2011 and today.

Stock

Ticker

Yield %

5-Year

DGR

%

10 Year

Ave Return

5 yr.

EPS

Growth

Omega Healthcare

Investors

OHI

5.8

9.4

29.56

7.3

Reynolds American

RAI

5

7.8

10.91

7.8

W.P.Carey

WPC

5.9

4.8

11.99

6.4

Pepsi

PEP

2.7

9.3

7.80

7.0

Procter & Gamble

PG

3

10.2

7.73

8.4

National Retail Properties

NNN

4.8

2.2

12.2

3.8

Altria

MO

5.1

15.0

17.1

7.4

Magellan Midstream Partners

MMP

3.3

6.8

21.60

16.3

Verizon

VZ

4.4

4.1

5.75

6.0

ConocoPhillips

COP

3.9

12.9*

13.5

4.53

Stock

Ticker

Yield %

5-Year

DGR

%

10 Year

Ave Return

5-Year EPS

Growth

Chevon

CVX

3.4

9.2

15.54

1.0

Health Care Reit

HCN

6.4

5.4

13.19

13.4

Digital Realty

DLR

5.5

20.6

16.29

8.1

Kinder Morgan Partners

KMP

7.2

7.4

13.54

11.8

Coke

KO

3.2

8.4

6.8

8.2

McDonald's

MCD

3.3

13.9

22.56

8.7

AT&T

T

5.2

4.4

7.01

6.1

Kimberly Clark

KMB

3.1

7.0

9.33

7.3

Sunoco Logistics

SXL

3

10.6

24.09

8.65

Plains All America

PAA

4.4

5.2

18.60

5.1

Stock

Ticker

Yield %

5-Year

DGR

%

10 Year

Ave Return

5-Year

EPS

Growth

Southern

SO

4.7

4.0

7.7

5.1

Realty Income

O

5.4

1.5

13.28

4.5

Ventras

VTR

4.6

16.4

11.53

19.5

BCE Inc.

BCE

5.1

16.4

11.83

2.5

Royal Dutch Shell

RDS.B

4.6

6.7

9.54

Nat. Health Inv.

NHI

5.1

5.8

19.48

10.0

Vanguard Nat. Resources

VNR

8.5

45.5

17.11

(12.7)

Avista Corp.

AVA

4.2

14.3

12.04

4.0

Lorillard

LO

4.5

17.3

21.6

8.6

Rogers Communication

RCI

4

38.2

27.26

9.3

Stock

Ticker

Yield %

5Year

DGR

%

10 Year

Ave Return

5 Year EPS

Growth

Lockheed Martin

LMT

3.2

22.2

7.55

4.6

Microsoft

MFST

2.7

16.1

6.48

7.6

Enterprise Product Ptnrs

EPD

4

5.4

14.8

6.3

Baxter

BAX

2.7

16.4

10.39

7.4

PPL Corp.

PPL

4.6

3.4

9.15

.3

Hasbro

HAS

3.1

18.1

14.37

7.4

Waste Management

WM

3.6

8.1

7.30

7.3

Triangle Capital

TCAP

8.2

9.6

22.38 3 yr.

15.0

Stock

Ticker

Yield %

5-Year

DGR

%

10 Year

Ave Return

5 Year

EPS

Growth

Ensco

ESV

5.5

7.69

SeaDrill

SDRL

11.15

19.9

35.1(5yr)

17.1

Bank of Nova Scotia

BNS

3.5

7.6%

12.22

Kraft

KRFT

3.7

3.35

Mattel

MAT

3.9

16.4

10.04

8.2

Bank of Montreal

BMO

4.1

4.6

12.15

7.12

Wisconsin Energy

WEC

3.4

19.1

11.17

5.6

Energy Transfer Parters

ETP

6.8

15.82

2.65

Alliance Resource Partners

ARLP

5.6.

15.0

21.5

6.0

Click to enlarge

A large number of the above are not currently available at fair value. Please do you own due diligence. Those of you building portfolios may also wish to consider some of the additional holdings which I call my Dividend Safety Superstars. That series, soon to be updated, begins here.

As always it's time again to hear from each of you on your current approach to portfolio management and your quarterly review process.

Disclosure: The author is long ARLP, AVA, BCE, BMO, BNS, COP, CVX, DLR, EPD, ESV, ETP, HAS, HCN, KMB, KMP, KO, KRFT, LMT, LO, MCD, MMP, MO, NHI, OHI, PAA, PEP, PG, RAI, RCI, SDRL, SO, SXL, T, TCAP, VNR, VZ, WPC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.