How A 2-Sided Dividend Portfolio Can Achieve Both Dividend Income And Growth

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Includes: AAPL, DIS, JNJ, STX, TU
by: Jason Fieber

Special note by Dividend Mantra: This is a guest post by Mike, aka The Dividend Guy. He’s authored The Dividend Guy Blog since 2010 and manages portfolios at Dividend Stocks Rock. He is a passionate investor.

I’ve been a long time reader of Dividend Mantra since the very beginning (2011!) because we both share a passion for dividend investing. When I started blogging about dividend stocks back in 2010 (when I bought The Dividend Guy Blog), there weren’t that many investors blogging about this type of investing. Now that bonds and CDs are paying yield less than the rate of inflation, dividends has been the buzz word over the past three years. Most retirees (read pension funds!) looked at how they could generate a steady income stream without jeopardizing their nest egg. This is why a regular dividend paying stock like Procter & Gamble (NYSE:PG) saw its P/E ratio going from 14-15 back in 2010 to over 20 in 2014:

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Dividend stocks rose from 2009 to 2014 for two reasons: the economy was slowly coming back, bringing higher sales and revenues, but the appetite for steady income such as dividends grew so much that we are currently willing to pay a premium for a rock solid dividend stock. Some even talk about a dividend bubble…

But now that the easy money is gone, it has become more difficult to find great dividend growth stocks at a reasonable price.

What I Look for as a Dividend Growth Investor

Investing in the stock market has never been an easy task. It seems easy when you are in a bull market like right now, but it gets a lot tougher than when you go through one of those “2008 market mayhem” conditions. This is why investing new money in the market right now is hard: you want to make sure you buy companies that will successfully endure a recession and keep paying their dividends. This is the main reason why I’ve built my own strategy with a two sided dividend portfolio.

Call it “philosophy,” “strategy” or “process” -- I call it my dividend growth model. What I’m after is: a long-term portfolio showing strong dividend growth. Prior to 2010, I was an “aggressive” trader with a great appetite for risk. After actively trading from 2003 to 2006, I sold my portfolio and bought my first house with $50K in trading profit. Oh… I started in 2003 with $0 in my brokerage account and a line of credit of $20,000. I “converted” to dividend investing because I wanted to have something more stable… and because I had lost 50% on a penny stock trade! I like the stability that dividend paying companies bring to a portfolio, but I was still hungry for high returns. This is why I focus as much on dividends as I do on growth.

For example, I selected Disney (NYSE:DIS) for my own portfolio paying a small dividend yield of 1% but it surged by 207% from 2009 to 2014. During the same period, DIS dividend payouts grew by 145%. This is what I call growth.

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Enter the Two-Sided Dividend Portfolio

In order to satisfy both my appetite for higher returns and stability, I’ve decided to divide my dividend portfolio into two kinds of investments: One side with higher capital gain potential and one side with the classic buy-and-hold-forever blue chip dividend stock. Therefore, while I build a solid core portfolio with stable companies, I also add some spice to my holdings with stocks I can buy and sell within a 12- to 24-month period.

Here are a few examples of stocks I bought and sold for a healthy profit: Seagate Technology (NASDAQ:STX), Intel (NASDAQ:INTC), Husky (OTCPK:HUSKF). More recently, I bought shares of Apple (NASDAQ:AAPL) and Gluskin & Sheff (OTC:GLUSF) based on the same principle: there are stocks providing both dividend growth and stock appreciation over a short period of time. If I had to design my dividend growth model on a piece of paper, it would look like the following:

The Core Portfolio Model

I built my core portfolio based on a very strict set of investing rules. I’ve been building this “investing code” over the past four years and had modified it slightly to reflect the current market. In order to select stocks that will be part of my core portfolio, I use a similar filter as the one creating the DSR Premium Stock list:

Dividend yield over 2.50%

Dividend payout ratio under 80%

3yr/5yr Dividend growth positive

3yr/5yr EPS growth positive

3yr/5yr Sales growth positive

P/E ratio under 20

When I first started investing in dividend stocks, I was looking for a higher dividend yield (3%+) and lower P/E ratio (under 17-18). But now that the market has surged for almost five years, I have no other choice to become less picky with dividend yield and more lenient with P/E ratio. After all, who would not pick Johnson & Johnson (NYSE:JNJ) right now even if the dividend yield is 2.73% and the P/E ratio is close to 19? This company has great years to come and I want to be on that boat!

The first three criteria help me understand where the dividend is going with this company. At best, I will pick a company with a 50%-60% payout ratio, but I will consider a company up to 80%. In both cases, there is still room for payout increases in the future. Then, I combine the 3- and 5-year dividend growth, EPS and sales on the same graph. I look to find similar trends between the three metrics:

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This is Telus (TU on the NYSE or T.TO on the TSE) chart. All three metrics are following pretty much the same trend.

Overall, my core holdings are meant to follow the traditional dividend investing approach, which is buying at a reasonable price, holding for several years and cashing an ever-growing dividend payout. However, I keep running my rules against my current holdings to make sure they meet my minimum requirements. If a company starts to lag with its financial results, the stock is put on the watch list for a sell. I try to identify the reason for the slowdown and will sell eventually if I lose faith in management.

The Dividend Growth Stock Additions

As I mentioned previously, because I find buy-and-hold boring, I also decided to pick a few stocks that do not meet my set of rules. This is what I call the “dividend growth stock additions.” They are being added to my portfolio as a “second” side to my dividend growth holdings. These stocks must pay a dividend and follow most of my investing rules. But they are allowed to skip a few requirements in exchange for a bigger growth potential.

You can take Seagate Technology as a great example. After an important flood in Taiwan, the stock sank and was trading at a ridiculous P/E ratio (as low as 3!). There wasn’t a great future ahead, and most investors got off the boat early. I waited a few months and started looking into the company when it was back in production. I decided to take the bet and bought it in 2012:

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Which Trigger I use to Sell in my Portfolio

I find selling stocks in my core portfolio easy. If a company doesn’t follow my set of rules year after year, I put it on a watch list and am pretty fast to pull the trigger to buy a more compelling company. For example, I sold Chevron (NYSE:CVX) in July 2014 to buy more Apple and Johnson & Johnson. While both AAPL and JNJ show strong sales and profit for the future, Chevron is stagnating on the sidelines.

But selling a winning pick such as STX is not an easy task. I remember at the time I sold; Seagate was up by more than 60% in my portfolio and paying close to 7% dividend yield based on my cost of purchase. Why did I pull the trigger then? The growth potential started to fade with a stock at $40. Once the stock reached $40 in 2013, the company was posting negative growth for sales and earnings:

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Since I was making a healthy profit, I put a stop sell at $40 when the stock was at $42. STX hit $40 not so long after and the cash was deposited in my account, ready to be used for the next stock on my watch list to buy.

The stop sell is my best selling tool. It protects my return and makes the decision to sell without involving my emotions on that day. Most of the time, I realize the stop sell went through the day after the sale. By putting the order through my broker account, I avoid the risk of “giving a second chance” to a stock on a losing trend. The stop sell is triggered upon the fact that I don’t see the potential growth I saw when I first buy the stock.

For example, I saw a buying opportunity in Apple (AAPL) when the stock was trading around $450 (now the equivalent of $64 with the 1:7 split). I bought the stock at that time, and I keep riding the wave right now because I can still see the potential as sales are rising again. At one point, if the company fails during the innovation process to bring more growth to the table, a stop sell will be put in place close out the trading price. If I’m wrong, the stock will continue to go up and I won’t have to worry. If I’m right, my profit will be protected.

Number of Transactions per Year

My dividend growth model doesn’t imply many transactions per month. In fact, I usually make about 5 to 8 transactions per year as I’m still building my own portfolio. My DSR portfolios will likely include less transactions than that. I don’t believe in actively trading dividend stocks as you pass by their most attractive asset: dividend payout growth! However, a great company today doesn’t mean it will continue to be a great company forever. It is also true as many companies become great buying opportunities over time.

Final Thoughts on my Dividend Growth Model

As you can see, I didn’t reinvent the wheel with my investing approach. The point of having two-sided portfolios enables me to generate higher growth than the market along with a more than reasonable dividend payout. I hope to retire young with my dividend holdings as a key point in my financial plan. This is how I built and manage twelve portfolios based on your country (6 US and 6 Canadian) and the amount you have to invest (going from starter to 500K+). The 12 DSR portfolios are managed based on my experience and inspired by my own dividend growth model; a simple but effective strategy.