I am a firm believer in Buffett’s old adage that "there are no called strikes in investing." If an investor is patient the market will eventually err and they will be in a position to capitalize on the mistake. There is no need to chase stocks for the sole reason of owning them. For instance, I love Chevron (NYSE:CVX) as a company. I feel it is the best integrated oil play on the market, but not at its current $90 cost basis. I will wait for Chevron’s price to come down, or allocate my capital elsewhere.
As a long term dividend investor, I have been twiddling my thumbs since July. Good entry points have been few and far between, with the market slowly, but steadily, grinding upwards. The economies seemingly renewed strength, pro-business Obama, QE2 and a Republican congress has changed my outlook for 2011. Barring any unforeseen macro events, the market wants to go higher and thus it will go higher. I have learned the hard way not to fight the fed.
Taking this all into account, how can we construct a long term dividend portfolio for 2011 and beyond? What companies will benefit from QE2 and an international economic recovery? What companies have lagged the market and offer capital appreciation as well as a stable yield?
Before we get to these questions, let’s take a look at some basic rules I use when constructing a long term dividend portfolio:
1. Diversification: In any portfolio diversification is essential. Spreading your money across sectors ensures you are not putting all your eggs in one basket. Diversifying a dividend portfolio can be exceptionally difficult as the majority of qualified companies are consumer staples, energy and utilities. Nonetheless, I cannot stress the idea of diversification enough. Look at the dividend investors that were overweight financials in 2009. Furthermore, we want to diversify internationally. Opening our portfolio to different markets hedges our investments against sudden downturns in certain economies and currencies.
2. Dividend Yield and Growth: When analyzing dividend growth companies I am looking for a yield greater than 3%, with a payout ratio lower than 50%. A company with consistent dividend growth as well as a low payout ratio is often financially secure and well managed. Good places to start looking for these companies are The Drip Investing Resource Center’s Dividend Champion list (here) or the S&P Dividend Aristocrat list. For the sake of this article I am not limiting myself to these lists as I am building a dynamic portfolio of dividend paying stocks.
3. Value: I'm always looking for value. I am looking for stocks that are selling for a discount to their peers or previous multiples. We are looking for beaten down stocks, not beaten down companies. The dividend yield from these companies allows us to sit on the stock as the market eventually realizes the company’s true value.
I want to start the portfolio by focusing on six separate sectors: Basic Materials, Finance, Consumer Staples, Energy, Healthcare and Utilities. This should give me broad exposure to the market while focusing my attention on the traditionally best yielding sectors.
Without further ado, I present the T20YM Dividend Value Portfolio (T20YMDVP):
Basic Materials: Weyerhaeuser (NYSE:WY) $18.84 2011 EST Yield 3.30%
Weyerhaeuser grows and harvests trees, builds homes and manufactures forest products worldwide. The stock is heavily levered to the housing market and has been pummeled since July. Barclays recently rated the stock as #2 on its 2011 buy list noting that WY trades below the liquidation value of Weyerhaeuser's various assets. Additionally, the stock has bounced nicely off its 52-week low and has made a steady march upward. WY is transitioning to a REIT and tripling its dividend in 2011. If you believe the housing market is recovering, or even bottoming, this is a great entry point on WY. The company is significantly undervalued and the 3% dividend allows you to get paid until the housing market corrects itself. Furthermore, timber performs well in inflationary environments, something I expect in 2011.
Finance: Bank of Montreal (NYSE:BMO) $57.38 EST 2011 Yield 4.20%
As far as financials go, I am a huge supporter of Canadian banks. Bank of Montreal provides a range of retail banking, wealth management and investment banking products and solutions in North America and internationally. Its stock price has recently been punished due to its peculiar acquisition of Marshall & Ilslley. Regardless of the risk involved in the deal, BMO is nearly doubling its exposure to the American market. The fundamentals of BMO are still sound, trading at a forward P/E of 9.8, Forward PEG hovering right around 1 and P/B 1.71. At its current price its payout ratio is high for my taste (77%) but this should correct as the stock price appreciates. BMO remains one of the strongest, stable banks operating in developed markets. Investors should take advantage of the recent pullback.
Health Care: Abbott Laboratories (NYSE:ABT) $47.42 EST 2011 Yield 3.70%
Abbott Laboratories engages in the discovery, development, manufacture and sale of health care products worldwide. It operates in four segments: Pharmaceutical Products, Diagnostic Products, Nutritional Products, and Vascular Products. This Dividend Champion is a model of consistency and has increased its dividend for 38 straight years. In addition to its consistent yield ABT is expanding its market share. Abbott will become the largest seller of prescription drugs in India following its $4 billion purchase of Piramal Healthcare, a maker of generic medicines in emerging markets. Its trading at a forward P/E of 10.2 and a forward PEG of 1.15. It’s just plain cheap. It seems to finally found support from its recent plunge and is on the mend. 2011 should be a great year for ABT share holders.
Consumer Staples: Diageo (NYSE:DEO) $74.33 EST 2011 Yield 4.00%
Diageo plc engages in producing, distilling, brewing, bottling,packaging, distributing, developing and marketing spirits, beer, and wine products. The company offers a range of brands, including Johnnie Walker scotch whiskies, Smirnoff vodka, Baileys Original Irish Cream liqueur, Captain Morgan rum, Jose Cuervo tequila, JeB scotch whisky, Tanqueray gin, and Guinness stout and many, many, more. The sheer brand strength of DEO alone makes it a fantastic investment. Furthermore, DEO has increased its annual dividend by nearly 7% over the last decade. Its payout ratio is approaching 55% which is a little high for my liking and its balance sheet is not pristine. Yet the average median price target for DEO 2011 is $82.13. Diageo is foreign owned consumer staple with considerable exposure to emerging markets. For a more detailed review of DEO check one of my favorite blogs The Dividend Monk's analysis here.
Energy: Total (NYSE:TOT) $52.82 EST 2011 Yield 5.10%
TOTAL S.A., together with its subsidiaries, operates as an integrated oil and gas company worldwide. The company operates through three segments: Upstream, Downstream and Chemicals. This French company is one of the largest integrated oil companies in the world. TOT has lagged the recent energy rally and has failed to recover from the European drubbing that occurred in September. Take a look at the 200 day returns from its closest competitors:
TOT is trading at a P/E of 7.7 and a P/B 1.57 is yielding 5.10% and has a payout ratio of 46%. This is the cheapest integrated oil play on the market with a great dividend. As much as I like CVX and Conoco Phillips (NYSE:COP), TOT is selling at a discount.
Utilities: Exelon (NYSE:EXC) $41.90 EST 2011 Yield 5.00%
Exelon Corporation is a utility service company that engages in the generation, transmission, distribution and sale of electricity to residential, commercial, industrial, and wholesale customers in northern Illinois. The company generates its electricity from nuclear, fossil and hydroelectric generation facilities. Exelon is one purest plays on nuclear energy in America as it generates roughly 92% of its electrical power from its nuclear power plants. Its forward P/E is 10.6 with a yield of 5% and a payout ratio of 44%. EXC does carry a considerable amount of debt on its balance sheet (as most utility companies do) but remains a safe and secure investment. EXC stock price is oddly levered to Natural Gas prices as most its competitors derive their electricity from the fuel. Thus as nat gas prices tumbled so did Exelon’s share price. Nat Gas won’t stay cheap forever, and neither will EXC. With both political parties committing to moving the country toward nuclear energy, EXC seems poised for big growth.
So there you have it, a well diversified Dividend portfolio for 2011 and beyond. Through ABT, TOT and DEO the T20YMDVP offers broad exposure to European and emerging markets. It contains commodity names such as WY and TOT that offer hedges against QE2 inflation. It plays the bottom of the nat gas and housing markets with WY and EXC. More importantly, all these stocks are offering excellent entry points with a combined yield of roughly 4.2%. This is a portfolio I would be comfortable purchasing today.
Best of luck in 2011.
Disclosure: I am long BMO, WY, DEO, EXC, ABT, TOT.