- 2014 finds an increasing number of overbought dividend stocks.
- This presents a real challenge to new self-directed investors.
- This article explores the question should recently retired investors build their portfolio in this environment?
Last weekend I read two great articles here on Seeking Alpha. One by Chuck Carnevale focused on the opportunities he found in Dividend Champions. The second by Mike Nadel spoke to the importance of owning dividend stocks that were recession proven. Both generated lively discussion. This time I around, I thought I would combine and build on both themes.
In reading the comments, I noticed the frustration being expressed by a number of new investors seeking to build new portfolios in what is becoming an increasingly oversold market.
For the sake of further discussion let's assume the following: It's 2014, you just retired and after listening to the suggestions of advisors connected to your 401ks, you decided perhaps it was time to manage your own accounts and join the growing number of self-directed investors. You discovered Seeking Alpha and found that you particularly enjoyed the articles written about actual self-managed portfolios. You also discovered that many of these writers favored an approach to distribution phase investing known as Dividend Growth.
For folks retiring in 2014, this presents a particularly challenging time to sell your mutual funds and build a dividend growth portfolio. By now many of you may have already begun and know of its difficulty firsthand.
You've started with the decision that the dividend approach to investing is right for you, particularly since you are risk-averse in your approach to investing. You completed a business plan using the framework provided here to help guide your buying and selling decisions.
You set an initial yield on cost of 4%-plus from your portfolio value. Since your portfolio is $400,000, this will mean a monthly paycheck from dividends totaling $1333 per month. Your first year goal is to obtain 6% dividend growth. A figure equal to twice the rate of inflation. If you obtain your goal, this would mean your dividend paycheck would increase to $1413 after one year.
You have decided to limit your holdings to Dividend Champions, Contenders and Challengers with a history of being Recession-Proven. For a list of some of the best Recession-Proven stocks, click here.
You also decided that your selections needed to provide a margin of safety. So you set a minimum yield for purchase of 2.75%, roughly 1.5 times the yield for the S&P 500 Index.
You downloaded your copy of the Dividend Champions and discovered that as of August, there were a total of 540 stocks reflected in the lists above. There were 106 Dividend Champions, of which 47 have a current yield of 2.75% or more. Of these only 10 -- 10% of the total -- currently satisfy the total dividend return or "chowder" rule after the Seeking Alpha contributor who writes under the name Chowder. This rule states that yield plus average 5-year Dividend Growth Rate or DGR equal 12. An exception is made for higher yielding slower growing utilities, telcos and REITs.
You know from your readings on Dividend Growth investing the importance of not overpaying for a new position. Ideally purchases should be made when stocks are unvalued. Of the 10 Champions providing your preferred margin of safety, none appeared to be currently unvalued.
By now you might be feeling a bit discouraged. You may be thinking, you wanted the measure of safety that you believe comes from holding Dividend Champions. The question you have to ask is whether it's worth overpaying to do this, or better to patiently wait for others to come down to at least fair value.
Let's take a closer examination of the stocks in question. Their combined yield is a little under the 4.0% you wish as a minimum. Combined 5-year DGR of 8.8 seems solid. Combined 10-Year Ave Return is a market-beating 10.59%. Finally 5-yr. Estimate earnings Growth is 6.14% more than twice inflation. This would appear to suggest capital preservation, a secondary goal for this portfolio after income. Not a bad start perhaps after all.
10 Stock Ave
Fortunately, you also uncovered 50 Dividend Contenders that satisfy the chowder rule and seem to suggest the margin of safety you're looking for. In Part Two of this series, we'll explore those currently believed to be fairly valued.
As you dig even deeper ,you find 34 Challengers that are both "recession proven" and satisfy the chowder rule. They will be explored further in Part Three.
If you are new to dividend investing, I would ask that you consider becoming a follower in order that you not miss Parts Two and Three of this important series.
Now it time to hear from you.
How important do you feel is obtaining a margin of safety when setting up a new dividend portfolio?
How important do you feel dividend growth is to a "distribution stage" portfolio?
What are your comments on the importance of using the "chowder rule" when selecting stocks for your portfolio?