Watching Dividends Rise: Putting Together a Focused Dividend-Growth Portfolio

|
 |  Includes: ABT, CVX, JNJ, KMP, LNT, MCD, O, PEP, SHW, T, TEF
by: David Van Knapp

In 2008, I re-tooled an existing aimless portfolio to become a focused dividend-growth portfolio. I did this in conjunction with publication of the first in what has become an annual series of e-books on dividend investing. The current edition is TOP 40 DIVIDEND-GROWTH STOCKS FOR 2011: How to Create Wealth or Income from Dividend-Growth Stocks. When I retooled the portfolio, I gave it a great name (Dividend Growth Portfolio) and used the e-book as a guide not only to what stocks to select but also to how to manage the portfolio. I created a strategy document and set of rules to govern the portfolio.

The Dividend Growth Portfolio's purpose is to demonstrate the results that can be achieved by following sound dividend-growth investing principles. I consider it in many ways to be a typical portfolio of its type. It is not a hypothetical, model, or back-tested portfolio. It is real, reflecting decisions made in real time..

I thought that it would be instructive to take a look at the portfolio now that it has three full years under its belt.

As should be obvious, the main focus of a dividend-growth portfolio is to create streams of dividends that become ever-larger over time. This portfolio is doing that.

Year

Dividends

Yield on Cost

Change

2008

$1316

3.3%

2009

$1568

3.9%

19%

2010

$1799

4.5%

15%

Click to enlarge

The yield on cost is based on the original value of the portfolio ($40,000). Note how the dividend stream and yield on cost both march continually upward. Yield on cost goes up steadily, because the divisor in the equation yield = dividends / price is fixed at the original $40,000, while the numerator increases every time a dividend increase is declared. Ultimately my aim is to have the portfolio generating 10% yield on cost within 10 years of its re-tooling in 2008. At this point, it appears on pace to accomplish that goal.

The portfolio exists at E-Trade. They have a tool called an Income Estimator that projects dividends over the next 12 months. The Estimator is a good tool, but it cannot predict perfectly, because it does not know some things:

  1. Dividend increases as yet undeclared by each company. The portfolio contains only companies that are expected to raise their dividends annually. Until the increases are actually declared, the Estimator cannot include them.
  2. Dividends on additional shares that will be purchased with incoming dividends. Unlike many dividend-growth investors, I do not “drip” dividends to purchase new fractional shares. Instead, I let the incoming dividends accumulate to a certain amount (currently $1000), then re-invest them in a company that is well-valued at the time. So the yield on cost shown in the table above is really a “dividend-reinvested yield on cost.” Reinvesting dividends speeds up the velocity of yield on cost from what would result from dividend increases alone. (See “How Reinvesting Dividends Accelerates Yield on Cost.”)
  3. Any other changes that may be made to the portfolio, such as swaps into higher-yielding stocks.

At the current time, this is what the Income Estimator projects for 2011:

Year

Dividends

Yield on Cost

Change

2011

$1905 e

4.8% e

6% e

Click to enlarge

The “e” in the last three columns indicates that the dividends are projected based on information known now. By year-end, all of those numbers should be higher for the three reasons listed above.

This year I am tracking the monthly changes in the Estimator’s projections. Here is what they have looked like for the “forward 12-month” period from the first of each month of 2011:

Estimate as of first of month…

Dividends Next 12 Months

Yield on Cost

Change

January

$1864 e

4.7% e

February

$1905 e

4.8% e

2% e

March

??

??

??

Click to enlarge

Part of the jump in February is the result of a reinvestment in January. I used accumulated dividends to add to an existing position in Abbott Labs. As more dividends roll in during 2011, I expect to make one or two more purchases this year. I believe the total dividend stream in 2011 will increase 10% to 15% compared to 2010. I’ll follow up from time to time to see whether that is being achieved.

These are the stocks currently in the Dividend Growth Portfolio. Some of them are legacy purchases that may not survive the next Portfolio Review. (This article, Portfolio Forensics, describes the last Review in August, 2010.) Others have been in the portfolio since it was first constructed in 2008.

  • Abbott Labs (NYSE:ABT)—added to position in January, 2011
  • Alliant Energy (NYSE:LNT)—new position in 2010
  • AT&T (NYSE:T)
  • Chevron (NYSE:CVX)
  • Johnson & Johnson (NYSE:JNJ)—new position in 2010
  • Kinder Morgan Energy Partners (NYSE:KMP)
  • McDonalds (NYSE:MCD)
  • Realty Income (NYSE:O)
  • PepsiCo (NYSE:PEP)
  • Sherwin Williams (NYSE:SHW)
  • Telefonica (NYSE:TEF)
  • Cash 0%--About $1000 was used in January, 2011 to add to position in Abbott Labs

Disclosure: I am long ABT, LNT, T, CVX, JNJ, KMP, MCD, O, PEP, SHW, TEF.