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A Dividend Growth Portfolio

A dividend growth portfolio is in the broadest terms a collection of stocks that have a regular pattern of increasing their dividends. If you do a search on Seeking Alpha for “dividend growth portfolio” you will get over 1,000 hits consisting of articles, instaBlogs and comments. Dividend growth Investing is a very popular approach to investing success and Seeking Alpha has the finest collection of wisdom available on the subject.

A very good place to start is Evelyn C. Roth’s "Seeking Alpha's Dividend Investing Primer". Other popular and respected authors include well educated and experienced investment professionals such as David Van Knapp, Dividends 4 Life, David Fish, Chuck Carnevale and many more.

The Core of Your Dividend Growth Portfolio

This article is about the core of your dividend growth portfolio. That is, the heart of your holdings and the several key companies that make up the central part of your dividend growth portfolio. These companies, which make up the core should be the most solid and reliable engines of American capitalism: Large capitalization and low levered blue chip companies with long and great histories and every indication of equally bright futures. This core is the powerful and perpetual money machine around which you build your portfolio.

The core is surrounded by a variety of other great companies of different types and sizes. These other companies can include stocks with 5 but less than 10 years of dividend increases, utilities, REITs, mortgage REITs, business development companies, small caps, mid caps, multi level partnerships, preferred stocks and even ETFs. They add diversification and yield to the portfolio.

World class foreign companies may fit in some portfolios, especially those that are not tax advantaged such as 401ks and IRAs. The reason why is that you may be subject to unrecoverable foreign taxes if foreign companies are held in tax advantaged accounts. David Hunker has written a Seeking Alpha article describing foreign taxation rates titled "Withholding Tax Rates by Country for Foreign Stock Dividends" and many others on foreign stocks.

A well-designed core adds huge stability to your portfolio. These are companies with significant economic moats around them that dominate their markets, often worldwide markets. These companies are your best ideas and you know these companies well and why you own stock. Your holding of these companies is a result of good planning, of discipline and patience, which very important keys to success in any investing.

Plan Your Work, Work Your Plan

In my Seeking Alpha author profile I lament the fact that I have not always been a prosperous investor, but then proudly state that I am a “man with a plan”. I will add further that if it’s not written down it’s not a plan. If it’s not written down it’s just some ideas, often fleeting ideas, and not a solid road map to meet your goals and objectives. My dividend growth portfolio plan describes a central core of holdings quantitatively as follows:

  • USA based companies
  • Yield at purchase >= 3%
  • Increased dividend for >= 10 years
  • Dividend growth rate (DGR) >=5% over the past 5 years
  • Market cap >= $15B
  • Debt to total equity < 60%
  • Payout ratio < 70%
  • No negative free cash flow (FCF) in 5 years
  • Market dominance (Moat)

Your plan may not look like my plan, which is fine. The intent of this article is to illustrate how a dividend growth portfolio may be constructed, not to present a portfolio for all time for all people. Your objectives may be different from mine. My objectives include providing a conservative “sleep at night” core of holdings yielding at least 3%, as described above. This is within a total portfolio of 20 stocks yielding an average of 5% to provide current retirement income, all with dividend growth to counter inflation.

You may wish to hold fewer or more stocks, or you may have a more distant time horizon before you will need the income from this portfolio. If that is the case a 2.5% yield with a healthy dividend growth rate might be suitable. Some build a portfolio out of ETFs. Others ban them from their holdings. I have an eclectic approach driven by my goals which are part of a written plan which is revised annually.

A good example of a well written plan for a dividend growth portfolio is David Van Knapp’s "Constitution for a Dividend Growth Portfolio". By reading a variety of knowledgeable authors you will get many ideas which will be helpful in designing your portfolio plan.

It is important to define very carefully the quantitative measurements of these companies that are so important to your economic future. These are essentially pass/fail screens and measurement that define many aspects of any firm. For example, a criterion for core holding could be that they must yield a 3% dividend when purchased. Of course, that is an arbitrary number as they all are. It could be 2.5% or 4%, however, the lower it is the higher the dividend growth rate (DGR) must be to provide the same return in a reasonable time span. Retired investors find that a higher yield today is very appealing while a 35 year old can take a longer view and focus on the higher DGR.

I offer the below list of candidates for the core positions in your dividend growth portfolio.

Dividend Growth Portfolio: Core Candidates

SYMBOL

LAST PRICE

FORWARD

P/E

PEG

DIV YIELD

PAYOUT RATIO

DGR 5 YR

MKT

CAP

YRS INC

ABT

$52.95

11.4

1.30

3.6%

61%

9.47%

82.30B

39

ADP

$53.23

19.5

1.90

2.7%

57%

16.50%

26.60B

35

AFL

$46.21

7.5

0.60

2.6%

26%

19.78%

21.61B

29

CB

$64.45

11.8

1.28

2.5%

21%

11.23%

18.85B

47

CL

$87.62

17.5

1.95

2.6%

44%

11.60%

42.84B

48

COP

$75.26

8.5

1.81

3.5%

28%

10.35%

106.38B

11

CVX

$108.97

8.3

2.04

2.9%

28%

9.07%

219.06B

24

GD

$70.80

10.0

1.22

2.6%

24%

12.66%

26.34B

20

JNJ

$66.72

13.4

2.20

3.4%

52%

9.46%

182.89B

49

KMB

$67.90

14.0

2.09

4.1%

61%

7.70%

26.68B

39

KO

$69.73

17.9

1.93

2.7%

34%

9.13%

159.63B

49

MCD

$88.56

16.9

1.67

2.8%

49%

24.35%

91.89B

35

MDT

$37.07

10.8

1.38

2.6%

31%

20.46%

39.30B

34

PEP

$65.76

14.7

1.79

3.1%

51%

13.15%

103.94B

39

PG

$64.25

15.1

1.75

3.3%

51%

11.02%

179.34B

54

SYY

$31.33

15.0

2.09

3.3%

52%

11.26%

18.28B

40

T

$30.32

12.8

3.36

5.7%

48%

5.67%

179.56B

28

WMT

$54.52

12.2

1.16

2.7%

28%

7.13%

189.32B

37

Data for the above came from several sources: Seeking Alpha; Yahoo Finance; Dividends 4 Life Data; Morningstar; Daily Finance (an AOL site) and company annual reports. Initial Screens were made using Yahoo Finance; David Fish’s Champions, Challenger and Contender Lists; D4L Data and Daily Finance. No doubt there are omissions and I am confident that Seeking Alpha readers will propose additions.

This table includes those large cap firms with at least a 2.5% yield and 10 years of dividend increases. If the number of years of dividend increase were lowered to a minimum of 5 the list would include several other good companies, though not perhaps as suitable as core holdings. These include Intel (INTC) 8 years; Hertz (HTZ) 8 years; Lockheed Martin (LMT) 9 years. The tobacco companies also yield impressive dividends but again, without the long history of increases (MO, PM, RAI).

Finally, before making any purchase I make sure I understand the company and believe in its plans. The best way to do that is to read annual reports. The stocks below are my selections; my best ideas. These are some of the great engines of American capitalism. These six holdings can be as much as 50% of the value of my dividend growth portfolio according to my current portfolio discipline.

Core Holdings

Name

Symbol

Price

Yield

Forward

P/E

PEG

Ratio

Market

Cap

Abbott Labs

ABT

52.95

3.70%

10.68

1.36

82.30B

ConocoPhillips

COP

75.26

3.50%

8.48

1.81

106.38B

McDonald's

MCD

88.56

2.80%

15.84

1.67

91.89B

PepsiCo, Inc.

PEP

65.76

3.00%

13.39

1.79

103.94B

Procter&Gamble

PG

64.25

3.30%

15.08

1.76

179.34B

AT&T Inc.

T

30.32

5.70%

11.94

3.39

179.56B

In the descriptions of these holdings below, I start with the company’s story. The company must clearly relate what it does, its purpose and its plan for the future. After it does this, the quantitative measurements will reflect the skillful application of their good planning. You will notice that in each case I selected only one company. These are, by my instincts and understandings, by my analysis of their finances, by their position in the marketplace the very best companies to accomplish my goals.

Some might feel that it is wiser to add other similar companies to create more diversification. That is, JNJ along with ABT; CVX along with COP; YUM along with MCD; KMB in addition to PG and VZ along with T.

I disagree. Like all investors, I have limited resources. If I determine that ABT is the best healthcare company why would I weaken my portfolio by adding a substantial amount of JNJ, the second best? If I own PG why also invest heavily in KMB? Certainly Kimberly-Clark is a good company, but by most measures, P/E, PEG and market cap, PG is the more powerful force in the world, it is the bigger more efficient profit machine. Some companies are simply better than others for the purposes of this core of portfolio holdings. I certainly don’t want to dissipate the effectiveness of the best I have selected by tying up substantial resources in “also rans”.

Warren Buffett is an example to me. He has over 20% of his money in Coca-Cola (KO) and another 20% or so in Wells Fargo Bank (WRC). I do not believe he has a single share of PepsiCo (PEP) or a position in CitiBank (C) or Bank of America (BAC). Does that mean I should not own any securities other than my six best? My decision concerning that is that I will not invest in the runners-up to the degree I do the core holdings. I currently have smaller positions in JNJ and KMB. In the booming healthcare industry JNJ brings product lines to the table which ABT does not have. KMB gives my total portfolio a yield boost.

Outside of the core holdings, yield is gained, as is diversification among the sectors by exposure to other large cap US stocks and other asset classes such as REITs, mREITs, master limited partnerships (MLPs), small caps, mid caps utilities and preferred stocks. Two carefully selected foreign stocks that do not have negative tax implications are held (BMO, RDS.B), as is one stock (INTC) with only 8 years of dividend increases.

Details of Core Holdings

Abbott Laboratories (ABT) – Miles D. White Chairman of the Board and Chief Executive Officer, said in his 2010 letter to shareholders:

In 2010, Abbott did what you expected us to do: we built on our long tradition of success and delivered another year of strong performance. Despite significant challenges in the global business environment and health care industry, we achieved double-digit sales and ongoing earnings growth, record cash flow and improved gross margin, while remaining strategically active to help ensure the sustainability of our performance. As a result, Abbott is positioned to maintain top-tier growth across our broad base of businesses.

Abbott Laboratories engages in the discovery, development, manufacture, and sale of health care products worldwide. It does business in 130 countries with sales of $36 billion, just over half of which are from outside the US. Founded in 1888 by a Chicago pharmacist, it now has a market cap of $82B. It has aggressive plans to expand sales in emerging markets.

The driving force behind all of Abbott’s actions is its promise:

A passion for improving the health of patients worldwide. A drive to expand our potential through innovation. A commitment to position our company for long-term success. This is the essence of Abbott: “A Promise for Life.”

The pharmaceutical products segment offers adult and pediatric pharmaceuticals for a broad range of diseases and conditions. There is an impressive drug pipeline and Abbott has recently ramped up its R&D budget to $4B.

The diagnostic products segment offers immunoassay systems, chemistry systems, assays used for screening and/or diagnosis for drugs of abuse, cancer, therapeutic drug monitoring, fertility, physiological, and infectious diseases. Abbott has been an innovator in the field of HIV/AIDS diagnostics and treatments.

The nutritional products segment provides a line of pediatric and adult nutritional products. Similac baby formula is a well known product.

The vascular products segment offers coronary, endovascular, and vessel closure devices, such as drug-eluting coronary stent systems, coronary metallic stents, balloon dilatation products, coronary guidewires, vessel closure devices, and carotid stent systems to treat vascular disease.

Morningstar sums it up saying,

On the foundation of a wide lineup of patent-protected drugs, a leading diagnostics business, a strong nutritional division, and a top-tier vascular group, Abbott Laboratories has dug a wide economic moat. We expect these operating lines will continue to generate strong returns and drive growth.” The stock price is not volatile as the stock has a low beta of 0.29.

ConocoPhillips (COP) is an international, integrated energy company. As of Dec. 31, 2010, it is the third-largest U.S. integrated energy company, based on market capitalization, as well as proved reserves and production of oil and natural gas, and the largest refiner in the United States. ConocoPhillips is the seventh-largest holder of proved reserves and the fourth-largest refiner worldwide, of nongovernment-controlled companies.

Soon to be spun off is its refining and marketing (R&M) segment. COP will focus where its expertise is, where it invests its capital, and where it derives the best profit: the exploration and production (E&P) segment of the business. This could be a very good plan.

Conoco Phillips pays the highest yield of any major US oil company and this is the deciding factor in my choice. It has increased its dividend for 11 consecutive years. It beats out CVX, another great company, in the areas of yield, 5-year dividend growth rate and PEG ratio. Both have forward P/E ratios of about 8.5 according to Yahoo Finance. Others might choose CVX. Exxon Mobil (XOM) is interesting due to its sheer size with a market cap of $419B. However, it only yields 2.2% so it is not suitable for this portfolio.

COP is going through a significant change, has a shorter period of dividend increases at 11 years and a higher beta than other core holdings at 1.24; it will bear the closest scrutiny going forward. However, it is a great investment today with the promise of being a better one in the future.

McDonald’s (MCD) is the largest fastest food chain in the world and operates 32,800 restaurants in more than 117 countries. Under its trademark golden arches McDonald’s sells billions of burgers and various other food items, often with a menu tailored to the local taste. The company has one of the strongest brand images in the world and is number 1 in most of its markets. It is growing at a rapid pace in developing countries. McDonald’s is an immensely profitable company with net profit margin of 20.6%, almost twice the industry average. Recently McDonald’s was trading at $88.50. Their market cap is $91.89 billion. The company has a forward P/E ratio of 15.84. The return on equity is 35%. The beta is a stable 0.36 which indicates that it is only about 1/3 as volatile as the broad stock market.

Morningstar says:

We are optimistic that [MacDonald’s] is capable of generating excellent returns on invested capital over an extended horizon. Our confidence stems from unrivaled scale advantages, an incredibly strong brand, and ample international growth opportunities. We don't expect these qualities to abate anytime soon, thus earning McDonald's the widest economic moat in the restaurant category.

Like other superior companies they have an understandable and effective plan. The Plan to Win is the foundation of their powerful, efficient systems and growth. They will continue with their winning formula: Building on the basics as we further modernize and differentiate the brand.

PepsiCo (PEP) is a 100 year old marketer of snack food and beverages that sells $62B annually in nearly 200 countries. Pepsi has a comprehensive plan: “Performance with Purpose”. This means delivering sustainable growth by investing in a healthier future for people and our planet.

A quote from the 2010 Annual Report:

As a global food and beverage company with brands that stand for quality and are respected household names — Quaker Oats, Tropicana, Gatorade, Frito-Lay and Pepsi-Cola, to name a few — we will continue to build a portfolio of enjoyable and wholesome foods and beverages; find innovative ways to reduce the use of energy, water and packaging; and provide a great workplace for our associates. Additionally, we will respect, support and invest in the local communities where we operate by hiring local people, creating products designed for local tastes and partnering with local farmers, governments and community groups. Because a healthier future for all people and our planet means a more successful future for PepsiCo. ...the promise of PepsiCo is to continue to generate solid value for our shareholders.

Coca-Cola (KO) may be the real thing but PEP has a better P/E ratio, lower PEG and higher yield. PEP also has a slightly lower beta of 0.53.

By selling a wide range of snack products PepsiCo can easily add products and profits to its distribution system. Brands fall into the following categories: Pepsi-Cola Brands; Frito-Lay Brands; Tropicana Brands; Quaker Brands; Gatorade Brands.

Procter & Gamble (PG), a Cincinnati, Ohio based company, is one of the best managed and most powerful companies in the world. P&G brands serve about 4.2 billion of the 6.5 billion people on the planet today. They have a plan, a well-articulated purpose.

From the company's website:

Companies like P&G are a force in the world. Our market capitalization is greater than the GDP of many countries, and we serve consumers in more than 180 countries. With this stature comes both responsibility and opportunity. Our responsibility is to be an ethical corporate citizen—but our opportunity is something far greater, and is embodied in our Purpose.

P&G’s "Purpose Statement" articulates a common goal:

Our Purpose

We will provide branded products and services of superior quality and value that improve the lives of the world’s consumers, now and for generations to come. As a result, consumers will reward us with leadership sales, profits and value creation, allowing our people, our shareholders and the communities in which we live and work to prosper.

  • Consumer Understanding -- No company in the world has invested more in market research than P&G. We interact with more than five million consumers each year in nearly 100 countries.
  • Innovation -- P&G is the industry’s innovation leader. Nearly all organic sales growth over the past decade has come from new brands or improved products.
  • Brand-Building -- P&G is the brand-building leader of our industry. Twenty-three of these brands each generate more than $1 billion dollars in annual sales.
  • Go-to-Market Capabilities -- We’ve established industry-leading go-to-market capabilities. We are frequently ranked as the industry leader in a wide range of capabilities, including clearest company strategy, brands most important to retailers, strong business fundamentals and innovative marketing programs.
  • Scale -- P&G is creating scale advantage by integrating across our enterprise, consistently acting as one Company across our businesses and markets. By harnessing the strength of our brands and categories as one Company, we can better serve more consumers around the globe.
  • Purpose-Driven Innovation -- We are growing P&G by fulfilling our purpose with innovative products that improve people’s lives in small but meaningful ways. We are bringing many innovations to the market around the world.” This is the heart of the plan.

The numbers reflect their success. PG has an operating margin of 20% and a return on equity of 17%. Revenues continue to grow in good times and bad and the dividend growth rate is over 13%/year. The debt to total equity is 41% and the payout is 51%.

AT&T (T), together with its subsidiaries, provides telecommunication services to consumers, businesses, and other service providers worldwide. Its wireless segment offers wireless voice communication services, including local wireless communications service, long-distance service, and roaming services.

This segment also sells various handsets, wirelessly enabled computers, and personal computer wireless data cards; and accessories comprising carrying cases, hands-free devices, batteries, battery chargers and, other items. This segment sells its products through its own stores, or through agents or third party retail stores.

The company’s wireline segment provides voice services, including local and long-distance services, calling card, 1-800 services, conference calling, wholesale switched access service, caller ID, call waiting, and voice mail services; and application management, security service, integration services, customer premises equipment, outsourcing, government-related services, and satellite video services.

This is a huge and growing worldwide company. There is a wealth of information on their website .

Our customers work and live in virtually every country and territory in the world. We serve millions of enterprise and multinational business corporations on six continents. We offer a variety of service plans that enable U.S.-based customers to stay connected to friends and work colleagues who are overseas. We also enable our customers to keep in touch when they travel outside the U.S.

The foundation for this is a network that's more powerful and capable than ever. The domestic wireless network covers more than 300 million people, and provides the broadest international access of any U.S. mobile provider. Global networking capabilities provide advanced connections for businesses to 182 countries. On an average business day, the global backbone carries nearly 24 petabytes of data traffic — more than 100 times the digitized Library of Congress.

AT&T is committed to staying on the leading edge of communications and entertainment technology,

For more than a century, telephone has consistently provided innovative, reliable, high-quality products and services and excellent customer care. Today, their mission is to connect people with their world, everywhere they live and work, and do it better than anyone else does. AT&T is fulfilling this vision by and entertainment industry.

AT&T’s market cap is $179B, it has a ROE of 19, a P/E of 12.8. The total debt to equity is 57% and the payout is 48%. The beta is 0.51.

__________________________________________________________________

Dividend Income Portfolio – Bob Johnson – 7/25/2011

SYMBOL

NAME

YIELD

ABT

Abbott Laboratories

3.60%

BMO

Bank Of Montreal

4.60%

CINF

Cincinnati Financial Corporation

5.60%

COP

ConocoPhillips

3.50%

CTL

CenturyLink, Inc.

7.60%

ED

Consolidated Edison, Inc.

4.40%

EPD

Enterprise Products Partners

5.50%

INTC

Intel Corporation

3.20%

JNJ

Johnson & Johnson

3.40%

KMB

Kimberly-Clark Corporation

4.10%

LEG

Leggett & Platt, Incorporated

4.60%

MCD

McDonald's Corporation Common

2.80%

MMP

Magellan Midstream Partners

5.10%

NLY

Annaly Capital Management

14.50%

O

Realty Income Corporation

5.00%

PEP

PepsiCo,

3.10%

PFF

iShares S&P US Preferred Stock

7.20%

PG

Procter & Gamble Company

3.30%

RDS-B

Royal Dutch Shell

4.50%

T

AT&T Inc.

5.70%

UHT

Universal Health Realty Income

5.70%

Source: Constructing the Core of Your Dividend Growth Portfolio