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It is the first week in October and the global stock markets are continuing the summer swoon. Here in Bumpass, Virginia the leaves are falling and fall has set in with colder weather. The thoughts of this retiree in October, especially after the 5 months of downdraft in the markets are preservation of capital. By holding an income portfolio of dividend growth stocks, there is some price resilience inherent. However, an additional layer of security can be added to the equity portion of the portfolio by diversification into Mid Cap stocks—stocks with a market capitalization of $1B to $10B—make up 28% of the MSCI US Broad Market Index. Large Cap stocks make up 65% and small cap stocks make of 7% of the US market. These stocks are usually considered more growth oriented, due to their smaller size. If one can find stocks such as these that meet my 4% minimum yield + Tweed Model metrics (yield + 5-yr dividend growth rate > ttm P/E), they should provide further protection during market volatility. For example, today the Dow Jones Industrial Average is down 1.36%, while the Mid Cap 400 is up .12%.

I have selected three stocks from David Fish's most recent CCC charts this week to illustrate their diversifying effects on the portfolio (Data from First Call, Yahoo Finance and David Fish's CCC charts).

  1. Leggett & Platt, (LEG) – Consumer Discretionary sector. This Dividend Champion has 40 years of consecutive dividend increases. The current yield is 5.7%. The 5-year annual average dividend growth rate is 11%. The current p/e is 16.63. The projected earnings per share growth rate for next year is 27.82%. However, the 5-yr projected annual average earnings per share growth is -6%.

  2. J. M. Smucker Company (SJM) – Consumer Staples sector. This Dividend Contender has 12 years of consecutive dividend increases. The current yield is 2.6%. The 5-year annual average dividend growth rate is 7.9%. The current p/e is 15.2. The projected earnings per share growth rate for next year is 6.44%, and the 5-yr projected annual earnings per share growth rate is 13.1%. It should be noted that SJM raise the dividend twice this year and I am using the 1yr. dividend growth rate of 13.1% as justification for the 15.2 p/e ratio. In addition, the fast price appreciation has caused this stock to fall below my minimum 4% yield for strategic purchase. This price appreciation is one of the reasons to diversify with Mid Cap stocks.

  3. Microchip Technology (MCHP) –Technology sector. This Dividend Contender has 10 years of consecutive dividend increases. The current yield is 4.46%. The 5-year annual average dividend growth rate is 24.9%. The current p/e is 13.6. The projected earnings per share growth rate for next year is -9.79%, while the 5-year annual average dividend growth rate is 9%.

During the present market turmoil, preservation of capital is paramount. The above Mid Cap dividend growth stocks provide a margin of safety through high dividend growth rate and above average yield. The companies have long enough histories of earnings growth to be resilient during the coming end of this business cycle. A chart comparing these three stocks over the last five years shows the cyclical nature of all three stocks.

However, What did the investor see from a dividend income stream for these stocks. With equal positions of $10k each purchased 1 year ago, these stocks will produce a quarterly income stream as shown in the following table:

Stock

Quarterly Dividend Rate

Number of Shares

Quarterly Income

LEG

$.27

447.23

$120.75

SJM

$.40

157.52

$63.01

MCHP

$.344

304.41

104.71

In order to investigate the growth of the portfolio, due to dividend reinvestment, I will once again

create a spreadsheet for only the last year (October 2010-October 2011).

Stock Date of reinvest Div Rate # Shares Dividend Drip price # Shares pur
Totals 463.24 496.30 22.28
LEG 09/13/11 $0.2800 463.24 $129.71 $20.67 6.28
06/13/11 $0.2700 457.89 $123.63 $23.14 5.34
03/11/11 $0.2700 452.63 $122.21 $23.22 5.26
12/13/10 $0.2700 447.23 $120.75 $22.36 5.40
Totals 160.56 280.06 4.11
SJM 08/10/11 $0.4800 160.56 $77.07 $71.86 1.07
05/11/11 $0.4400 159.62 $70.23 $74.73 0.94
02/09/11 $0.4400 158.51 $69.75 $62.97 1.11
11/09/10 $0.4000 157.52 $63.01 $63.48 0.99
Totals 313.33 427.03 12.39
MCHP 08/16/11 $0.3470 313.33 $108.73 $31.36 3.47
03/17/11 $0.3460 310.60 $107.47 $39.25 2.74
12/09/10 $0.3450 307.60 $106.12 $35.39 3.00
11/16/10 $0.3440 304.41 $104.72 $32.85 3.19

The Spreadsheet shows the growing income stream for the four quarters under the heading Dividend. It can be seen from the totals at the top of each column that the dividend stream was rising for each stock, each quarter. It can also be seen, especially with LEG that with falling stock prices, the dividend stream rises more rapidly! The total dividends were $427.03+$280.06+$496.30=$1203.39. On the initial investment of $30,000 this works out to be 4.01% yield. It can be seen that this yield meets my 4% minimum yield for strategic investment. However, these stocks were selected at a time when my minimum yield for purchase was 3.5%. These results have been graphed:

Conclusion: It is possible to diversify an income portfolio with Mid Cap stocks which pay high yields, while growing capital. When encountering secular bear markets, like the present, a cash reserve is also necessary to buy stocks during market bottoms. One should always have a minimum of 10% cash and during expected downdrafts, I raise that to 30% of the total portfolio. These three stocks were selected with safety of principal in mind, during a time of global financial turmoil. It is critical that one does their own due diligence on any investment.



Disclosure: I am long SJM.

Additional disclosure: I may start a position in LEG or MCHP in the next 72 hours.

Continue to Part 2 >>

Source: 3 Mid Cap Stocks For The Retiree Part 1