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Dividend growth investing, retirement
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This is the sixth article about my Dividend Growth Portfolio. Two earlier articles in the series dealt with Portfolio Reviews:

As many of you know, the Dividend Growth Portfolio is a public “demonstration” portfolio that I use to illustrate the practical application of dividend-growth investing principles. The portfolio contains real money and actual stock holdings. It is part of my retirement assets. I publicly report on its results. I encourage comments and criticisms.

Dividend-growth investing is “buy and monitor.” I keep track of major news about the portfolio on an ongoing basis. I want to know immediately things like:

  • If a stock cuts its dividend.

  • If a company makes an acquisition or announces that it is in play itself.

  • If it has an oil rig that blows up and is on the nightly news for weeks with pictures of oil spewing uncontrollably into the Gulf of Mexico.

Beyond that ongoing attention, I perform semi-annual formal Portfolio Reviews. I like to maintain a disciplined schedule to examine the portfolio in depth, consider it from a strategic point of view, and take appropriate actions based on what I find out. The day-to-day awareness and formal Portfolio Reviews combine to create a buy-and-monitor habit that helps avoid the pitfalls of a passive buy-and-forget approach.

Last time, in April, the review led me to sell one of the portfolio’s charter holdings, Sherwin Williams (NYSE:SHW). The company was guilty of a series of paltry 1% dividend increases, and I got tired of waiting for it to step up its game. I had a good capital profit in SHW, so with the proceeds of the sale, I purchased…well, here, let me show you a piece of the table that I use to track all buys and sells for this portfolio:

4/26/11

Sold Sherwin Williams (SHW) (4998)

Bought JNJ (2908)

Bought McDonald's (NYSE:MCD) (1936)

Also since the review in April, I used accumulated dividends, plus $150 from the SHW sale, to purchase more Abbott Laboratories (NYSE:ABT), a position that I have been growing since I first purchased it in October, 2008. That makes two purchases of ABT this year.

The overall goal in this portfolio is to attain a yield on cost of 10% within 10 years of the portfolio’s creation in 2008. Some people object to the yield on cost metric, stating that it just measures past performance and has no relevance for future decisions. I see their point, but I find it inspiring to set a goal such as attaining 10% annual return on my money within 10 years after I start investing it. That is about the historical annual total return of the stock market, and dividend return is much more reliable and less volatile than price return. Another way of stating exactly the same goal would be to say that I want it to be delivering $4678 in annual dividends when it hits its 10th anniversary. The two goal statements are mathematically identical. Maybe it’s less objectionable to state it the second way.

Why $4678? This portfolio was converted from an older aimless portfolio to a focused dividend-growth strategy. So on its “official” starting date (June 1, 2008), it had a goofy value of $46,783 rather than a nice round number. So $4678 is 10% of that.

In a dividend-growth portfolio, price gains are nice, but they don’t help toward the central goal. So during the Portfolio Review, I look to answer questions such as these.

  • Should some profits be taken? If a company’s price has skyrocketed, that may be an opportunity to grab some profits and purchase another stock with a better valuation and offering a higher current yield. (The owned stock’s price incline will have caused a decrease in its current yield, possibly taking it below what I would require for a new purchase.)

  • Has the company slowed its rate of dividend growth? That may be OK for a high-yielding stock (such as AT&T (NYSE:T) at 6.1%) but a lousy situation for a low-yielding stock. Each holding has to do its part in getting to the 10% yield-on-cost goal. That’s why I jettisoned SHW in April, because it had gotten into the habit of declaring 1% annual increases. That might have been the right decision for them as a company, but it made it a bad stock for this portfolio. I’m running my own little business here, and the dividends are my sources of cash flow.

  • Is the safety of its dividend in question? Fortunately, none of my stocks has come up yet in the monthly Dividends in Danger series.

  • Is there a chance to improve the portfolio by making a stock swap or adding a new position? Improving the portfolio can mean various things, such as increasing the current dividend stream, adding diversification, or attaining a higher expected rate of dividend growth.

  • Has the rate of growth of the dividend taken a turn for the worse? Why? How important is that to the overall goal of the portfolio? Being deep into the year now, most stocks have established their dividend increases for 2011.

Here is a complete history of the dividend stream generated by this portfolio since it was configured as a "dividend machine" in 2008. Note how the actual dividends received and yield on cost keep marching higher.

Year / Dividends Received / Yield on Cost / Increase from Prior Year
2008 / $998 / 2.1%
2009 / $1568 / 3.4% / 57%*
2010 / $1799 / 3.8% / 15%
2011 / $2033 [indicated] / 4.3% [indicated] / 13% [indicated]
Next 12 mo. / $2133 [indicated] / 4.6% [indicated] / NA

*The big jump in dividends from 2008 to 2009 is mostly the result of 2008 being only a partial year, as the inception date of the portfolio was June 1, 2008.

The source of the “indicated” figures is E-Trade’s “Income Estimator,” which projects dividends based on current information about payout rates. It presumes no cuts or increases, but it does include dividend increases that have been announced but not yet paid. It tends to underestimate the dividend stream for the next 12 months, as it is likely that every stock in the portfolio will have declared another dividend increase by a year from now. As an illustration of how this works, in January the Estimator’s projected dividends for the next 12 months (from then) was $1864. By the beginning of October, that estimate had risen to $2133, an increase of 14%. Of course, the pace of increase is fueled not only by companies increasing their dividends, but also by stock swaps (such as the SHW switch) and by the reinvestment of dividends.

The boring part is that, as a result of this review, I have decided to make no changes to the portfolio. Each holding is working to my satisfaction. Here are the 10 stocks in the portfolio, along with the percentage of the portfolio’s capital value that each one comprises, their projected yield (per Morningstar), and the percentage amount of their dividend increase in 2011:

  • Abbott Labs (ABT) 10% of portfolio | 3.7% projected yield | 9% dividend increase
  • AT&T (T) 2% | 6.1% | 2%
  • Alliant Energy (NYSE:LNT) 10% | 4.4% | 8%
  • Chevron (NYSE:CVX) 6% | 3.3% | 8%
  • Johnson & Johnson (NYSE:JNJ) 12% | 3.6% | 6%
  • Kinder Morgan Energy Partners (NYSE:KMP) 7% | 6.6% | 4% so far
  • McDonald's (MCD) 19% | 3.7%* | 15%*
  • Pepsico (NYSE:PEP) 18% | 3.4% | 7%
  • Realty Income (NYSE:O) 11% | 5.7% | <1% so far
  • Telefoncia (NYSE:TEF) 4% | 8.6% | 15% so far

*McDonald's has pre-announced a 15% dividend increase for December, 2011; it has not yet been declared officially

As of October 1, the capital value of the Dividend Growth Portfolio was $50,450, or 8% more than its inception value. This number is less important to me than the dividend numbers, because the eventual goal of this portfolio is to help fund my retirement through its dividend stream. So the amount and growth of that income stream are more important than what the underlying investments could be sold for.

Source: Dividend Growth Portfolio Semi-Annual Review: Pretty Boring Stuff... The Dividends Just Keep Increasing (Yawn)