I've been responsible for the research for my investment club for several years now. If we were to classify our strategy thus far, it would probably fall into the GARP category - Growth At a Reasonable Price. But, with everything that has happened recently, I'm not embarrassed to admit we're changing our approach. We're chasing yield.
After reviewing DGI - Dividend Growth Investing - concepts at our January meeting, we voted to set our sights on aggressively growing annual income in 2016. It will be a nice distraction from nursing the impact of frequently free-falling stock prices experienced thus far in this new year. More importantly, it will hone our analysis skills and investing rationale.
We begin every year with goal-setting. Goals serve to not only direct my research but also keep the club on track during decision-making throughout the year. So, as is typical at our January meeting, we set a goal, albeit a simple one:
In the first six months, increase annual income by 10%.
This may seem too remedial at first glance. But, let's be honest, when learning new skills, it doesn't hurt to initially experience an easy and quick success. That's not to say there's absolutely no challenge in the task.
Consider a $50,000, $500,000 or $5,000,000 portfolio - the number of zeroes does not specifically matter. Now suppose that portfolio is generating a 3% yield or $1,500 or $15,000 or $150,000, respectively, in annual income. If monthly dues in six months increase the portfolio size by 5%, then expecting annual income to increase by double that rate does provide challenge. The table below details the challenge based on the $500,000 example.
Original Portfolio Investment
Beginning Annual Income
Six Months Income (assuming earned evenly throughout year)
Six Months Dues or Additional Investment at 5%
Goal - Increase Annual Income 10%
Yield Needed on New Investment to Achieve Goal - $1,500 / $32,500
In the simplest form, new investments of income and monthly dues would deliver the additional income. However, it is certainly plausible existing dividends could increase. Such increases would directly decrease the yield needed on new investments. Another realistic possibility for achieving the goal includes reallocation. Existing investments in non-income-producing stocks can be reallocated to income producers.
The club does certainly not intend to attempt to reinvent the rules and recommendations of DGI. We already reinvest every dividend possible. There are plenty of stable and solidly-performing companies paying attractive dividends to consider. Valuations will not be ignored. Price-to-earnings ratios must be reasonable. Debt loads can not be too heavy especially considering a company's business and industry. A track record of paying as well as growing dividends is preferable. Payout ratios must fall within reason, again considering the company's business and industry. Healthy profit margins, earnings growth and sound returns on equity will be favored.
Fifteen days into the 180-day challenge and we're well on our way. Frankly, unless a handful of existing dividends are cut or eliminated, we'll likely be setting a new goal at the 90-day mark. With the January investment, announced dividend increases and existing reinvestment, the club has already increased annual income by 6.5%. But, we do realize this performance is not likely repeatable.
Three companies in the club's existing portfolio were considered for reinvestment in January. After applying a self-defined volatility resilience filter to the Dow Jones Industrial Average, Cisco (NASDAQ:CSCO) and Intel (NASDAQ:INTC) had survived the cut. Recent news about ONEOK (NYSE:OKE) had also caught the club's attention.
The club has been overweight in the Technology sector for years attributable to owning Apple at an average cost under $20. Further, the club had reinvested in both Cisco and Intel in the past. To say the two nominees from the Technology sector received fair consideration would be a stretch.
ONEOK, on the other hand, caught the club's attention quickly. First, we did not yet have a "full" position. Second, despite a cautious outlook on natural gas and natural gas liquids prices, ONEOK confirmed on December 21st, 2015 it expected to have $675 million in cash flow available providing dividend coverage of 1.3 times. The confirmation came less than two weeks after a Jeffries analyst suggested a distribution cut by the company was possible. Subsequent to the ONEOK announcement, firms Oppenheimer, Credit Suisse and Argus followed with upgrades. Analysts cited contract restructuring efforts as one reason for confidence. ONEOK Partners also does not expect dilutive action in 2016. ONEOK does not have debt maturities until 2022 and maintains an un-utilized $300 million credit facility. Finally, ONEOK's yield now tops 10%. There is still a possibility the company will not be able to stand by its confirmation and will end up cutting its dividend. But, unless the dividend is eliminated or cut by more than 75%, the club still prospers. Additionally, the reinvestment lowered our average cost.
As newly-declared yield-chasers, the club's interest was piqued by the Dividend Kings, companies that have increased dividends for 50+ years. Currently, the club has an investment in but one king - Procter & Gamble (NYSE:PG). After a cursory review of the list, three industrial giants appear inviting when considering current yield and payout ratios - Dover (NYSE:DOV), Parker Hannifin (NYSE:PH), and Illinois Tool Works (NYSE:ITW). Preparation for the February meeting will include due diligence on the three and a comparative analysis.
Dues accumulated at the February meeting will not likely reach the club's minimum amount needed for an investment. Therefore, the subject of reallocation will also be on the agenda. Typically, the club recoups its original investment when an investment doubles. Two existing investments will be highlighted.
First, our investment in Myriad Genetics (NASDAQ:MYGN) has not yet doubled. It may be time to challenge our historical practice in light of the new strategy. Perhaps a 60%/40% split is more appropriate where we retain 40% when 60% will recoup our original investment. On the other hand, Myriad Genetics has performed significantly above our defined expectations. Does it make sense to abandon 60% of an investment that is exceeding expectations regarding return in exchange for the opportunity to increase our income?
Second, because of our small position in Alphabet (NASDAQ:GOOGL), though it has more than doubled, the club has not yet pulled the trigger on recouping the original investment. But, Alphabet is not a dividend payer and thus is not an income producer. With our new strategy, a portion of our Alphabet investment may well deserve to be on the chopping block. Simply, while it may produce return, it is not producing income. The rumors around an Alphabet dividend will be weighed. This suggestion will certainly test the club's commitment to the new strategy.
This transition from GARP to DGI will, no doubt, mold us into better investors. It will test our ability to release previous mindsets and to adopt new. It will be a healthy distraction from the market's volatility. It will, likely, even ruffle some feathers. Oversight, advice and recommendations from Seeking Alpha's faithful are definitely welcome.
Disclosure: I am/we are long CSCO,INTC,PG,OKE,GOOGL,MYGN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.