Long-Term Portfolio Building: Next Addition Planning

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Includes: AAPL, AVA, COST, D, KHC, MKC, SBUX, SO, V, VZ, WEC
by: ScottU

Summary

Scottrade's FRIP program gives the opportunity to use the entire portfolio to build either one or multiple positions at once.

Using this program we have added Costco, Starbucks and Apple over the last three years.

Within the next five months a new position will start being built.

Just over two years ago my grandmother allowed me to help her form a portfolio from the proceeds of an annuity she was forced to cash in. She had very few rules in order to set it up, she wanted me to be able to explain what each company in the portfolio did, she wanted me to update her on how its progress was going and she wanted to make at least a few of the companies ones she could see in the newspaper. The goal for the portfolio was to create an income stream from the portfolio that could cover a possible loss in Social Security income due to her being forced to cash that annuity. In the future this income stream will either continue to be reinvested or may at times help fund family needs; first for my parents, then eventually my sister and myself and hopefully for any children we have.

Due to a stroke of good luck we received the funds to invest during the period where Congress was arguing over sequestration and thus we were able to lock in solid entry points on quality companies that had been researched. At set up we started with 26 companies and were able to cover her initial goal of not having to deal with a potential drop in income from her lost social security should the need arise. After her taxes were prepared for the following year, the anticipated possible loss in income never materialized and we were able to continue to reinvest the income created going forward.

The account was set up with Scottrade using the Flexible Reinvestment Program (FRIP) which allows you to pool dividends for investment into either new companies or those that you already own. For those that are not aware of the program, Scottrade will pool dividend payments together and at the discretion of the owner they will reinvest those dollars into purchasing up to five companies as long as you have enough dollars to purchase at least a share of each company chosen at the given time. Those shares then contribute to the pool for the next period and the process continues.

In order for her to be able to follow those reinvestment's more closely the first time through, we chose two companies that she could follow in the local newspaper: Costco (NASDAQ:COST) and Starbucks (NASDAQ:SBUX). Both were and currently are lower yielding, more growth oriented companies with dividend yields right around 1% and payout ratios well below 50%. To complete the positions took nearly two years and at completion we ended up buying enough Costco shares for it to become an average sized position with an average price of $130.04 a share. Starbucks we filled with an average share price of $37.78. In both cases one of our original fears was that we were buying the companies when most considered them overvalued. This was one the our prime reasons for choosing these two for this initial FRIP purchase and filling them over a couple years using this dollar cost averaging approach versus having them be two of the original investments into the portfolio.

Once these two positions were filled we needed to add another company, so I simply let her make the decision and she chose Apple (NASDAQ:AAPL). These transactions have not turned out nearly as positive for us the previous two do. We currently have an average share purchase price of $114.27 on a company whose yield is 2% but with a 21% payout ratio. One reason for the high entry price is a decent percentage of these shares were purchased with the special dividend from Kraft Heinz (NASDAQ:KHC). Her logic for purchasing Apple was solid, in her mind we were doing the same thing with Apple that we had with the previous two. Finding a perfect entry point is difficult so using a year or so to build the position would give us somewhat of a natural hedge. She also had the solid observation that us 'kids' always have our phones around and are always doing something on them. She concluded that it would make a nice combination to hold with Verizon (NYSE:VZ) which was one of our original purchases.

Where do we sit today?

Within the next five months her purchase of Apple will be completed and we will have to shop for our next purchase for the portfolio. I asked her last weekend if she had any thoughts on what she might want to add next and she said she did not have anything in particular in mind. She went on to say that she is very happy with both the income stream growth and the total returns of the portfolio. This time around she would rather have me choose something for her. In my initial screening process I found three companies which have peaked my interest for further evaluation: Dominion Resources (NYSE:D), McCormick Incorporated (NYSE:MKC) and Visa (NYSE:V). All three of these companies are positions that I eventually want to add to both this portfolio and my personal portfolio, and all three are companies I have had a hard time finding good entry points on through the years. They also all have compelling reasons to add them despite the valuation concerns.

Dominion Resources is an utility company that provides its customers needs through all different sources of energy production throughout the Mid-Atlantic region. At a current PE ratio of 23 it is without question on the expensive side of the value spectrum. Morningstar has a fair value estimate on the company of $72. Earnings expectations are that they will grow by 4.6% this year, solid for the industry they operate in. The company currently yields 3.75% and provides its shareholders with $2.80 per share in return. The dividend has increased by 8% a year each of the last two years, and the company has been increasing its dividend since 2004. They are a solid utility that has increased payments to shareholders while continuing to invest in the long term stability and growth of the company. They make an excellent companion to her shares in Southern Company (NYSE:SO), Wisconsin Electric (NYSE:WEC) and Avista (NYSE:AVA).

McCormick Incorporated is involved in the manufacturing and distribution of spices both domestically and internationally. The companies PE ratio of over 30 is definitely on the high side also, however the forward PE is currently estimated at 23. They recently announced a new cost reduction plan late last week that has been well received. Consensus earnings estimates for 2016 show an increase of over 6%, while 2017 estimates are showing consensus estimates of over a 10% increase. Morningstar rates the company as a hold, with a fair value estimate of $88 per share. The current yield of the company is 1.8% on a payout of 1.72 per share a year. The company has seen its dividend double in the past 8 years, while seeing it increase each year by three cents a quarter for each of the last five years. They're a company that has a wide economic moat and has developed a great following amongst its customers.

Visa is a payment technology company, they help facilitate financial transactions around the world. Like the first two they're not a cheap company trading at a current PE of over 26. They're currently selling off the 52 week high by nearly 10%. Morningstar considers them a buy with the fair value at $104 while S&P has a very different fair value estimate at $63. I believe that the price had gotten a bit ahead of itself, but the correction to this level has it near its fair value. Earnings growth has projected to slow for 2016, but in 2017 it is expected to move back to well over 10% increase rate. The current yield of the company is only .75% with a forward rate of $.56 per share per year. The company has increased its dividend since its inception in 2008. The increase this last year was 16.7% while the current payout ratio is just over 20%. This should give the company plenty of room to continue to reward shareholders during earnings cycles over the next few years. During the last year when Seeking Alpha Contributor Mike Nadel asked me to be part of a panel to pick the best stock in the world, Visa was my choice for the one I would invest into at that time.

Conclusion

As of now the decision on where to invest next with this portfolio has not been completed, but these three companies are at the top of my continued diligence list. Several questions I continue to ask myself include is my process for choosing which company to dollar cost average into the correct one? If not, what other companies or industries have I missed out on? Is there a company that is so undervalued out there right now that I would be a fool not to add to the portfolio? Are there companies out there that simply make good sense to build through processes like this? Before I continue my dive into the company financials I am hoping that I can get some solid feedback from other investors to ensure that I'm making a sound decision. If anyone has ideas that they'd like to be put under consideration, let me know in the comment section.

Disclosure: I am/we are long ALL COMPANIES EXCEPT D AND MKC.

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.