6 Months Into DGI - Lessons Learned

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Includes: AAPL, CSCO, CSX, DPS, GE, GM, KO, LUV, PFE, PRU, RY, TWX, VLO, VZ
by: New Div on the Block

Summary

About six months ago, I took over a previously custodial brokerage account.

Since then, I have diversified from 1 to 9 stocks, and am beginning to focus on a DGI strategy.

I provide a few lessons learned and plans moving forward.

The Journey Begins

Last November, I inherited a custodial brokerage account from my parents, who had managed it on my behalf for several years. As it was turned over to me and I began my journey into the world of investing, I began to seek out resources like Seeking Alpha to understand strategies, learn about stocks, and set myself up for a prosperous future. The more I read, the more I was drawn to the investment philosophy known as dividend growth, an increasingly popular strategy for building a portfolio.

Intuitively, taking a two-pronged approach to dividend growth investing makes perfect sense. First, buying stock in undervalued companies with solid business models and above-average dividend yields to hold for the long term allows for compounding dividend reinvestment to augment gains in share price or even to mitigate losses from stock depreciation. Second, finding companies that may have lower yields now but with consistent or increasing dividend growth rates in recent years and moving forward demonstrates the very definition of compounding returns.

Additionally, knowing that I have a separate, newly established and relatively aggressive retirement portfolio with a time horizon of at least 40-45 years, another reason to embrace dividend growth here was to offset that portfolio with a more disciplined and defensive approach. Thus I will value established companies with solid track records such as the Dividend Aristocrats or Dividend Champions above more speculative positions.

With this strategy in mind, I am looking back on my first full six months as an investor (I began trading in January) to try and gain a better picture of my behavior as an investor, look back at what has and has not worked in my portfolio, and to set some concrete goals for the future.

Early Moves and Goals

When my portfolio was turned over to me, it consisted of about 60% mutual funds (which I won't cover here) and 40% stock, all of which was in a single company: Apple (NASDAQ:AAPL). With a very low cost basis and a passive buy and hold management strategy, these shares had appreciated well over 500%. As happy as I was to see this incredible gain, I knew that holding only one company, even one as solid as Apple, was not going to be a recipe for long-term success.

At first, I began to open tiny positions in other companies to diversify the portfolio. However I quickly realized this would be ineffective for two reasons: 1) paying brokerage fees on trades of only a few hundred dollars each is a quick way to throw away money and unnecessarily drive up one's cost basis; and 2) with such an outsized juggernaut of a position already in the portfolio, small trades here and there wouldn't do much to change the overall composition of the portfolio.

Around April, as I thought more concretely about what my goals for the portfolio would be, I began to envision a basket of 20-30 well-diversified stocks. Anticipating that over time I will strive to contribute between $50,000 and $75,000 to this portfolio, assuming an equal contribution to each stock gives me "full" positions at around $2,000 to $2,500. But with a very long time horizon to compound dividends, some of that work could be done for me by opening "starter positions" of around $1,500 and slowly letting the rest DRIP in over time to reach my optimal amount of invested capital.

At the same time, I also began to refine how I was thinking about potential new investments, using the wealth of information here on SA as well as access to resources provided by my broker such as S&P Capital IQ, Morningstar, and Argus. Using the lists I mentioned above such as the Dividend Aristocrats or Dividend Champions as a starting point, I then began calculating entry points using a 15% discount to a weighted average of analysts' one-year target prices and fair value estimates. In this way, I target companies with strong track records of paying (and growing) dividends while opening positions at prices that allow plenty of room for capital appreciation up to target and/or fair value prices.

In addition, I am developing a set of criteria to guide new stock purchases. While the stock does not have to meet all of these criteria, the more it adheres to, the more likely I am to initiate a position.

  • Dividend yield above the S&P 500 average of just over 2%;
  • PE ratio below the S&P 500 average of around 24;
  • Sustainable payout ratio for dividends no greater than 50%; and
  • Three- and five-year dividend growth rates of at least 20% among companies with relatively young dividend histories OR three-, five-, and ten-year growth rates of at least 8% among companies that have paid dividends for at least several decades.

As an example, of the 10 stocks I am currently following most closely for potential new positions, 5 of them meet all of these criteria: Cisco (NASDAQ:CSCO), Time Warner (NYSE:TWX), CSX (NASDAQ:CSX), Royal Bank of Canada (NYSE:RY), and Prudential (NYSE:PRU).

Summary and Current Portfolio

Below you can see my current portfolio (not including mutual funds or Apple stock, for the sake of demonstrating what I have contributed to the portfolio myself in the last six months).

*Note: Italicized dividends were reinvested.

Ticker Shares

Value (7/1/16)

Cost Basis Gain/Loss YTD Dividends
DPS 3 $286.95 $280.90 2.15% $1.59
KO 5 $225.60 $223.20 1.08% $3.50
VZ 5 $281.15 $258.20 8.89% $2.83
PFE 10.0863 $358.77 $306.95 16.89% $3.00
GE 15 $472.35 $481.45 -1.89% $0.00
GM 50.6567 $1,463.47 $1,534.80 -4.65% $19.00
VLO 25.2859 $1,300.45 $1,476.63 -11.93% $15.00
LUV 25.0645 $992.55 $1,114.20 -10.92% $2.50
TOTAL: $5,381.29 $5,676.33 -5.20% $47.42
Click to enlarge

Given that I am new to investing and am only just now solidifying my approach to portfolio management, it is not surprising to find my portfolio down just over 5%, while the S&P 500 is up over 2% YTD. I am okay with making some small mistakes now if they help me to see how I should change my behavior for the long term. You can see the tiny positions I opened first are actually outperforming my more recent purchases, but I still plan to close out these positions with market value and cost basis of less than $500 at or above my break-even price (including fees), since they do not significantly affect the composition of my portfolio.

The one exception to this is Pfizer (NYSE:PFE), which (on dips) I am hoping to bring up to a more equitable position with my other holdings as I feel it is a solid stock with continued strong growth outlook and a great dividend yield to boot.

After those sales, I do not plan to ever initiate complete sell-offs of positions except in the following cases:

  • Stock price depreciation of over 40% with little positive outlook;
  • Significant dividend cut of at least 20%; or
  • Spin-off or merger shares that do not meet criteria outlined above.

Like many things in life, investing takes skill, practice and sometimes a fair bit of luck. While luck is hard to plan for, skill and practice are two things we can control with dedication and an eye for strategy. Though I have made some mistakes in my first few months of investing and my portfolio is down thus far, these lessons learned will help make me a better investor moving forward and contribute to my greater understanding of the market and of myself.

I hope you found this interesting and if you have suggestions, please comment! I look forward to contributing to the active SA community through periodic updates and closer looks at stocks I'm following. Happy investing!

Disclosure: I am/we are long AAPL, DPS, KO, VZ, PFE, GM, GE, VLO, LUV.

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.