In December 2010, I created a screen/hypothetical portfolio called the "High Yield Dividend Champion Portfolio." The screen is tracked publicly as a continuous hypothetical portfolio with a starting balance of $100,000 on Scott's Investments (see the right hand column for a link to the spreadsheet).
Like many of the screens, strategies, and portfolios I track and prefer, this strategy takes a small number of historically relevant ideas, to create a simple, yet powerful action plan for the individual investor. As I have previously detailed,
Some studies have shown that the, highest yielding, low payout stocks perform better over time than stocks with higher payouts and lower yields.
This portfolio attempts to capture the best high yield, low payout stocks with a history of raising dividends. There are numerous ways to gauge the "best" high yield/low payout stocks. The list starts with the "Dividend Champions" as compiled by DRIP Investing. The list is comprised of stocks that have increased their dividend payout for at least 25 consecutive years.
The Dividend Champions are the starting point and we begin by ranking the top third highest yielding champions. With the remaining high yielding stocks, we will eliminate 50% with the highest payout ratio. The remaining stocks are assigned a rank based on the ratio of their dividend yield to payout ratio (the same as a trailing earnings/price ratio, or the inverse of the trailing P/E ratio). Stocks must also have a positive forward projected P/E, to eliminate stocks with no projected earnings for the next year.
The top 10 stocks based on this ratio make the portfolio. Stocks will be sold at the re-balance date (generally around the 5th of the month) when they drop out of the top 12 (to limit turnover) and are replaced with the next highest rated stock.
For April we are selling RPM International (NYSE:RPM) and Pitney Bowes (NYSE:PBI). RPM was sold at a gain over 41% (excluding dividends) since its purchase in September, 2011. PBI was sold for a loss of 9.55% (excluding dividends) since its purchase in December 2011. The proceeds of these two transactions were used to purchase Universal (NYSE:UVV) and PepsiCo (NYSE:PEP) at today's closing price.
The overall equity market, which has had a stellar 2012 so far, has cooled this week. The technical analyst in me has seen momentum in US equities slow the past few weeks. This particular portfolio has returned over 27% since inception but now may be a time to temper expectations.
The High Yield Dividend Champion Portfolio was designed to be fully invested at all times regardless of market conditions. However, as part of a larger portfolio there may be additional steps an investor can take to reduce risk and diversify strategies. For example, the Ivy Portfolio uses a 10 month moving average to dictate an invested or cash position (signals are updated daily at Scott's Investments). Michael Dever's Jackass Investing: Don't do it. Profit from it also provides several different methods for diversifying strategies and not just asset classes.
Covered call writing is another potential tool to generate additional income. By selling a call against an underlying equity position, the seller earns income upfront but gives up a certain amount of potential capital appreciation. Using Born To Sell we can explore potential covered call opportunities on stocks in the High Yield Dividend Champion Portfolio. For example, PEP May $67.50 calls had a last bid of $.55 and the May $60 calls for ED had a last bid of $.20.
The simple system I developed for the High Yield Dividend Champion portfolio is not without its drawbacks. When a stock is near the bottom of the rankings for yield or payout, minor fluctuations in yield or payout could put the stock in or out of the current portfolio each month. In other words, turnover could potentially be a drag on returns. One potential solution would be to rebalance the portfolio less frequently, or to give stocks more room to fall in rankings before being removed from the portfolio.
The portfolio's equity curve is below, plotted against the SPY (distributions included in both):
click to enlarge
All discussions of returns are strictly hypothetical and exclude commissions and taxes.
The top 18 rated stocks for the purposes of this portfolio's criteria are listed below:
|Tompkins Financial Corp.||TMP||3.59||45.14||0.080|
|Mercury General Corp.||MCY||5.58||70.11||0.080|
|Community Trust Banc.||CTBI||3.87||49.01||0.079|
|Sonoco Products Co.||SON||3.49||54.46||0.064|
|Eagle Financial Services||OTCQX:EFSI||3.47||54.96||0.063|
|MGE Energy Inc.||MGEE||3.45||57.97||0.059|
|RPM International Inc.||RPM||3.28||56.95||0.058|
|Johnson & Johnson||JNJ||3.46||65.52||0.053|
|California Water Service||CWT||3.46||70.00||0.049|
|Conn. Water Service||CTWS||3.36||73.64||0.046|