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This is an update on my four research-based Dividend Growth Model Portfolios. The Dividend Aristocrat+ portfolio focuses mostly on stocks with 25-year+ histories of dividend increases and uses equally weighted sectors. The DG-SmallCap portfolio concentrates on medium and smaller-cap firms with strong dividend growth, with preference to higher yielders. The DG-IncomeGrowth model is similar, but pursues non-small caps with high yields and high dividend growth rates. The newest model, DG-HYLP, screens for high-yield, low-payout ratio stocks as value plays with safe and growing dividends. The first three models were initiated on August 16, 2011, whereas the DG-HYLP was started on January 1, 2012, so there is less data history for that portfolio.

Performance Summary

(click to enlarge)3-month Performance

Over the last three months, the S&P 500 Index (SPY) continued to outperform the DG models, though not by as much as in the previous update. We generally expect the SPY to rise faster than DG stocks in an up market, and that is the case here. The DG stocks also exhibit the lower beta that we expect, with the DG-IncomeGrowth portfolio having the lowest of the group. On a beta-adjusted basis, all of the DG models had about the same performance for these three months, as shown by the Treynor ratio. They are lagging the SPY in the short-term, but over a longer time period, they are outperforming it.

(click to enlarge)Perf-Inception

Since inception, the original three DG models have delivered total returns higher than the SPY and with less volatility. The HYLP model has a later inception date, but has performed very well since January 1 versus the SPY. All of the DG models have higher volatility-adjusted (Sharpe) and beta-adjusted (Treynor) return ratios than the SPY. In simpler terms, these portfolios produced higher returns for each unit of risk, as measured by volatility or beta.

Focus on the DG-Income Growth Model

This month, I thought I would provide more detailed information about the Income Growth portfolio. I will highlight a different model with each update. Since the portfolio rebalance on February 1, 2012:

15 of the 30 holdings are down, but only five by more than 5%. 7 of 30 delivered over 5% in total returns during these 3 months, with 3 gaining over 10%. The top performers mostly belonged to the Consumer Staples, Telecom, Utilities, and Energy. Weaker performers were in Industrials and Consumer Discretionary stocks. A few selected stocks are mentioned below; all performance numbers are since the rebalance on February 1, 2012. For comparison, the SPY was up 6.83% during this time period.

  • Abbott Labs (ABT) delivered 15% in total return, the highest in the portfolio. The firm has a pending spinoff and recently raised its dividend by 6.25%. ABT beat Q1 revenues and earnings estimates. With the price run-up, the yield has dropped to 3.3%, but with its consistent performance, dividend growth, and low beta, ABT remains a solid holding.
  • Altria (MO) gained 14% over the last three months. The firm had a good first quarter. Its Marlboro brand gained market share, earnings were up 6.7% (11.4% excluding special items), and MO reaffirmed its target of 6% to 9% growth for the year. The dividend yield remains over 5% and despite a high payout ratio, MO has the cash flow to cover (and increase) its dividend. It also continues to repurchase shares.
  • AT&T (T) performed well, increasing 11%. Q1 earnings were up 5%, beating expectations. Revenues were up slightly and T had higher wireless margins. T added 187,000 subscribers this quarter, though its competitor Verizon (VZ) added 501,000. One-time charges have impacted earnings, making the payout ratio over 200%, but operating cash flow is sufficient to cover the dividend.
  • Kimberly-Clark Corp (KMB) increased 9% in total return. It produced stronger than expected Q1 profit thanks to cost cutting and growth in emerging markets. KMB recently raised its dividend by 5.7%.
  • McGrath Rentcorp (MGRC) was the worst performing stock in the portfolio, losing 19%. It just announced Q1 results with revenues up 8%, but earnings missed by 2 cents, causing an 8% drop today. This drop puts MGRC 20% below the SPY's performance in relative terms (excluding dividends). If this continues for 3 more weeks, it will trigger my "-20% rule" and result in MGRC being replaced in this portfolio.
  • Meredith Corp (MDP) declined 17%. It recently reported better than expected quarterly earnings, but MDP lowered guidance for the year. The price drop has pushed MDP's yield to 5.5%, and on a relative basis, it has underperformed the SPY by over 20% for 2 weeks (excluding dividends). With revised estimated fiscal year earnings of $2.50/share (June 2012), the stock trades at a forward PE of 11. The firm has acquired additional digital brands (Rachael Ray, allrecipes.com) and should benefit from election year advertisements.
  • Microchip Technology (MCHP) fell 10% in the last three months, and its yield is now at 4.1%. MCHP beat earnings estimates by a penny in this quarter, but earnings and operating margins were lower than in the year-ago period. MCHP made a couple acquisitions, including: Roving Networks, a developer of wireless network and Bluetooth solutions, and Standard Microsystems (SMSC) to gain access to the lucrative market for electronics used in automobile entertainment systems. MCHP has been raising its dividend by a half-cent each quarter. While this qualifies as an increase, it isn't very impressive.

Income Growth Portfolio Changes

There are no changes to the DG-Income Growth portfolio this month. As mentioned above, a couple of stocks are near my -20% performance gap rule, which my data has shown often signals either a dividend cut or a larger future decline in price. If a stock in this portfolio is 20 or more percentage points below the S&P's performance for 4 consecutive weeks (using end-of-week data), then it will be replaced.

Last month, I pondered some changes to this rule to account for different business models (utilities, telecom) and payouts. I am experimenting with adding in the stock's yield when calculating the performance gap. Under this scenario, MGRC, MCHP, and MDP would receive a 3.5% to 5.5% annualized cushion before triggering the stop-loss rule. None of the stocks are beyond -20% in this case, but they are still close. To avoid selling stocks that are gaining slowly, but lagging a strong S&P rise, stocks must at least be down 5% relative to their purchase price. This seems consistent with dividend growth investors being less concerned with slow appreciation and more focused on the dividend.

Summary

Overall, the DG models continue to perform well versus the SPY and do so with less volatility, which was a primary objective. I will continue to monitor and report on these funds, and welcome any feedback and suggestions for improving them.

Source: Dividend Growth Portfolio Models Performing Well On A Risk-Adjusted Basis