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Dividend growth investing, retirement
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My Dividend Growth Portfolio (DGP) is a public portfolio that I created to illustrate the principles of dividend growth investing. I report on it periodically so that people can see how one person (me) executes a dividend growth strategy and what its results are.

The DGP's main purpose is educational. Both myself and readers can learn from my good moves and mistakes. I use both hits and errors to tighten up the Dividend Growth Portfolio Strategy that I use to govern the portfolio. In addition to its educational goal, the DGP is an actual component of my retirement portfolio. It has my own real money in it.

It is too bad that this portfolio has only existed since 2008. But it is now in its fifth year and beginning to render meaningful results for examination. It reflects real-time decisions made with real money, not back-tested examples of what would have happened if you did such-and-so 20 years ago. There is no survivorship bias. This article is about what actually did happen and is happening now.

The DGP exists at E*Trade. Its background is that I took an old aimless portfolio and retooled it in 2008 to become a dividend growth portfolio. Its starting value at inception was $46,783 on June 1, 2008. You may recall that early 2008 was not a great time to start a new stock portfolio.

Nevertheless, beginning the portfolio in a bear market has had the educational advantage of showing how dividends help a portfolio recover from even a major market skid such as we had in 2008. It also shows the effects of using a buy-and-monitor strategy. There was no temptation to sell anything during the market downturns in Q2 2010, Q3 2011, or recently this year. Those were non-events (noise) as far as management of this portfolio is concerned.

Income Performance

The principal investment goal for the portfolio is to create a dependable rising stream of income that I will use in retirement. Therefore, the primary metrics for tracking performance are the portfolio's income and growth.

Indeed, the DGP's numerical goal is to have it yielding 10% on my original investment within 10 years of its creation. That would be its yield on cost (YOC) in 2018. I understand that the term yield on cost sounds like fingernails screeching on chalkboard to some ears, so let me restate the mission in a different way: In 2018 I want to receive at least $4678 (10% of the original invested amount) in dividends from the portfolio. The two formulations are mathematically equivalent, but no one seems to react violently to the second way of stating it.

At the moment, the DGP appears to be on track to achieving that income mission. In 2011, the DGP's dividend stream increased by 9% over 2010, and it is currently on track to increase by more than 9% in 2012. DGP is a closed portfolio in the sense that no new money is added to it except the incoming dividends. I accumulate those dividends (rather than drip them) and reinvest them in a single purchase when they reach $1000. No matter how you reinvest dividends, whether through accumulation or by dripping them back into the same stocks that dispensed them, reinvesting dividends accelerates the pace of increase of the dividend stream. That is because reinvestment adds a second layer of compounding to the base layer of the rising dividends themselves.

Here's the year-by-year progress in dividends received:

Year

Dividends Received or Expected

Yield on Cost

% Increase over Prior Year

2008 (7 mos.)

$998

2.1%

 

2009

$1568

3.4%

57%

2010

$1799

3.8%

15%

2011

$1960

4.2%

9%

2012 (projected)

$2142+

4.6%+

9%+

Next 12 months

$2189+

4.7%+

 

2008's through 2011's dividends shown are actuals. The 2012 and Next 12 months projections are based on E*Trade's Income Estimator. That tool calculates expected future dividends based on information known when you run the Estimator. Thus it usually underestimates future dividends for three reasons:

  • Companies will increase their dividends. Dividend increases still to be declared during 2012 and 2013 are not included yet in the Estimator's projections.
  • Additional shares purchased with reinvested dividends will pay
    dividends themselves.
    Until the new shares are purchased, the Estimator
    does not know about them and cannot include them in its calculations.
  • Other changes may be made to the portfolio-such as swaps into higher-
    yielding stocks-that will increase the dividend stream.
    Again, the effects of
    these changes are not known to the Estimator until they are made.

By way of illustration: In 2011, the Estimator's first projection of dividends at the beginning of the year was $1832. That proved to be 7% short of the actual dividends received during the year ($1960). All three reasons listed above played a role.

On my website, I track this portfolio each month, and it is fun to see the Income Estimator's projections advance every month as it has new information to work with. By December, of course, all new information will be in for the year, and the estimate in early December will match what the year's total income actually will be.

Portfolio Reviews

As part of my standard portfolio management practices, I review this portfolio twice per year. These formal reviews are both high-level (from a strategic perspective) and ground-level (how is each stock doing?). The most recent Portfolio Review was described in this article: April, 2012: "Spring Cleaning My Dividend Growth Portfolio."

The Abbott Situation

The DGP contains a 10% helping of Abbott Laboratories (NYSE:ABT). As explained in a recent article, I have a stop-loss order under Abbott. I started this order at 7% in April and am tightening it 1% each month. It is now at 4% for July. The idea is to milk remaining capital gains out of the stock before Abbott as we now know it splits into two companies by the end of the year. My feeling is that if Abbott does not better explain their intentions with respect to the dividends of the two new companies before they implement the split, I want to be out of the stock. I would like more certainty about the intended dividend practices of both new companies than management has provided to this point. If the stock sells off (as I expect it will), I will redeploy the proceeds into other dividend growth stocks in which I have more confidence.

It has been interesting to note that the stop-loss order has not been executed in three months even though I have been tightening it each month (it started at 7% in April). From a price standpoint, the market has applauded the proposed split-up, so Abbott's price has been rising pretty steadily since the announcement. That does not change my thinking about keeping the two new companies. Unless something unexpected happens, by October there will be no gap between the order and the price, so the stock will sell then if not sooner. Abbott's next earnings announcement is scheduled for July 18, so perhaps they will address the issue then.

Dividend Reinvestments

Under the rules governing this portfolio (linked earlier), when the accumulated cash from dividends reaches $1000, the funds are re-invested in a company from the current edition of Top 40 Dividend Growth Stocks, which serves as my shopping list each year. The particular stock for reinvestment is selected based on current valuations, yields, diversification objectives, and the like. The object is always to improve the DGP in some way.

In 2012, there has been one reinvestment so far: I purchased $1000 worth of Intel (NASDAQ:INTC), beginning a new position in that stock. There were three dividend reinvestments in 2011. I expect a second dividend reinvestment opportunity later this year.

Diversification

From its inception, the DGP has been a fairly concentrated portfolio. Its original governing documents called for 10-15 individual stock holdings, and in fact the number has always been closer to 10 than 15. However, earlier this year I wrote an article about risk and diversification from the unique point of view of an income investor. I concluded that reducing income risk required more diversification than my original "best ideas" concentrated approach allowed for.

So going forward, I am going to increase the actual number of stocks in my dividend growth portfolios from 10-15 to 20-25. I will also probably reduce the maximum allowable position size from 20% (currently) to 15% or maybe less. I would expect to move in that direction gradually as opportunities present themselves. I will not buy a low-quality company or an overvalued one simply to become more diversified.

I have not moved quickly to diversify the DGP, mainly because I am waiting to see how the Abbott situation plays out. If Abbott sells off, as I expect it will, I will use the proceeds from the sale to raise the total number of stocks in the portfolio by at least one. Going forward, I intend to trim oversize positions and use the $1000 dividend reinvestments to slowly increase the number of stocks in the portfolio.

Current Portfolio

The DGP currently holds 11 stocks, with Abbott on death watch. I take a relaxed view about position sizing, meaning that I let them float against each other so long as they stay within broad parameters for position sizing. I take the same approach to sectors, meaning that I don't try to have each one represented. Rather, I "follow the money" in the belief that dividends are where you find them.

Stock

Ticker

Comments

Abbott Labs

ABT

On death watch pending its split into two companies. Yielding 3.2%, raised dividend 6.2% in Q1 2012.

Alliant Energy

LNT

Yielding 3.9%, increased dividend 5.9% in Q1 2012.

AT&T

T

Yielding 4.9%, increased dividend 1% in Q1 2012.

Chevron

CVX

Yielding 3.4%, raised dividend 11% in Q2 2012. Raised dividend twice in 2011.

Intel

INTC

New position in 2012. Yielding 3.2%. Next increase expected in Q3 2012. Last increase was 16% in Q3 2011.

Johnson & Johnson

JNJ

Yielding 3.6%, increased dividend 7.0% in Q2 2012.

Kinder Morgan Energy Partners

KMP

Yielding 6.0%. Typically raises distribution 3-4 times per year. Raised distribution 3.4% in Q2 2012.

McDonald's

MCD

Yielding 3.2%. Next dividend increase expected in Q4 2012. Last increase was 15% in Q4 2011.

Realty Income

O

Yielding 4.2%. Distributes monthly, typically raises quarterly. Annual total increases have slowed to < 1% per year since 2006.

PepsiCo

PEP

Yielding 3.0%, raised dividend 4.4% in Q2 2012.

Shaw Communications

SJR

Yielding 4.9%. Typically pays monthly. Increased 5.4% in Q1 2012.

Cash

 

$441. This will be reinvested when it reaches $1000, which will probably occur in the Fall.

Earlier this year, I sold Telefonica (NYSE:TEF) after it cut its dividend late last year. Although the stock was still yielding better than 10%, it was in the midst of a long price decline, which continued after the dividend cut. I used that money to initiate the position in Shaw Communications shown above. The portfolio took a short-term hit to its dividend yield, but long term I think the switch improved the portfolio. As noted earlier, the DGP's total payout is on track for a 9%+ income increase in 2012 over 2011.

Total Returns

As stated earlier, the investment mission for this portfolio is focused on generating dependable growing income for my retirement. That said, the current total value of the portfolio is $58,797, or +26% since its inception. Its total value increased by 15% in 2011.

Issues and Decisions in 2012

One issue for 2012, Telefonica's dividend cut, has already been dealt with by selling it.

The big issue is Abbott Labs. That has been tentatively handled by employing the tightening sell-stop technique for wringing price increases out of the stock before selling it. It is possible that some news will come out that will convince me not to sell it despite the radical change in its business model, but I doubt that will happen.

A final issue concerns McDonald's. Its position size is currently 16% of the DGP, which is slightly above the new guideline of 15% maximum. I have put this issue on hold pending resolution of the Abbott affair. I expect that eventually I will sell a portion of this position and use the proceeds to add to a current position or start another one in pursuit of my new diversification policy.

I'll report on this portfolio again in October after the next Portfolio Review. In the meantime, your comments and observations are welcomed.

Disclosure: I am long ABT, CVX, INTC, JNJ, KMP, SJR, LNT, MCD, O, PEP, T.