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This is the September 2012 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.

Notes:

  1. The performance figures are total return as of September 28, 2012.
  2. Three of the portfolios now have over one year of data. For now, I will continue to report the 3-mo, YTD, and Since Inception time periods. Starting January 1, 2013, when the DG-HYLP hits one year, I will switch YTD to a one-year measure (trailing twelve months).

Performance Summaries (3mo, YTD, and Since Inception)

(click to enlarge)Perf-3mo

Over the last three months, the S&P 500 Index (NYSEARCA:SPY) experienced a nice gain of 6.30%, while the S&P Dividend ETF (NYSEARCA:SDY) rose 4.40%. The SDY is the more comparable benchmark for these dividend growth models. In the long run, I hope to see these models outperform the SPY, as research has shown DG stocks to deliver superior total return versus the overall market. On a volatility-adjusted basis using the M2 measure, the DA+ and DG-Income Growth models, which have low betas and a bias toward higher-yielding, larger-cap stocks, outperformed both the SDY and SPY. The DG-Small Cap model, and particularly the DG-HYLP model, had higher betas, and lagged in absolute and relative returns for the period.

(click to enlarge)Perf-YTD

Year-to-Date, the dividend models are trailing the SPY by 3.6 to 5.1 percentage points, though their returns are still pretty good (~9%-10%) and with much lower volatility and beta. Using the M2 measure, the portfolios are performing close to the SPY. The four models are all beating the SDY on both an absolute and relative basis. The lower portfolio volatility has made for a smoother ride for DG investors, which is a plus. I find it interesting that the DG-HYLP model has the highest beta of the four models. With relative high-yields and low payouts, I would think these stocks should be less volatile than the small caps. Regardless, its beta is below the SPY's.

(click to enlarge)Perf-Inception

Since inception, the original three Dividend Growth models have been delivering absolute total returns higher than the SPY and SDY with less volatility, though the SPY just nudged ahead of the DG-Small Cap model. The DG-HYLP model has a later inception date, so the YTD results are more appropriate for this model. All of the original DG models have higher volatility-adjusted and higher beta-adjusted return ratios than the SPY and SDY. In simpler terms, these portfolios produced higher returns for each unit of volatility or beta.

Focus on the High-Yield, Low Payout Model

This month, I am providing an update on some of the holdings in the DG-HYLP model portfolio. Since the portfolio rebalance on July 3, 2012, 11 of the 30 holdings are down, and 3 by more than 10%. 12 of the 30 holdings delivered over 6.5% in total returns each during these 3 months, exceeding the SPY's total return for the period. Three of the top 9 performers belonged to the Consumer Discretionary sector.

Here is a recap of some of the major movers for the DG-HYLP portfolio over the last 3 months. For reference, the SPY was up 6.30% for this period. Price information is as of September 28, 2012; all percentages are since the July 3, 2012 rebalance.

Decliners:

  1. Intel (NASDAQ:INTC): Down 15.7%. INTC lowered its revenue guidance by about $1B in early September. The stock had already been declining, and since the announcement, it is down even more. With its very low payout ratio, the dividend is safe and was recently raised by 7.1%. INTC has been flirting with my -20% stop-loss rule, though given INTC's good cash flow and $15B in cash, and its continued dividend increases and stock repurchases, I don't feel that this stock is in the same boat as most of the others that triggered the stop-loss. See the section below for further discussion about this.
  2. Textainer Group Holdings (NYSE:TGH): Down 21.7%. TGH leases a fleet of marine cargo containers. It had a strong first half of the year, going from $30/share to almost $40/share, so a pullback is not completely unexpected. Issuing around 8 million shares at $31.50 didn't help to increase the stock price though. The Company intends to use all of the net proceeds from this offering for capital expenditures and general corporate purposes. While earnings projections appear to be flat for the next year, with its low 43% payout ratio, there is room to grow the dividend. In fact, TGH has increased its dividend each quarter since February 2010. It currently yields a juicy 5.6%. I couldn't resist buying some shares around $31.25.
  3. Safeway (NYSE:SWY): Down 10.5%. SWY missed earnings in April, and then profits were down 16% in July for Q2 due to higher advertising costs and its new loyalty program. Between fierce competition and rising costs, grocers are in a challenging environment. SWY hopes that its new, personalized loyalty program will help it retain customers and grow. Safeway's stock prices seems to have stabilized at the $15-$16 level, and the firm has been buying back stock. SWY also announced plans to sell a minority stake in its Blackhawk Network Holdings gift card and payment service in an IPO next year.

Gainers:

  1. Walgreens (NYSE:WAG): Up 23.0%. WAG struggled earlier this year in part because it did not renew a pharmacy network agreement with Express Scripts (NASDAQ:ESRX). In July, the two companies announced that a new agreement had been reached, and WAG's stock jumped over 10%. It has been holding steady around $36/share since then. WAG yields 3.1%, has a low 38% payout ratio, and has been buying back stock the last three years.
  2. A. Schulman Inc. (NASDAQ:SHLM): Up 17.4%. SHLM supplies plastic compounds and resins for packaging, consumer products, industrial, and automotive applications. It raised guidance for fiscal 2012 in early July and has followed the market higher over the summer. Based on estimated 2012 earnings of $2.05, the firm has a forward payout ratio of 37%, providing room for future dividend increases. Even after the summer run-up, SHLM still yields 3.1%.
  3. Target (NYSE:TGT): Up 9.8%. TGT had a nice run the last three months. It reaffirmed its earnings forecast, had higher sales in August, and raised its dividend a sweet 20%, pushing its yield to 2.3%. TGT has had strong dividend increases for many years, yet its payout ratio is still low at 33%. While the current yield may be below the threshold for retirees seeking income, for longer-term investors, this stock has room to grow its dividend, which should lead to good total return. In addition, TGT has repurchased about $4B in shares over the last three years, which is about 10% of its current market cap.
  4. Hasbro (NASDAQ:HAS): Up 12.6%. Like TGT, HAS also has a record of strong dividend increases, raising its dividend by 20% earlier this year, and still has a fairly low 54% payout ratio. In July, HAS reported lower revenues, but earnings beat expectations as operating margins improved. They also expected to shift more shipments to the second half of the year. The stock currently yields close to 4%, and like TGT, HAS has been buying back stock the last three years, about $1B, which is around 20% of its current market cap.

Stop-Loss Rule - Should It Apply to Low Payout Stocks?

In prior articles, I wrote about using relative price changes as a predictor for dividend cuts and larger price declines. Under this stop-loss rule, when a stock underperforms the SPY by 20 percentage points for 4 consecutive weeks, the stock will be sold. The DG-HYLP model does not follow this rule, as the stocks in this portfolio have low payouts (under 65%, most even lower) so there is generally little risk to the dividend. The other models continue to follow this stop-loss rule, and it has saved me a few times, though I continue to evaluate this rule and will adapt it based on research and input from readers. This month, I would specifically be interested in feedback as to whether all of the portfolios should ignore the stop-loss if the stock triggering it has a low payout ratio, say under 50%.

Two DG-HYLP stocks are flirting with the stop-loss (3 consecutive weeks), and while it does not impact this portfolio, one of them is owned by two of the other portfolios, hence my interest in some discussion on this topic. The first stock is Textainer Group Holdings . It now yields a nice 5.6% with a 43% payout ratio. I couldn't resist buying some recently at these levels. The other stock on the watch list is Intel . It has a decent yield of 4.0% and a low payout ratio of 38%. In addition, INTC recently raised its dividend. For these reasons, I'm inclined to ignore the stop-loss, as the dividend is quite safe and for the DA+ and DG-Income Growth models, income is primary over capital gains. However, if I make an exception, it needs to apply to all future stocks in this situation, so I want to be careful in how I define this.

Summary

The SPY had some very strong gains the last quarter, so not surprisingly, it outperformed the DG models. However, the DG models continue to deliver relatively comparable returns, particularly on a volatility-adjusted basis, and to give investors a much smoother ride. The Gainers share common traits of strong dividend growth rates, low payout ratios, and stock repurchases. I've started looking for this trifecta more as I determine stocks for my portfolio. IBM (NYSE:IBM) is another great company that fits these characteristics.

The DG-Small Cap model is the next one scheduled for a rebalance at the end of November. No other changes will occur between now and then, unless a stop-loss is triggered, and I will be interested in reader feedback on whether exceptions should be made for stocks with low payouts (<=50%). For my personal holdings, I do not intend to sell either INTC or TGH.

Source: Dividend Growth Model Portfolio Update: High-Yield, Low-Payout Gainers And Decliners