This is the October 2012 update for 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.
- The performance figures are total return as of November 2, 2012.
- 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 (3-mo, YTD, and Since Inception)
Over the last three months, the S&P 500 Index (NYSEARCA:SPY) experienced a modest gain of 2.15%, while the S&P Dividend ETF (NYSEARCA:SDY) rose 3.30%. The SDY is the more comparable benchmark for these dividend growth models. On a volatility-adjusted basis using the M2 measure, two of the DG models outperformed both the SPY, but none beat the SDY. The DG-HYLP model underperformed in absolute return and had the highest standard deviation of weekly returns among the DG models, which resulted in the negative M2 measure. This model has had more extreme performers. Since the July rebalance, there have been 4 stocks gaining over 14.5% and 3 losing over 14.5%.
Year-to-Date, the dividend models now only trail the SPY by 1.4 to 2.7 percentage points, and with much lower volatility and beta. Using the M2 measure, the portfolios are performing close to the SPY, though the DG-HYLP model slipped a bit. Three of the models are beating the SDY on both an absolute and relative basis.
Since inception, the original three Dividend Growth models have delivered absolute total returns higher than the SPY and SDY with less volatility. 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 DG-Income Growth Model
This month, I am providing an update on some of the holdings in the DG-Income Growth model portfolio. Since the portfolio rebalance on September 3, 2012, 13 of the 30 holdings are down, and 6 by more than 4%. 17 of the 30 holdings delivered over 0.82% in total returns each, exceeding the SPY's total return of for the period. The top performing sectors were Energy and Materials.
Here is a recap of some of the decliners and gainers for the DG-Income Growth portfolio over the last 2 months. For reference, the SPY was up 0.82% for this period. Price information is as of November 2, 2012; all percentages are since the September 3, 2012 rebalance.
- Altria (NYSE:MO): Down 6.7%. MO is off of its highs for the year. Its most recent quarter's earnings were 44% below last year; however, excluding one-time items (early debt retirement), MO's earnings were 58 cents/share, which met analysts' average estimate and was higher than last year's 57 cents. MO's PE ratio was getting rather high, considering its relatively slow growth, so the recent pullback isn't a surprise. The firm continues to generate a lot of cash, so while its payout ratio is high, the dividend appears to be covered.
- Waste Management (NYSE:WM): Down 7.0%. WM beat earnings estimates by a penny, but revenues were down on lower commodity prices for recycling and lower electricity prices for its waste-to-energy operations. WM lowered full-year guidance, but noted that it was on-target to meet cash flow targets. The firm has been investing in compressed natural gas stations and vehicles that will replace its diesel fleet. These vehicles will run on natural gas collected from WM landfills, so the company will be supplying its own fuel. In addition to the environmental benefits, I would expect this to improve the bottom line in the future.
- AT&T (NYSE:T): Down 4.7%. T beat earnings estimates in its latest report, though year over year growth was low. Sales declined 0.1% and were below estimates, new mobile contract growth slowed from the previous quarter, and margins narrowed to 40.8% from 45%. Despite the huge run-up in T this year, it still yields 5.1% and the dividend appears to be well covered by cash flows. T should increase its dividend in January 2013, though based on recent years, the increase may only be another penny.
- BHP Billiton (NYSE:BBL): Up 9.4%. Workers at BBL's jointly owned Australian coking coal mines agreed to a new workplace agreement, settling a 2-year dispute. BBL is also cutting costs at its Australian nickel mines by cutting up to 155 employees and contractors. Iron ore operations are also being trimmed due to the drop in ore prices. China's weak outlook has impacted commodity prices. The rebalance happened to occur at a short-term low price, so for this portfolio, despite the concerns, there is a nice gain.
- Nucor Corp (NYSE:NUE): Up 7.9%. NUE had lower earnings, as it was impacted by lower prices and demand for steel. However, NUE delivered earnings above expectations, at the high end of its guidance for Q3. As with BBL, this model purchased the shares near a short-term low, so there is a gain.
- Johnson & Johnson (NYSE:JNJ): Up 5.1%. JNJ reported an unexpected increase in quarterly earnings, showing growth in key products and launching new products. It also raised full year guidance. U.S. sales increased by 13.4%. Even with the price run-up, JNJ still yields 3.4%.
- Plains All American Pipeline (NYSE:PAA): Up 5.1%. PAA raised its distribution to 54.25 cents per unit, its 13th consecutive quarterly distribution increase. It also had a recent 2-for-1 stock split in early October.
Stop-Loss Rule - INTC, DBD, MCHP; SWSGX for cash
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. Recently, the Information Technology sector has been under pressure and several IT holdings triggered the stop-loss, all on October 5, 2012. Replacements were based on the original screens for each model at the last rebalance, with preference to the stock with higher yield and higher dividend growth rates.
- Intel (NASDAQ:INTC): INTC triggered the stop-loss and this impacted two portfolios. It was replaced with Maxim Integrated Products (NASDAQ:MXIM) in the Dividend Aristocrat+ and DG-Income Growth models. I really hated to see this happen, but the models have rules, and until I have enough data to justify a change to the stop-loss rule, the models will follow it. On a personal note, I continue to hold some INTC shares in my personal account, though I did sell half at $27 a few months ago.
- Microchip Technology (NASDAQ:MCHP) was sold and replaced with Molex (NASDAQ:MOLX) in the DG-Income Growth portfolio, and with Xilinx (NASDAQ:XLNX) in the DG-Small Cap model.
- Diebold (NYSE:DBD) was sold in the DG-Small Cap portfolio and replaced with Harris Corp (NYSE:HRS).
Cash Balance Change
Effective October 1st, the models will sweep all cash from dividends into a Schwab GNMA fund that pays monthly dividends of around 2% (MUTF:SWGSX). This will keep all funds actively earning a return in the account.
The DG portfolios continue to perform very well compared to the SPY. With earnings reports not being very impressive this quarter, I expect many investors to seek the safety found in dividend growth stocks. Several of the stocks in my DG portfolios raised their dividends in the last few months, which also provides support and higher income streams for owners of those shares.
The DG-Small Cap model is due for a rebalance at the end of November, but I am debating terminating this model, as I am more interested in developing a lower-yield, low-payout, high-dividend growth model, which covers a different sector of the payout-yield matrix from the other portfolios. The stocks in the DG-Small Cap model that I am more interested in seem to show up in my other models. I'm not sure I'll have time to keep track of so many portfolios, but we'll see.