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Counterpoint
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I have been a Seeking Alpha contributor since September 2011. I enjoy writing articles about dividend theory, taxes and off-the-run macro policy issues.
  • Income Weighting Versus Market Value Weighting A Dividend Growth Portfolio - Part 1 6 comments
    Aug 20, 2012 12:02 PM

    In a comment David Van Knapp's article seekingalpha.com/article/805611-open-let..., I brought up the idea of weighting a portfolio of dividend growth stocks by income as opposed to market value. I thought this would be something intriguing to dividend growth investors as so often I read how many of the investors that follow this investment approach have little or no interest in the underlying market value of the stocks other than at the point of purchase.

    Surprisingly, the idea received a rather cold reception by a few of the frequent dividend growth contributors (the exception being Robert Schwartz who seemed interested). Perhaps this was a function of me (Counterpoint) bringing this up as I know I am generally viewed as an "outsider" so my comments tend to be viewed with skepticism regardless of their content. On the other hand, perhaps there is a subset of dividend growth investors who call themselves this but are really just plain old value investors trying to wear dividend growth clothing…even though they violate one of its key rules…letting market values materially affect their post-investment decisions.

    Let me state, contrary to the implications of the comments responding to this idea, I would not view either approach, income or market value weighting, as something that should be rigidly applied to portfolio management any more than an MPT practitioner would rebalance his or her ratio of stocks and bonds with each movement of the markets. While it would actually be possible to do this with a dividend income weighted portfolio due to dividend changes happening, typically, once per year as opposed to second-by-second with prices, it would still result too frequent rebalancing in a portfolio of 20 or 30 stocks in my opinion. Much like I manage my asset allocation portfolio, I would not reallocate more frequently than once a year (of course, one of the nice things about dividend growth investing is that you have periodic mini-rebalancing opportunities if you reinvest your dividends).

    More importantly, I would not rigidly say that each holding has to produce the exact same amount of income after a rebalancing. Again, as I do with my asset allocation portfolio, I create "curbs" such that each category stays with a range of a few percent. So, let's say that in a portfolio of 20 stocks for example, where in a completely equal situation each stock would provide 5% of the income, any stock with more than 6.5% or less than 3.5% of the total dividends would be adjusted downwards or upwards respectively at the time of a rebalancing. Let me note too that special dividends would, of course, not be part of such a calculation (can't believe I had to add that).

    I am not making any assertion that one will achieve a superior return with such an approach, but that is not why I raised this idea. I raised it because the purpose of diversifying your holdings is risk management. As an asset allocator, I view "risk" as the possibility of a deterioration in the market value of my holdings so I diversify my holdings based on market value. Dividend growth investors view risk as the possibility of a deterioration of their income stream. If this is the case, their holdings should be diversified based upon the income not the market value.

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Comments (6)
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  • Robert Allan Schwartz
    , contributor
    Comments (12743) | Send Message
     
    "Surprisingly, the idea received a rather cold reception by a few of the frequent dividend growth contributors (the exception being Robert Schwartz who seemed interested). Perhaps this was a function of me (Counterpoint) bringing this up as I know I am generally viewed as an "outsider""

     

    CP, I don't know of anyone who decides who is "inside" and who is "outside". I certainly don't think that way.

     

    "so my comments tend to be viewed with skepticism regardless of their content."

     

    No, I look at the content. A good idea is a good idea, no matter who it comes from.
    20 Aug 2012, 04:56 PM Reply Like
  • Counterpoint
    , contributor
    Comments (905) | Send Message
     
    Author’s reply » Robert, the fact is I am not a dividend growth investor so that alone makes me an "outsider" IMO. You are right though...I should not have said the "viewed as" part...it really is the way I view myself I guess and I shouldn't presume how other people view me unless they state it as such (which no one has that I can recall). I should accept the feedback on the idea at face value and not read anything more into it.
    20 Aug 2012, 07:14 PM Reply Like
  • David Van Knapp
    , contributor
    Comments (10069) | Send Message
     
    I think you make a strong case for balancing by income. Not all investors (of any persuasion) rebalance. I don't. But I do have broad guidelines for maximum position size. Your argument here makes me think that I should look at "maximum" based on income rather than on cap size in my portfolio. I'll look into this during my next portfolio review in October. It makes me wish that my broker displayed annual income in its basic portfolio view. That would make the proportions obvious and save me some work.
    Dave
    20 Aug 2012, 10:01 PM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    Counterpoint,
    Thank you for sharing your ideas.

     

    "Perhaps this was a function of me (Counterpoint) bringing this up as I know I am generally viewed as an "outsider"" "
    No, no, no!!!
    I value any idea independent of it source: Nobel winner might have a stupid idea and amateur might have a brilliant one. Believe me I know both these categories of people and title is close to nothing for me when I refer scientific papers.

     

    Let me discuss DG/EI/F = dividend growth-equal income-fund problems.
    1) Formally (as far as I know US laws) an equity fund should have at LEAST 30 stocks but for proper DG diversification proper number in the range of 100 stocks (BTW, City of London - the best DG fund known to me has now 109 stocks). Now imagine that at initial day DG/EI/F has 100 stocks each of them deliver 1% of income. Although DGRs of each stock are different let simplify picture (well as a physicist I always do this) and put all stocks into 3 categories - low DGR, median DGR and high DGR. So at the end of period (e.g., 1 year) fund manager need to trade 2/3 of portfolio. IMO it is too much and leads to high fund expenses.
    2) Open-end fund has money in/outflow during rebalance period and fund manager might NOT be able to keep EI principle at dissent yield.
    3) Huge special dividends like CHH this weak is big trigger for DG/EI/F.
    4) Although each position provides same $$$ as dividends, reinvesting these money in the same company leads to disbalance because stock prices vary a lot.
    5) "I would not rigidly say that each holding has to produce the exact same amount of income after a rebalancing." OK - so DG/EI/F has strong drift around the target it stated.

     

    Any equal portfolio (income or capital) in the framework of broad fund is close to nightmare. My DG portfolio /100+ different stocks / is quasi-equalized on amount of money I invested in each company and with freedom to be as flexible as I want (that is forbidden by any ETF/index by-lows) I do reallocation on case by case principle (e.g. I might trim a stock using fool-free-money approach, but I do it at at arbitrary point not only at 2X as discussed in my SA blog). By definition index/ETF must hve rigid rules for everything including rebalance.

     

    On another hand, I thing market cap has nothing to do with DGI. Personally I prefer to find "hidden value" in micro/nano-caps that are out off Wall Street radars.

     

    I appreciate your concern about DGI risk factors and agree that they are mostly around income stream. Based on this DGi has to have wider diversification than "capital gain" investor, it is more similar to the bond investor case.

     

    I get sick from articles like "5 best stocks to be framed in your bathroom", so I'm looking forward for Part 2.
    Thank you for article
    SDS, contrarian & eclectic dividend investor
    21 Aug 2012, 01:13 AM Reply Like
  • AgAuMoney
    , contributor
    Comments (4430) | Send Message
     
    I considered and tried to implement a portfolio alloted by equal income rather than by cap value. I ran into enough issues I reverted to equal cap value (roughly) instead. The two big issues for me were:

     

    *) To get the most bang for the buck it helps to buy low -- when a company is under valued or at least fairly valued. Most dividend growth investors seem to agree, and the evidence from the tech bust confirms the strength of this approach. Rebalancing is a good way to sell high and buy low. This can boost income by picking up more of a better value using cash raised from selling a portion of a more fully or an overvalued company. But even without rebalancing, the allocation of available cash "what to buy now" it is also beneficial to buy low, and so buying more of an under-valued can be helpful. When using income weighted portfolio it was too hard to just 'see' the relative valuation changes.

     

    *) Some companies yield far more than others and often the risk was disproportional to the income. I didn't want to hold enough Polaris or Costco to generate the same income as my holding in AT&T or Suburban Propane.

     

    I decided rather than try to balance income, I should divide my holdings such that any one income cut would not be catastrophic. With approximately 50 companies, roughly equal market value weighted, no single income stream is so large as to concern me, and the portfolio is much easier to manage.
    21 Aug 2012, 01:42 AM Reply Like
  • SDS (Seductive Dividend Sto...
    , contributor
    Comments (3182) | Send Message
     
    See My Portfolios Construction Principles (Jan 21, 2012) in my instablog
    21 Aug 2012, 02:15 AM Reply Like
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