My Retirement Income Quarterly Review - The Final Wrap Up

by: Bob Wells

I'm a Dividend Growth oriented investor and I have been conducting the first quarterly review of my retirement income stream portfolio. Let's look at what has happened affecting your investments and mine in the time since our last discussion in October: An election, increased tension in the Middle East, concerns about the fiscal cliff, concern about a dividend bubble, just to name a few. As a Dividend Growth investor, all of this shouts out to me loud and clear … stay with the plan. I have a plan, a portfolio business plan and one of its most important components is a thorough quarterly review. I believe that a thorough review remains second in importance only to choosing stocks with safe growing dividends when they are fairly, or better yet undervalued, in determining my long range investment success.

Those of you familiar with my articles know that I'm retired and generating a steady and growing income stream from dividends remains job one along with preserving capital.

Earlier this year I finalized a portfolio business plan that carefully defined my investment objectives. This plan includes specific guidelines for both the buying and selling of stocks in my portfolio. My retirement income portfolio was first revealed here.

The Dividend Growth Portfolio I have developed over the past year represents roughly 30% of our total retirement income. The remaining 70% comes from several fixed income sources including Social Security and traditional pensions. Each of our fixed income sources are adjusted for inflation.

I currently have a portfolio of 53 equal weighted Dividend stocks the majority of which are Dividend Champions, Challengers and Contenders. I chose to own a large number of Dividend Growth stocks in order to reduce the effect on monthly income should one or more holding reduce or eliminate their dividend. I fully respect the rights of others who may disagree with this approach or take another approach to retirement investment. I also elect not to exercise buy or sell options, including protective puts.

Before continuing with my review I want to thank all of you who offered suggestions and comments during its early stages. Your suggestions helped add clarity to my decision making as I move forward.

Well it's time to get back to my review; focusing first on:

Portfolio Construction:

My plan calls for seeking diversification across sectors, industries and geographies. It calls for establishing a range of yields and dividend growth rates.

I currently am represented in all ten major sectors, though I am seriously underweighted in tech, industrials and materials. I have chosen to underweight these sectors because of yield and beta. These three sectors are among the highest in terms of beta and the lowest in terms of yield. Most fail to meet my 3% yield criteria required for inclusion. In contrast, I am overweight in the consumer staple sector due to safety, low beta and higher yield.

I currently own 53 stocks in my portfolio with an equal amount invested in each stock as the norm. All but seven of my holdings are included in the lists of Dividend Champions, Challengers and Contenders. An additional two stocks Paychex (NASDAQ:PAYX) and Royal Dutch Shell - (NYSE:RDS.B) are Frozen Angels, having frozen their dividend within the past five years. I hold no stock which cut its dividend since 2007. My portfolio currently yields 5% and my current lowest yielder is Coke (NYSE:KO) yielding 2.7%. The Five Year average Dividend Growth Rate (DGR) for my portfolio is just over 10% helping ensure the probability that income from dividend growth will increase more than income lost to inflation.

My portfolio guidelines require that no more than 5% of the portfolio's value be invested in a single stock. I have my largest position in Kimberly Clark (NYSE:KMB), a position representing 3.8% of my portfolio.

My plan requires that I make opportunistic switches between stocks if such a more will serve to improve the portfolio. There have been changes to the core portfolio that will be discussed in a moment.

Dividend reinvestment:

The goal of my portfolio is to generate income solely from dividends and the growth of those dividends. Dividends are only reinvested when they exceed the 5% required for income. When reinvesting dividends, it is my aim to improve the portfolio in one or more of the following dimensions: yield, dividend growth, or diversification.

Selling Guidelines:

Business Plan guidelines require that each quarter I investigate and consider selling a stock for these reasons:

  • It cuts, freezes, or suspends its dividend.

American Capital Agency (NASDAQ:AGNC) cut its dividend and as such was sold.

  • It becomes seriously overvalued. Profit taking and re-investment will likely be the first step.

After a full review using Fast Graphs none of my holdings were found to have become seriously overvalued at this time.

During Part One of my review I stated my intent to examine all holdings currently yielding less than 3%. I asked the community for suggestions on each moving forward.

After reviewing all the comments and suggestions received, I decided to sell my position in Abbott (NYSE:ABT). Questions concerning yield and dividend makeup following the split caused me enough concern to sell and redeploy the funds to higher yielding Dividend Growth stocks.

In addition, I sold my current position in Wal-Mart (NYSE:WMT), yielding just 2.1%. Once again I redeployed the funds to high yielding offerings.

Finally I decided to sell Unilever (NYSE:UN) since it appears to be the lowest yielding over valued stock in my portfolio. Again I redeployed the funds into a higher yielding undervalued stock.

  • A holding incurs a loss in excess of 10% and such a percent represents a loss significantly greater than similar stocks in that sector or industry.

None of my holdings have incurred a loss in excess of 10%.

Buying Guidelines:

After selling the above three positions and making a final fund rollover to my account it was time to do some shopping. First I reviewed the guidelines of my portfolio business plan pertaining to stock purchases:

Stock Selection:

Use the current Champion, Challengers and Contender (CCC) Lists as my principal shopping list when considering new equity purchases. Subject each stock to a year - by - year back test for the period 2002 - 2011.

Alternative: Select stocks from Safe Dividend Stock document generated from my back testing of Dividend stocks from 2002-2011.

Give priority to stocks that meet both standards

Require the following from any stock selected:

  • Price at least $5 per share. Minimum projected yield 3.0% at time of purchase.
  • Total Portfolio Dividend growth rate over past 5 years at least 7% annually.
  • Yield + 5 yr. DGR equal 12% for new purchase.
  • Positive annual total returns in at least three of past five years (2007-2011).
  • Annualized average total return of at least 5% over past five years.
  • Increased dividend payout in each of past 5 years.
  • An understandable and sustainable business model with meaningful competitive advantages, also called a "Moat".
  • Good fundamental business metrics. Low debt. Low payout ratio or one below average for that sector. Strong credit rating.

Stock Valuation:

Buy stocks with "Fair" or better valuations as determined by average PE for past five years. Seek an overall portfolio PE of 15 or under. Be cautious of buying a stock at a point where it is at its 52 Week High.

Consider multiple sources of value assessment when seeking to determine value. Sources include but are not limited to the following:

  • Merrill Lynch
  • Morningstar
  • Fast Graphs
  • Select SA Contributors

After consideration of the above, new positions were established in the following:

  • Alliance Resources Partners (NASDAQ:ARLP) - 7.8%
  • Enterprise Product Partners (NYSE:EPD) - 5.3%
  • National Health Investors (NYSE:NHI) - 4.72%
  • Realty Income Corporation (NYSE:O) - 4.47%
  • Triangle Capital Corporation (NYSE:TCAP) - 8.28%

Each of the above is a Dividend Challenger or Contender. Each meets the buying standards highlighted above.

Portfolio Performance:

Finally, the last thing I wish to discuss before concluding this first review is how to best evaluate portfolio performance. Clearly moving forward the most measure of performance will be the month income coming from yield and dividend growth of my holdings. If monthly income is greater by an amount that exceeds inflation come January 1st of 2014, the first objective is meant.

The second performance objective is capital preservation. If capital has grown at a rate higher than inflation this objective is achieved. As of December 9th, my capital has grown 14.2%. When 5% is withdrawn for income, my portfolio balance is 9.2% for the year. The total return of 14.2% is greater than the total return of the S&P 500 at 13%.

It is difficult to measure the performance of a Dividend Growth portfolio beyond the first two measures. Most continue to use indexes such as the S&P 500 to gauge overall performance as I just did a moment ago.

Using the S&P 500, however, appears inappropriate due in large part to beta and low overall yield. In addition, the S&P is highly weighted in banks and tech, two sectors I significantly under weight. Comparing a portfolio with a yield of 5% and a Beta of .7 against an index that yields less than 2% and a Beta of 1.0 is clearly comparing apples to oranges.

Similar problems exist in using Dividend oriented ETFs as a performance gauge. Most remain high beta and yield less than 3 percent. The high yield offerings tend to select high yield equities without consideration for low payout ratios, increasing the possibility of dividend cuts and subsequent loss of monthly income.

For now I'm using the performance of appropriate Sector ETFs such as XLU as a gauge. For example: How was the average performance of my individual utilities vs. the performance of the XLU for that quarter. I am considering using the Alerian MLP Infrastructure Index as a performance gauge for my MLP holdings. Serious under performance will be closely examined to see if an exchange for other DG equities within that sector has the potential to further strengthen my income stream and preserve capital.

I conclude with an important question for each of you - How do you evaluate capital gain performance in your Dividend Growth Portfolio?

Disclosure: I am long ARLP, EPD, NHI, O, TCAP, KMB, KO, PAYX, RDS.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.