How To Intelligently Reload Your Dividend Portfolio

Includes: ED, INTC, MCD, MO, PCL, SPY, WM, XOM
by: Jeffrey Dow Jones

I've never been afraid to take money off the table when I feel the odds have shifted away from my favor. Enthusiasm and excessive optimism have always made me uncomfortable, or at the very least skeptical. And this character flaw counts double when it comes to the markets. I wish I wasn't this way, but I am. Until I fully understood this part of my personality and embraced it, I was a terrible investor and analyst, too caught up trying to be something I wasn't.

So is the market topping out? Should the rest of the world be skeptical of this rally? At the risk of harshing everyone's buzz, I'll hedge and say, "only time will tell."

I investigated the topic last week and offered up some evidence suggesting that the market could be at or approaching a short-term top. Give it a read. It's a quick article that looks at how some of the internals are flashing yellow have diverged with the rest of the market. Since then a couple more indicators have starting flashing yellow, particularly a continued rolling-over in emerging markets.

Whether you agree or not, it's worth asking questions of short-term valuation. It's worth a little strategizing.

Today we're going to design a simple strategy. The explicit goal will be to help you get some more bang for your buck out with your dividend stocks, or whatever portion of your portfolio you've carved out for income investing. (But seriously, where else are you getting income in the market right now?)

Our strategy has to be flexible, easily tailored to one's personal objectives. In case you hadn't figured it out a few paragraphs in, I'm a believer that the single most important lesson for successful investing is to find a style that suits your personality.

Our strategy also can't bring about crazy new risks. It can't include any aggressively directional bets on market activity. It should help keep us in the game rather than take us out if we're wrong.

And, of course, it has to move us efficiently towards our longer-term objectives. In this instance, it's a portfolio that generates better cash flow per dollar invested.


STEP ONE: Sell all your dividend stocks.


I know. Calm down. It's OK. If you really don't want to sell them or you've owned them for a long time and are worried about the taxes or are emotionally attached to them, then it's cool. You're an adult and you can accept responsibility for your actions.

Sell some of them.

Don't worry, we're not going to cash. Though I continue to think it's fine to hold a big pile of cash, negative real yield and all, for tactical opportunities later in the year.

We're going to Treasuries!

I know. That 2% yield is depressing.

But forget about that! You're buying these things on sale. Treasuries are about as cheap as they've been in the last year.

We like to buy stocks on a dip? Why don't we like to buy Treasuries on a dip?

Seriously. Buying Treasuries right now would be the functional analog of buying stocks last July. In hindsight, it was a pretty darn good idea. Last July we were all pretty freaked out. Remember how worried we were about the Greek elections? They even put the vote-count up on CNBC.

And today, everything is hunky dory, right? The economy is fine. Europe is quiet. Nobody cares about the sequester. Who on earth wants Treasuries in that kind of environment?

I do. That's who.

So forget about that 2% yield. Sometimes you just own these puppies for price appreciation. Who holds a T-note for 10 years, anyway? Love Gary Shilling or hate him, you have to agree that nobody else has done a better job teaching the world of sophisticated investors about the concept of total return in bonds.

So after you've sold off some of your equities, go bond shopping. You'll have to hold your nose because, blech, Treasuries! Nobody said making money in the markets would be easy.

The quickest way to do this right now is with something like the iShares 10-20yr Treasury ETF (NYSEARCA:TLH), or if you're skittish, you can use the 7-10yr fund (NYSEARCA:IEF). Anyway, there are plenty of ways to execute this portion of the trade. You're smart enough to figure out what will work best for you. Personally, I love the TIPS ETF (NYSEARCA:TIP), and that'll work too while also giving you some legitimate inflation protection, even though there isn't much of that going on right now.

Besides, you've still got some nice tailwinds at your back. The Fed launched Q-Infinity last year. The "don't fight the Fed" rallying cry is usually used in conjunction with stocks. But why fight them in the bond market? That's where they can actually do some direct damage.

The point here is that if some new risks do materialize in the coming months or if the stock market just happens to be overextended and overenthusiastic and needs a breather, you'll actually grow your capital instead of watch it disappear.

STEP TWO: Just hang out.

Just hang out until the shakeup happens. Don't worry, it will happen. I don't have a clue what'll cause it or how big it'll be, I just know that the stock market doesn't go in one direction forever. History suggests that these things correct with disturbing regularity. Markets go up and up, and then they freak out for a bit and go down again, if only for a little while.

Warning: You might be tempted as you sit on these boring old bonds to do something exciting. Try and resist. Hit the slopes for a weekend or go to the gym. Go drinking with your buddies at the club -- you may have to buy them a few so they don't laugh at your silly bond love.

When we do get that correction the stock market will pull back. Then it's time to go shopping! And it will be nice because your buying power will have increased because your bonds, under this scenario, will have appreciated in value. Had you held on to all those original stocks you might not have had as much capital to redeploy.

STEP THREE: Go back to those dividend stocks.

The cool thing about going shopping for dividend stocks after a pullback instead of in the late stages of a giant cyclical rally is that you get a whole lot more yield.

You probably have your own list of dividend stocks. But here are some names from the current iteration of my Copper Canyon Dividend Income Portfolio.

Altria Group (NYSE:MO) - The classic dividend champ. It's yielding 5.1% right now and has a great looking medium-term chart. If stocks sell off a bit, you could lock down a dividend at or around 6%. Awesome. In the words of Walter Sobchak, "Dude, let's go bowling!"

Consolidated Edison (NYSE:ED) - To be honest with you, I'm not sure how much I love ED with a 15x P/E and a 4.3% yield. This is probably a target to get culled from the portfolio right now. But if we get a pullback, and I can own it closer to 11-12x and a yield over 5%? I'll probably start loving it again.

Apple (NASDAQ:AAPL) - The newest member of my dividend portfolio. I'm just as surprised as you are that they turned into a dividend value stock. I wrote another big piece here at Seeking Alpha last week discussing where it's fair value really lies. But that's irrelevant for today's discussion. All that matters today is that the stock yields 2.3% right now and with that balance sheet and a long, bright future of dividend increases ahead, I'll happily take it and take more the closer that yield gets to 3%.

Exxon Mobil (NYSE:XOM) - Another granddaddy of dividends. It's fairly priced right now and I like the dividend of 2.6%. But there's probably no better company in the world to buy on a dip than Exxon.

Intel (NASDAQ:INTC) - Intel has been a heck of a ride in the last year or so. But at 9x earnings and a dividend yield of 4.3%? I'm listening. Check out this great analysis of Intel which will walk you through a valuation that possibly isn't justified. If the market corrects and I can lock down Intel at a yield over 5%, I am a happy camper, content to ignore the share price and enjoy my cash flow just like Benjamin Graham would have always wanted.

McDonald's (NYSE:MCD) - A 3.3% dividend is OK. But the stock has run up a lot, and it's probably more vulnerable than some of these other companies to a broader correction. Should the stock retest support in the mid/high 80's -- which could happen before you know it -- you're looking at a yield pushing 3.7%.

Johnson & Johnson (NYSE:JNJ) - The stalwart. Seems like this thing has yielded 3+% forever. The stock exploded to the upside lately, which is cool if you own it. But if you don't, there are plenty of other businesses to look at in the meantime with equally strong footing and similar dividend. It's always a target to buy on dips, and a safer name than most to hold through long-term bear markets.

Plum Creek Timber (NYSE:PCL) - This is a fun, different one. Timber! If you're a Jeremy Grantham disciple, you know that he loves timber for the next decade and I do too. PCL is a leader in this space and wood is a much more awesome resource than you might be aware of. A 3.5% yield ain't bad either, even if their earnings multiple is a bit rich.

Waste Management (NYSE:WM) - A 3.9% yield is nice, but this is another fundamentally sound company that will be with us for a long time to come. I challenge you to name an industry with more inelastic demand than waste disposal.

Here's a long, long-term chart of the S&P Dividend yield. As you probably surmised, it's historically low. (The good news, at least, is that inflation is low too). But yields are trending higher, and while that happens, you can employ some tactical allocation techniques to enhance your total return and lower your volatility.

Always caveats

There is risk in this strategy. The risk is an opportunity loss that you might experience if the stock market keeps on running higher for longer than you or I expect. You'll miss out on that capital appreciation of your stocks, and the rising yields that will most likely accompany that environment will be a drag on your bonds.

We talk a lot about how scary it is to buy when there's blood in the streets. But it's equally hard -- for me, harder, actually -- to sell when everything is going up.

Personally, this is risk I can deal with. I can deal with not making as much on my investment as my buddies down at the golf club. I lose less sleep from their ridicule than I do by having risk on that I can't justify. Your mileage will certainly vary. If you're the guy who always likes to have the biggest, flashiest investments, then this strategy isn't going to work for you. But I have to ask, why on earth are you reading an article about dividends?

The kind of risk that I can't deal with is the risk that a whole bunch of my stuff goes "poof." I do not want to be the guy at the clubhouse bar who lost 15 or 25% on his portfolio, crying in his gin and tonic. I don't care that all my other buddies would be commiserating with me, I want to be the guy who says "Hey, I came out of this thing even stronger." These buddies, by the way, were the same ones telling me to load the boat with dot-com stocks in 1999 and were all urging me to go in with them on a couple of spec homes in 2005.

The good news is that it's possible to hedge this psychological risk if you want.

First, you can write some puts on something like the S&P SPDRs (NYSEARCA:SPY). That'll help you keep up with the yield. Or you can write cash-secured puts on the dividend stocks that you someday want to own. This is a really cool strategy. If you want to liquidate your entire dividend portfolio right now and then write a bunch of puts on those exact same companies, you have my blessing. Ideally, you're kind of hoping you'll get those stocks put to you. Write those puts at levels where their dividend yield gets you excited.

This is both a flexible and robust strategy.

OK, let me recap it for you.

In case you were daydreaming while you scrolled to the bottom, I'll sum it up:

  1. Switch to bonds for a little while. Sooner is probably better.
  2. Wait for the shakeup and the market correction we all can feel coming.
  3. Reload your dividend portfolio with great companies at higher yields.
  4. Go brag to your friends at the club about how you made money and boosted the income power of your portfolio. Buy them all gin and tonics. They'll probably need them.

Just remember that this is a dividend-specific strategy. If you prefer to take a more balanced approach with your investing, you can take the basic essence of this and apply it to your tactical allocation. I'm doing exactly this in my other Alpine Adivsor portfolios right now, lightening up on stocks and weighting cash and bonds a little more. (You can subscribe to the Dividend & Income portfolio for free.)

Listen: opportunity will come. It always does. I get that we're all afraid of the correction that we know is coming. But some of us are a little greedy for what we'll be able to grab when it does finally occur.

Fear & Greed.

Taming those two emotions has always been the psychological challenge of the markets. Even if they're manifesting a little differently today, it still pays to understand them and build a strategy to navigate the economic ocean in one piece.

Disclosure: I am long INTC, XOM, AAPL. 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.

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