My Dividend Growth Portfolio: Selling Guidelines And General Rules

Includes: KMB, KMP, KMR, NUE, PBI, PG, SO, T
by: Ong Kang Wei

This article is an continuation from this previous article describing my 7 buying guidelines. To ensure that first-time readers get a clear sense of what my portfolio is about, please read the article linked above.

For more information about my portfolio and its rules, one can read this too, which includes my portfolio of 25 stocks and other details about it.

Without further ado, here is the main content of this article:

Selling Guidelines

1. Decrease/Elimination/Freezing Of Dividend

We will start with the selling guidelines. Since my portfolio is a dividend-orientated portfolio, I will definitely take a certain company out of my portfolio if it decreases, eliminates or freezes its dividends. I would only continue holding them if there is a really good reason why they should be kept. Although there could be some exceptions, keeping them in my portfolio is rather unlikely, as I believe that there will always be better opportunities in the market.

2. Dividend Growth Extremely Slow, below 4% (with the exception of stable utility companies and high-yielding REITs

I will also eliminate companies from my portfolio if their dividends growth start to slow down considerably. My main aim is to outpace inflation, and I will give a certain company up if it cannot help me in achieving this objective.

A company will first normally catch my attention when its 'Chowder score' (get more information about the Chowder rule here) dips below 12% for normal stocks. For these exceptions [includes Utilities like Southern Co. (SO), Telecom companies like AT&T (T), Oil Pipelines like Kinder Morgan (KMR), (KMP), Stable consumer stocks like Procter & Gamble (PG) and Kimberly-Clark (KMB)], I start to get cautious only when the number dips below 8%.

One example of a company that would have gotten eliminated if it were in my portfolio is Nucor (NUE). It is one steady dividend aristocrat, having increased its dividends for 40 consecutive years. But, its dividend growth has slowed considerably from its 5-year dividend growth rate of 18.3% to its latest year increase of 0.7%, barely beating inflation. Even if its dividends could increase from here, I am not willing to take such a gamble - I would rather buy a company that is expected to grow its dividends consistently.

3. Losing market share to competitors/ Not Competitive Enough/ Fundamental Problems/ Unsustainable or Uncertain future for Business

Problems like these are everywhere, even in dividend stocks. One existing example is Pitney Bowes (PBI), which pays a really high dividend of 11.15% at the moment, has an acceptable payout ratio of 71% and a low valuation of 6X earnings. Furthermore, the company is a dividend aristocrat, having increased dividends for a whopping 30 consecutive years.

This would undoubtedly sound enticing to any dividend growth investor, but the situation is different if one researches about the company and its fundamentals. All one would find is a business with an uncertain and bleak future (mail services). Along with its incredible $4.02B in debt (as compared to a $2.78B market cap), its practically zero growth in EPS over the past 10 years ($2.10 in 2003, $2.16 in 2012), and the company's future EPS estimates (-6% over the next 5 years) the company's fundamentals and future prospects do not look good at all.

As I stated in my previous article, I consider a company's EPS growth very important. This earnings growth is the main driver behind the dividend, and therefore, a situation like PBI's would definitely not look attractive at all, no matter how high the dividend is.

Having said this, Pitney Bowes could have had great investment prospects 20 years ago, but not now. My point is: I will not hesitate to sell any holding in the future if I find, under further research, that the company has deteriorated considerably in any way, or have fulfilled any selling guideline.

After all, as Lowell Miller wrote in his book 'The Single Best Investment', "A funny odor in the basement might well be the first hint of corpses buried there".

General Portfolio Rules

4. Always Diversify And Be Well Represented in All Sectors

Diversification is extremely important to me. As a dividend growth investor focused on buying stocks for the long term, I like to hold a diversified range of companies which serve a variety of different areas, to reduce risk as well as downside, in case there is an industry or a sector performing really badly at any one point of time. A diversified portfolio is also expected to fluctuate less as losses from some investments are offset by gains in others - which fulfills my aim of having low volatility.

One should diversify based on his investment goals, time horizon and risk tolerance. Although studies have proven it takes at least 50 stocks, diversified among at least five different sectors to achieve effective diversification, due to my availability of funds, I am only planning to hold about 30 stocks at the moment.

5. Hold No More than 8% of the portfolio in any stock

Every position will typically represent 3% of my portfolio, and when any single position gets to 8% of my portfolio, it usually means that the stock has risen significantly more than the other stocks. When they get there, I may do one of the two options here:

  • Take some profits, and cut the position back down to 3%.
  • Sell my entire position, as the dividend would have been reduced to a puny amount if the stock had risen so much (3% to 8% - that means the stock nearly tripled!), and buy again when the stock has pulled back.

6. Always Reinvest Dividends

As Albert Einstein stated, "Compound interest is the eighth wonder of the world." Even so, most people do not know the power of compounding. To show the true power of compounding, here is an example showing how important compounding is in a dividend growth investor's portfolio.

Assuming that a certain company

  • Pays a 4% dividend
  • Has dividend growth of 9% yearly,

The first table shows the amount dividends one would have gotten and the yield on cost if someone had bought $10,000 worth of shares in the company without reinvesting dividends.

Years Dividends Received Dividend Yield On Cost
0 $400 4.0%
10 $947 9.5%
20 $2,057 20.6%
30 $4,869 48.7%
40 $11,526 115.3%
50 $27,287 272.9%
60 $64,599 646.0%
70 $152,928 1,529.3%

That looks really impressive, but the next table shows the amount of dividends one would have received if all the dividends were reinvested. There was no change in the other variables.

Years Dividends Received Dividend Yield On Cost
0 $400 4.0%
10 $1,202 12.0%
20 $4,079 40.8%
30 $13,846 138.5%
40 $47,002 470.0%
50 $159,552 1,595.5%
60 $541,611 5,411.6%
70 $1,838,538 18,385.4%

Although we might not live to invest for that many years, and there might not even be any company with such consistent dividend growth over 70 years, this just shows the power of compounding when one reinvests all the dividends. If you add a designated amount every month to the investment, the number will only be more astounding.

Let me end off this point with a study done by some professors from the London Business School a few years back:

It has been proven that every $1 invested into U.S. stocks in 1900 would have grown to $198 by 2000. That sounds impressive, until one realizes that if he had reinvested all the dividends, the portfolio would have grown to a whopping $16,797 by 2000.

This further shows the importance of reinvesting, especially for the long-term investor.

With this, I conclude this article series about my portfolio and a few of its rules. I would also appreciate it if you could voice what you think about these rules in the comment box below. Your opinions and comments will be greatly treasured.

Disclosure: I am long KMP. 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.