My Dividend Growth Portfolio Strategy

by: Integrator

I have been following a dividend growth investing strategy for a number of years now, which has allowed me to build up a steady stream of passive dividend income. My objective is to be able to add progressively to my dividend growth portfolio over the next 5 to 10 years with the addition of high-quality dividend-paying businesses to allow me to shoot for an accelerated financial independence in my early 40s through harvesting the dividend income from the portfolio. I am currently 36-years old.

Portfolio Objective: To achieve a dividend income stream of about $50,000 per annum from my portfolio of dividend growth stocks. This is the amount that I have determined will provide myself and my young family with expense replacement (rather than income replacement), which is really the focus of the portfolio.

I have determined this amount based on our current expense run rate, and by factoring in some significant childcare expenses that I expect to fall away within the next five years. The portfolio currently provides around $27,000 per annum in dividend income. My objective is to be able to reach an annual dividend income of $50,000 which then grows at an annual rate of at least 5% per annum to allow me to at least grow my income at a rate exceeding the rate of inflation.

Current portfolio composition: My dividend portfolio is held in a taxable account, given my interest in accelerating my financial independence and my desire to live off my dividend income. The portfolio is also significantly concentrated with Australian dividend stocks like Westpac Bank (NYSE:WBK), National Australia Bank (OTCPK:NABZY), Commonwealth Bank (OTCPK:CMWAY) and Telstra (OTCPK:TLSYY). This resulted from a conscious decision I made in 2010 to cash in some gains I made from investing in some quality U.S. dividend-paying stocks through 2008 and 2009 and move more of my capital to the Australian market.

I perceived the Australian market as having more positive prospects for near-term growth, higher dividend yields and better access to smaller dividend-paying companies, which yield higher dividend growth to maximize my dividend income. While the net result has been a faster acceleration of my dividend income, this has resulted in a portfolio that is heavily skewed to the Australian economy and the Australian currency.

I still have a positive view on the Australian economy and so don't intend to sell any of these holdings. I am aiming to bring better diversity to my portfolio with the addition of some quality multinational dividend payers such as McDonald's (NYSE:MCD) and BP (NYSE:BP) that I have already added to the portfolio. Shifting my capital to Australian companies did come at some cost as I sold out some very stable U.S. dividend paying companies that I had picked up during the depths of the 2009 recession, including American Express (NYSE:AXP) (acquired at $12, with an effective yield of 6%), Kimberly-Clark (NYSE:KMB) (acquired at $50, effective yield of 5%), The Coca-Cola Company (NYSE:KO) (acquired at $40) and Caterpillar Inc. (NYSE:CAT) (acquired at $30, at an effective yield of 5.5%). While I was able to realize substantial capital gains on all of these stocks, these companies are now particularly expensive to get back into compared to my original acquisition price and they are also trading at far lower yields than what I had originally acquired them for.

The portfolio currently has approximately 30 positions. I am aiming to add another 15-20 fresh positions in identified companies over the next 5-10 years. These positions will be balanced across industries and will be roughly equal in terms of weight. No new position will account for more than 10% of the overall portfolio size. I am targeting financial services, industrial, consumer goods, healthcare and infrastructure as areas of focus.

Company Characteristics: I aim to acquire a portfolio of high-quality dividend payers with wide moats, strong return on equity and sustainable competitive advantages. My criterion for adding new positions to the portfolio the following:

  • Companies with a history of growing revenue and earnings over an extended period of time
  • Companies with a history of paying and growing dividends for an extended period of time
  • Companies with a strong competitive position, defensible barriers to entry and wide economic moats
  • An ability to add to a position at a discount to intrinsic value or at intrinsic value
  • A preferred initial yield of approximately 3%, with prospects for ongoing dividend increases of at least the rate of inflation.
  • Manageable payout ratios that are less than 70%

Existing Positions:

McDonald's, Western Union (NYSE:WU), BP, Novartis (NYSE:NVS), CME Group (NASDAQ:CME) and Visa (NYSE:V) are all existing positions in the portfolio. All these companies generally meet my stated goals for the portfolio.

McDonald's Corp. - Leading fast food franchisor with a moat developed from significant international scale and brand strength. Added with to the portfolio with a yield of 3.3%.

Western Union - Leading operator in the money transfer and remittance market. Western Union has a moat developed by virtue of its vast agent network and distribution assets, which is not easily replicated. Recently added to the portfolio with a yield of 3.5%

BP- Oil major with upstream and downstream assets. Added to the portfolio with a yield of 5%.

Novartis - Global pharmaceutical company with a strong and diverse drug pipeline. Added to the portfolio with a yield of close to 3%

CME Group -Dominant platform for the trading of futures and options with massive network effects providing a wide moat. CME was added to the portfolio with a yield of 3.2%.

Visa - One of the duopoly of credit card processors, Visa has also developed a wide moat from network effects. Visa did not meet my current yield requirements, (it was added to my portfolio with a yield 1.2%) however I believe it has ample scope to increase its yield going forward and rapidly grow its dividend.

Targeted Positions:

I am hoping to add positions in Coca-Cola, Clorox (NYSE:CLX), Paychex (NASDAQ:PAYX), Lockheed Martin (NYSE:LMT), Colgate-Palmolive (NYSE:CL), Procter & Gamble (NYSE:PG), Moody's (NYSE:MCO), CSX Corp. (NYSE:CSX), Norfolk Southern Corp. (NYSE:NSC), Caterpillar, PepsiCo (NYSE:PEP), Kimberly-Clark Corporation, Wells Fargo & Company (NYSE:WFC), JPMorgan Chase & Co. (NYSE:JPM) over time.

The Coca-Cola Company and PepsiCo are both wide moat stocks by virtue of having strong brands and a globally efficient distribution network, with yields close to 3%. Clorox, Colgate - Palmolive, Kimberly-Clark and Procter & Gamble are some leading providers of day-to-day essential items for consumers and have all been paying dividends for many years. CSX and Norfolk Southern have dominant railroad assets, which provide regional economic moats and strong growth potential with the emerging economic recovery in the U.S. They also provide additional growth upside with higher oil prices. Caterpillar is well positioned to benefit from the continuing industrialization in the emerging market economies. I also believe Wells Fargo and JPMorgan are two of the large money center banks that are the best placed to benefit from a post recession banking environment that is more concentrated with lower price competition.

Funding the Portfolio:

I aim to reinvest all of my Australian dividends into the portfolio. This provides the opportunity to deploy some $27k of new capital annually. My hope is that I can take advantage of the strong Australian dollar to accelerate the acquisition of U.S. dollar denominated dividend paying stocks and accumulate dividends at a rapid rate in the near term, while the Australian dollar remains strong. I also intend to add an extra $2000 per month of fresh capital into the portfolio (we manage to save close to 50% of our post tax income) to take total fresh investment in the dividend portfolio to close to $50,000/year.

Portfolio outlook

I have deployed most of my intended capital for 2013 into positions at the very beginning of the year. I don't expect to add new positions to the portfolio unless there is a major market retracement, or any company specific opportunities that emerge on lower valuation.

Based on my expectations for dividend growth in the portfolio of 7-8%, reinvestment of my existing portfolio dividends and fresh injections of capital of approximately $2000 per month, I hope to be able to achieve my dividend target of $50,000 per year in approximately 6 years or so.

Disclosure: I am long WU, BP, MCD, WBK, OTCPK:TLSYY, CME, NVS, V, OTCPK:CMWAY, OTCPK:NABZY. 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.