401k Reconstructed: My Transformation From Mutual Funds To Dividend Growth Investing

by: Eric Landis

Over the last year my 401k has gone through a series of twists and turns and as of last week, my work in transforming it into my own is complete. In this article I'd like to share my experiences during this process and hopefully generate some ideas and discussion for other investors as they go through similar transitions on their own.

The process for me began in the beginning of 2012 when my employer decided to switch from a full service broker account to an individually managed online broker. Prior to the switch I had periodically purchased mutual funds over the last six years and, with the help of a company match on investments, slowly built up the balance of the account.

When the switch was made to an online brokerage, the positions held in mutual funds were transferred over to the new account and I continued with those same investments. Then, as new monthly contributions accumulated in the account, I began building positions in individual stocks and in the second half of 2012 I sold the first of my mutual fund holdings and used the proceeds to purchase more individual stocks.

The problem I began to run into, which is a common mistake among many individual investors, was that I didn't really have a game plan for what type of investments I should be concentrating on. I had a wide assortment of investment classes that included MLP's with Calumet Specialty Products (NASDAQ:CLMT) and Enterprise Products Partners (NYSE:EPD), ETF's like United States Natural Gas ETF (NYSEARCA:UNG), a royalty trust in Chesapeake Granite Wash (NYSE:CHKR), a few speculative growth companies like Clean Energy (NASDAQ:CLNE), 3D Systems Corp. (NYSE:DDD) and Sirius XM Radio (NASDAQ:SIRI), a few dividend paying stocks with Quality Systems (QSII) and Cliffs Natural Resources (NYSE:CLF) and the obligatory bottom feeder near-bankruptcy special in the shipping company Excel Maritime (NYSE:EXM).

Needless to say I wasn't overly successful in my approach. I basically had "Investor A.D.D." and would take a look at whatever shiny object caught my eye, which isn't a particularly good recipe for long term success.

Then, around the end of January of this year, I found Seeking Alpha and began reading the articles and the corresponding comments section for them. I found a recurring theme from some of the veteran investors who often talked about long term buy and hold, and more specifically, Dividend Growth Investing. While reading the comments section of an article, I came across a recommendation for a book called "The Single Best Investment" by Lowell Miller.

That book and the wisdom shared by some of the "seasoned" investors on this site probably saved me from myself when it came to building a portfolio towards my retirement. Over the course of the last two months I have methodically sold off nearly all of my original collection of higher risk stocks and mutual funds and built a portfolio of 50 companies that I hope will pave the way to my retirement.

There were a few reasons why I chose 50 as the number of companies to hold. First of all, I believe it is important to start out with a balanced portfolio covering multiple sectors, and by starting with 50 positions each one will have a 2% weighting in the portfolio at the start. Secondly, by choosing so many positions, I am able to buy a "basket" of the top companies in each sector. Rather than agonizing over who the very best retailer, oil company, consumer goods, railroad, etc. to buy, I decided to buy who I thought the top few were in each category. I figured the more trees I plant at the start, the better chance I have over the next 30 years to pick a couple that will yield a lot of fruit, while also overcoming the few along the way that wither and die.

The biggest downfall to this approach was that in buying so many positions the upfront transaction costs for the stock purchases add up after awhile. I entered positions in each company with a minimum of a $500 investment and my total fees ended up being around 1.8%. This was higher than I'd like, but also about one third of what the front end loads charged by full service brokers are when buying some mutual funds. The upside is that now I have created my own personal mutual fund that is completely under my control and I no longer have to pay the ongoing expense ratios for the mutual funds which can be in the 1% range annually.

In selecting my possible investments, I decided the hassle of dealing with K1's and Unrelated Business Taxable Income "UBTI" in a 401K account were not worth the headache for me. I also chose to avoid investing in REIT's and companies headquartered in foreign countries as I don't have a good understanding of REIT's and wanted to avoid any foreign taxes on dividends. I'm a big fan of the K.I.S.S. principle and, for me, keeping options centered on American stocks was the best approach.

Without further ado, here is my final portfolio of dividend paying stocks. The information listed in the tables below was collected from Yahoo Finance, Charles Schwab Client Center, and David Fish's Dividend Champions Spreadsheet, with stock prices from the close of April 2.



Dividend Champions (25+ Years) Ticker Price Dividend Yield PE 5YR Dividend Growth Rate Trailing 5YR EPS Growth Rate Forward 5YR EPS Growth Rate
3M Company (NYSE:MMM) $ 106.52 $ 2.54 2.4% 16.9 4.2% 6.6% 10.4%
AFLAC Inc. (NYSE:AFL) $ 52.90 $ 1.40 2.6% 8.7 10.9% 13.9% 6.5%
Chevron Corporation (NYSE:CVX) $ 119.00 $ 3.60 3.0% 8.9 9.2% 12.3% 1.9%
The Clorox Company (NYSE:CLX) $ 89.17 $ 2.56 2.9% 20.9 10.3% 5.1% 8.0%
Genuine Parts Company (NYSE:GPC) $ 78.01 $ 2.15 2.8% 18.8 6.2% 9.9% 8.9%
Leggett & Platt, Incorporated (NYSE:LEG) $ 33.53 $ 1.16 3.5% 19.8 10.1% 23.2% 15.0%
McDonald's Corp. (NYSE:MCD) $ 100.26 $ 3.08 3.1% 18.7 13.9% 12.4% 9.3%
Raven Industries Inc. (NASDAQ:RAVN) $ 33.61 $ 0.48 1.4% 23.3 14.0% 15.3% 10.0%
Target Corp. (NYSE:TGT) $ 68.80 $ 1.44 2.1% 15.2 20.5% 9.1% 11.9%
Vectren Corporation (NYSE:VVC) $ 35.45 $ 1.42 4.0% 18.3 2.0% 8.4% 5.0%
Walgreen Co. (WAG) $ 47.32 $ 1.10 2.3% 21.0 23.7% 4.9% 12.9%
Wal-Mart Stores Inc. (NYSE:WMT) $ 76.02 $ 1.88 2.5% 15.1 13.5% 9.6% 9.0%

Why I chose Raven Industries:

Raven Industries is a small cap ($1.15B) diversified industrial goods producer that serves the agricultural, energy, construction and military/aerospace markets. It has a 27 year track record of increasing dividend payouts. Raven has grown earnings at a 14% clip over the last 5 years and its dividend payout over the last decade has increased at a compounded annual growth rate of 19.4%. On March 25, Raven announced a 14% increase in the dividend rate to an annual $0.48/share which provides a yield of approximately 1.4%.

The company has no debt on the balance sheet and its low payout ratio of just 29% of earnings gives ample room for continued strong growth in the dividend. The stock is currently about 20% below its 52 week high which I felt provided a solid entry point into the stock.



Dividend Contenders (10-24 Years) Ticker Price Dividend Yield PE 5YR Dividend Growth Rate Trailing 5YR EPS Growth Rate Forward 5YR EPS Growth Rate
Church & Dwight Co. Inc. (NYSE:CHD) $ 64.54 $ 1.12 1.7% 26.3 45.0% 15.4% 11.5%
Cracker Barrel Old Country Store (NASDAQ:CBRL) $ 80.84 $ 2.00 2.5% 17.1 18.5% 14.3% 10.0%
Deere & Company (NYSE:DE) $ 84.04 $ 2.04 2.4% 10.5 14.5% 20.6% 10.0%
EOG Resources, Inc. (NYSE:EOG) $ 129.05 $ 0.75 0.6% 61.1 15.2% -3.3% 17.8%
Flowers Foods, Inc. (NYSE:FLO) $ 32.73 $ 0.64 2.0% 33.4 17.8% 4.7% 8.7%
General Mills, Inc. (NYSE:GIS) $ 48.81 $ 1.52 3.1% 17.9 10.8% 8.9% 8.0%
Lockheed Martin Corporation (NYSE:LMT) $ 95.62 $ 4.60 4.8% 11.4 22.2% 2.3% 7.9%
Meredith Corporation (NYSE:MDP) $ 38.33 $ 1.63 4.3% 15.5 15.6% 2.3% 15.0%
MDU Resources Group Inc. (NYSE:MDU) $ 24.51 $ 0.69 2.8% 19.1 4.0% -10.8% 6.8%
Microsoft Corporation (NASDAQ:MSFT) $ 28.80 $ 0.92 3.2% 15.8 15.1% 10.8% 9.1%
Norfolk Southern Corp. (NYSE:NSC) $ 76.25 $ 2.00 2.6% 14.2 15.1% 10.8% 10.6%
Occidental Petroleum (NYSE:OXY) $ 80.68 $ 2.56 3.2% 14.2 17.2% 4.1% 5.8%
Polaris Industries, Inc. (NYSE:PII) $ 89.75 $ 1.68 1.9% 20.4 16.8% 31.3% 16.7%
QUALCOMM Incorporated (NASDAQ:QCOM) $ 66.26 $ 1.00 1.5% 17.5 12.3% 18.8% 14.7%
Ross Stores Inc. (NASDAQ:ROST) $ 59.41 $ 0.68 1.1% 16.8 30.1% 31.1% 12.1%

Why I chose EOG Resources:

At quick glance at the reported PE ratio from Yahoo Finance, EOG Resources appears to be overvalued at its current price. The PE is misleading however as the reported EPS of $2.11 per share includes non-cash charges of ($3.13 per share) related to impairments on natural gas assets in Canada. The company reported adjusted non-GAAP income of $5.67 in 2012, which would give a much more reasonable PE ratio of around 22.

According to the current investor presentation, EOG increased production by 39% in 2012 and is projecting growth of 28% in 2013, led primarily by continued drilling in the Eagle Ford Shale in Texas and the Bakken in North Dakota. EOG is the #1 producer and leaseholder in the Eagle Ford with 639,000 net acres and is one of the top producers and leaseholders in the Bakken as well.

EOG has been a pioneer in crude oil transportation by rail and as a result has realized much higher prices for their product in 2012. EOG is also a leader in well completion technology as documented by Michael Filloon in "Bakken Update: EOG Resources' Completion Technology Is A Game Changer". Another positive for the company is that EOG has begun sourcing its own frac sand, which should help to further cut drilling costs for the company.

EOG may have a low current yield at just 0.6%, but it has steadily grown the dividend payout at an annual rate of nearly 14% for the last decade and is one of the most well run oil companies in the country.



Dividend Challengers (5-9 Years) Ticker Price Dividend Yield PE 5YR Dividend Growth Rate Trailing 5YR EPS Growth Rate Forward 5YR EPS Growth Rate
AmerisourceBergen Corporation (NYSE:ABC) $ 52.41 $ 0.84 1.6% 18.1 39.8% 17.7% 12.0%
Baxter International Inc. (NYSE:BAX) $ 72.21 $ 1.80 2.5% 17.3 16.4% 8.5% 8.7%
Cummins Inc. (NYSE:CMI) $ 111.84 $ 2.00 1.8% 12.9 33.2% 33.6% 9.7%
Darden Restaurants, Inc. (NYSE:DRI) $ 51.33 $ 2.00 3.9% 15.7 25.8% 3.0% 5.2%
Intel Corporation (NASDAQ:INTC) $ 21.46 $ 0.90 4.2% 10.1 14.1% 28.8% 12.3%
Thor Industries Inc. (NYSE:THO) $ 36.73 $ 0.72 2.0% 14.3 16.5% 27.8% 14.0%
Union Pacific Corporation (NYSE:UNP) $ 140.82 $ 2.76 2.0% 17.0 29.8% 21.0% 14.2%

Why I chose Union Pacific Corporation:

I've always been intrigued by the railroad business and became even more so after Berkshire Hathaway acquired BNSF railroad back in 2009. I knew when I was in the process of constructing my new portfolio that I wanted to include the railroad industry as part of my holdings. I chose to pair Union Pacific with Norfolk Southern as a play on the massive growth in oil transportation and growth in industry in the country.

Union Pacific's rail lines generally span from the Mississippi River west to the Pacific Coast. This puts the company in the heart of the commodity markets with large markets of coal, oil and agricultural products. The coal business has been a drag on earnings the last few years, but that has been offset somewhat with increasing volumes of crude oil, frac sand, vehicles and domestic goods as detailed in their investor presentation. Strong pricing has allowed the company to grown earnings at an impressive 21% over the last 5 years and analysts are projected continued growth at a 14% clip going forward.

Since 2007 Union Pacific has been aggressive with stock buybacks and has decreased shares outstanding from approximately 540 million in 2007 to 470 million today and has increased the dividend at a 10 year growth rate of just over 20%.



Near Challengers (3-4 Years) Ticker Price Dividend Yield PE 3YR Dividend Growth Rate Trailing 5YR EPS Growth Rate Forward 5YR EPS Growth Rate
Coach, Inc. (COH) $ 50.39 $ 1.20 2.4% 13.9 135.1% 16.3% 13.9%
Dr Pepper Snapple Group, Inc. (NYSE:DPS-OLD) $ 46.64 $ 1.52 3.3% 15.8 108.5% 14.3% 5.9%
Gannett Co., Inc. (NYSE:GCI) $ 21.26 $ 0.80 3.8% 11.9 71.0% -7.0% 5.0%
Lorillard, Inc. (NYSE:LO) $ 41.22 $ 2.20 5.3% 14.7 17.4% 13.2% 9.0%
Mattel, Inc. (NASDAQ:MAT) $ 44.02 $ 1.44 3.3% 19.8 10.6% 17.1% 10.1%
Sturm, Ruger & Co. Inc. (NYSE:RGR) $ 50.73 $ 1.62 3.2% 14.1 61.9% 73.5% NA
Wells Fargo & Company (NYSE:WFC) $ 36.88 $ 1.00 2.7% 11.0 21.6% 15.6% 9.7%

Why I chose Dr. Pepper Snapple Group:

Since being spun off from Cadbury Schweppes in 2008, DPS Group has shown a strong track record of looking out for shareholders. The company has shown a strong commitment to buying back shares and has decreased the number of shares outstanding from 254 million in 2009 to 208 million currently and has grown the dividend steadily to a current yield of 3.3%.

With the recent announcements of their re-acquisition of distribution rights in the Asia Pacific and bottling assets in the western U.S., the company is positioning itself for future growth into new markets.



Other Dividend Payers Ticker Price Dividend Yield PE Trailing 5YR EPS Growth Rate Forward 5YR EPS Growth Rate
Apple Inc. (NASDAQ:AAPL) $ 429.79 $ 10.60 2.5% 9.7 71.7% 19.0%
Eagle Materials Inc. (NYSE:EXP) $ 63.80 $ 0.40 0.6% 50.1 5.1% 8.0%
Linn Co, LLC (LNCO) $ 39.70 $ 2.84 7.2% 13.8 -2.2% 7.0%
Phillips 66 (NYSE:PSX) $ 66.84 $ 1.25 1.9% 10.3 NA 10.8%
Questcor Pharmaceuticals (QCOR) $ 32.54 $ 1.00 3.1% 10.4 47.1% 28.0%
Starbucks Corporation (NASDAQ:SBUX) $ 58.26 $ 0.84 1.4% 31.3 28.4% 18.6%
Southern Copper Corp. (NYSE:SCCO) $ 36.29 $ 0.96 2.6% 15.9 17.3% 16.8%
Watsco Inc. (NYSE:WSO) $ 82.35 $ 1.00 1.2% 30.5 13.5% 16.8%
Wynn Resorts Ltd. (NASDAQ:WYNN) $ 123.26 $ 4.00 3.2% 25.6 39.1% 10.9%

Why I chose Wynn Resorts:

Wynn Resorts has grown EPS at an astounding rate of 39% over the last 5 years and analysts are projecting a growth rate of 11% over the coming 5 years. The company opened Wynn Macau in September of 2006, Encore at Wynn Macau in April of 2010 and are in the planning and development stages for Wynn Cotai, which will have another 1,500 rooms in Macau. Gaming revenues have been growing at a dramatic pace in Macau and according to this article from April 3, gaming revenues in Macau increased 25% year over year to a record $3.92 billion dollars for the month, which could provide upside over the analysts current projections for Wynn earnings.

In January of 2013 the company increased the dividend to an annual rate of $4.00 per share, which provides a yield of just over 3%. In addition to this quarterly dividend, the company has paid out special dividends every year since 2009 with the amount ranging from $4.00 per share in 2009 to $8.00 per share in 2012.

Total Portfolio Summary

When totaling everything up for the entire portfolio, the average dividend yield is around 2.7% with a PE of 18.4, 5 year dividend growth rate (Dividend Challengers through Champions) of 17.2%, a trailing 5 year EPS growth rate of 16.2% and a projected 5 year EPS growth rate of 11%.

I believe this new portfolio provides a solid diversification across multiple industries and has a nice mix of core blue chip holdings and higher upside growth plays. The portfolio contains 12 holdings on the Dividend Champions list, 15 holdings on the Dividend Contenders List and 7 on the Dividend Challengers List. Of the 50 companies in the portfolio, 27 of them are projected to grow earnings at greater than a 10% rate over the next 5 years.


As a 34 year old investor in the accumulation phase of my retirement planning, I believe the high earnings growth rates coupled with a demonstrated commitment by the companies to grow dividend payouts should lead to solid growth in the portfolio value in the years ahead as well as a growing dividend income stream as I near retirement.

Disclosure: I am long DPS-OLD, EOG, RAVN, UNP, WYNN. 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.

Additional disclosure: Disclaimer: The companies listed in the tables of this article are all held in my personal 401K account. I am a Civil Engineer by trade and am not a professional investment adviser or financial analyst. This article is not an endorsement for the stocks mentioned. Please perform your own due diligence before you decide to trade any securities or other products.