Your Portfolio Business Plan: You Really Need To Do This

by: Bob Wells

I believe that the single most important action any investor can take is to spend some time carefully crafting a business plan for their investment portfolio and then actually adhering to their plan once developed.

At the end of 2011, my first year as an independent investor, I read my first article by Seeking Alpha Contributor David Van Knapp on Dividend Growth Investing. Of those early articles, the one that affected my thinking most simply suggested a portfolio be treated like a business and be supported by a formal business plan.

Each portfolio business plan needs to be self-written in order to reflect your personal goals, investment preferences and volatility tolerance. I took this task seriously, and what followed was the development of a business plan that would guide our actions moving forward. I believe that our plan helps take a good bit of emotion out of the business of buying, selling or even trimming positions. Our business plan helped to provide guidance since its formal inception in July 2012. Like all plans, it can always be improved. I revised mine in January of this year.

Since its inception, besides providing guidance, our plan has helped to provide increased safety and an overall sense of security. It assists in taking emotions out of the decision making process. I believe there is nothing more important any investor can do than spend time carefully crafting a business plan for their portfolio, and then actually adhere to the plan you developed.

After a careful review, I made considerable changes to my original plan. Changes in part were prompted by events affecting my portfolio over the past year and by the need to provide guidance for my family should I be unable to manage our portfolio in the future. Our revised plan is presented below:

Business Name: Wells Family Income Stream Portfolio

Goal: Generate a steadily increasing stream of income paid solely from the growing dividends generated by low-risk companies with a track record of providing safe and growing dividends. Target is to deliver a 4.7% plus yield during 2013 with a gain in overall portfolio capital.

Business Model Strategies:

Stock Selection:

Use the current Champion, Challengers and Contender (CCC) Lists as my principal shopping list when considering new equity purchases.

Alternative: Select stocks from Safe Dividend Stock document generated from my back testing of Dividend stocks from 2002 to 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% at time of purchase.
  • Positive annual total returns in four of past five years.
  • Increased dividend payout in each of past five 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 only stocks with "Fair" or better valuations as determined by average PE for past five years. Seek an overall portfolio PE of 15 or below. 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:

  • Morningstar
  • Fast Graphs
  • Select SA Contributors

Buy stocks with a current payout ratio of under 70% or one in line with its peers.

Buy stocks that meet the Total Dividend Return (TDR) rule a/k/a the "chowder rule," requiring a yield plus Five year Dividend Growth Rate (DGR) total of 12% or more. In the case of utilities, MLPs and REITs, the total is 8% or more.

To help insure capital preservation, est. five-year growth figures will be examined and compared for all stocks under consideration. As a minimum standard, only stocks with growth equal to inflation will be considered.

A watch list of stocks of Dividend Champions, Contenders and Challengers with a minimum yield of 2.7% that meet the Total Dividend Return (TDR) rule standard a/k/a chowder rule shall be maintained at all times and revised quarterly. The chowder rule score is located in Column BX of The CCC spreadsheet. This edited list of Dividend Champions, Contenders and Challengers - Dividend Growth Income Index will also serve as an Index for the purpose of gauging portfolio performance.

A full year by year performance back test for each stock will be conducted going back to 2002 or in the case of Challengers the earliest date possible. Results will be maintained and used when considering new holdings or adding to existing holdings.

Portfolio Construction:

Aim for a well rounded portfolio. Diversify across sectors, industries, geographies, and different ranges of yields and growth rates.

50 will be the minimum number of stocks owned at any time.

The portfolio should maintain an overall beta of less than 0 .7.

Be alert to position sizing. Investing an equal initial amount in each stock is the norm. Adjustments may be considered as prices change, yields decline and perceptions of risk and reward change.

Hold no more than 3% of the portfolio's value in a single stock, with 2% or less being the norm. When a position exceeds 3%, sell the excess and re-deploy the proceeds.

Make opportunistic switches from one stock to another if such a swap will upgrade the portfolio. The expected frequency of such exchanges is low.

The major focus is total dividend return - dividends and dividend growth not share prices. The portfolio will usually be 95% or more invested. Generating a steady and growing income stream from dividends remains job one.

Dividend Reinvestment:

Since retirement income is supplied solely from dividends and dividend growth, dividend reinvestment will likely be rare. Our goal as retirees is to enjoy our dividend income while preserve capital for future generations.

When reinvesting dividends, consider new positions designed to improve the portfolio in one or more of the following dimensions: yield, dividend growth, or diversification.

Selling Guidelines:

Investigate and seriously consider selling a stock for these reasons:

  • It cuts, freezes, or suspends its dividend.
  • It becomes seriously overvalued as determined by a dividend of under 2% or an evaluation by Fast Graphs. Re-capturing and re-investment of gains will likely be the first step.
  • It underperforms stocks in its sector in total returns (price + dividends) for two years running.
  • It incurs a price loss in excess of 10% and maintains such a loss for a quarter, and where such a percentage represents a loss significantly greater than similar stocks in that sector or industry. If losses increase into the next quarter, suitable replacements will be carefully evaluated. A stock can continue on "probation" as long as it is showing a price improvement.
  • Plans are announced to split or divide the company.
  • Acquisition announcements are made.
  • Announcements of an investigative inquiry.

Portfolio Review:

Monthly Review - Estimated Time - 30 minutes

The first of each month download a new copy of Dividend Champions, Contenders and Challengers using this link. Next clip on Changes Tab at the bottom. Check for any stocks which cut or froze its dividend or was acquired that month. Consider possible replacement for stocks cutting dividend. In the case of a freeze consider a period of probation as the first step where yield in 5% or more. Conduct a performance review the next quarter

Quarterly Portfolio Review - Estimated Time - 3 to 6 hours

Measure the Portfolio's overall progress toward the overall goal of maintaining stable growing income and capital preservation.

Record monthly dividend income for the portfolio. Note dividend increases for each quarter.

Measure performance for any stock "on probation".

No longer use either the Dow or the S&P 500 as a measure of the success of the portfolio. Instead use performance of the Dividend Growth Income Index. Serious under performance will be closely examined to see if an exchange for other DG equities within the Index have the potential to further strengthen income stream and capital preservation. Portfolios are set up on Seeking Alpha website under the Portfolio tab. Three have been established: CCC Index, CCC MLP and Current Portfolios.

Run each of the holdings through Fast Graphs to determine if any are overvalued.

Measure final success against the "Chowder Index." Check to see if this quarter's income from dividends exceeds that of the same quarter last year. If it does, celebrate with a cold one or two. If it doesn't, make appropriate adjustments based on stated guidelines and portfolio objectives.

That's it, our new and improved portfolio business plan. We're proud of it, but would sure like to hear from you about how we might further define and improve it. I hope our effort generates thought and comment, but most of all I hope it generates action. Whether you're a few years out or already retired, no matter what investment vehicle or mix of vehicles you choose, whether you are a self-directed investor or work with an adviser, take the time to develop your plan.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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