The Perfect Portfolio: End Of Year Review

by: David Crosetti


The end of the year is a great time for reviewing your investment portfolios and doing some kind of analysis as to how well or how poorly your investments are doing, relative to your individual goals.

As a Dividend Growth Investor, first, most of my holdings are in the traditional DG stocks that you can find in the Dividend Champions, Dividend Contenders, and Dividend Challengers list that David Fish publishes and updates at the end of each month. If you are not familiar with the list, here is a link where you can download your own copy.

The first portfolio that we will discuss in this series of articles is called "The Perfect Portfolio." This portfolio was created for the purpose of generating income for my mother. She had been putting her money in a laddered CD program and while she was enjoying nice interest income, as the interest rate markets tanked in 2008, we made the decision to take her maturing CDs and investing that money into the stock market, specifically in DG stocks.

Her CD ladder consisted of three $100k certificates that would mature in 2009, 2010, and 2011, a total of $300k. Interest income from the CDs was routed into her checking account and she used that money to supplement her retirement pension, my late father's union pension, and Social Security.

What You Should Know:

We call this portfolio The Perfect Portfolio for a reason. As an investor, one of the mantras that I believe in is "value, value, value." At the point in time that we created this portfolio, each of the companies that we bought were priced at a value to intrinsic worth. As CDs matured, these same companies remained a value to their intrinsic worth and that is why we continued to add more shares to our holdings.

Every company, regardless of the emotional baggage that we bring to the table, has a value point at some particular point in time. Do companies become overvalued? They sure do. When they do, your course of action should be simple--don't purchase any additional shares or create a new position in those companies that no longer represent a value.

Instead, allow the stock fundamentals to catch up to the price, relative to the value point. Like we choose not to chase yields, we don't choose to chase companies.

How We Put The Portfolio Together:

When the first CD matured in 2009, we put $100k into equal amounts of 10 DG stocks (for a $10k investment in each). Those companies were Abbott Labs (NYSE:ABT), Coca-Cola (NYSE:KO), Colgate-Palmolive (NYSE:CL), Johnson & Johnson (NYSE:JNJ), Kimberly-Clark (NYSE:KMB), Procter & Gamble (NYSE:PG), McDonald's (NYSE:MCD), Altria (NYSE:MO), AT&T (NYSE:T), and Chevron (NYSE:CVX).

The second CD matured in 2010 and we put $100k into equal amounts of the same 10 DG stocks.

When the third CD matured in 2011, we invested $5k in each of the same 10 core holdings and then added 5 additional companies with $10k positions in each of them. The new additions were Intel (NASDAQ:INTC), Microsoft (NASDAQ:MSFT), Reynolds Tobacco (NYSE:RAI), Verizon (NYSE:VZ), and Exxon Mobil (NYSE:XOM).

Over time, the market has made some changes to our portfolio. For example in 2013, there was a 2:1 split in both Coca-Cola and Colgate-Palmolive. There was also a split in Abbott Labs as the company became two companies, Abbott and AbbVie (NYSE:ABBV).

How The Portfolio Has Performed:

So, at the close of the markets on 12/27/2013 our portfolio currently looks like this:

The portfolio, since inception has appreciated $184,702.70 from our initial investment of $300,000. Cost basis is arrived at from the three purchase events in 2009, 2010, and 2011. There have been no additional purchases made and dividends have not been reinvested.

Income In 2013:

When we consider the income from this portfolio in 2013, the picture looks like this:

In 2013, the portfolio threw off $15,770,67 in dividend income. This equates to a 3.25% current yield (based on actual dollars paid and not future dividend amounts).

So, for example, while we received $0.56 a share in 2013 for our holdings in Abbott Labs we are showing that number, and not using the new dividend amount of $0.88 a share, which will be paid in 2014.

For those who use YOC numbers, the portfolio delivered a 5.26% YOC in 2013.

So, Where Do We Go From Here?

This portfolio was constructed with the premise that it should follow a strict DGI strategy. Let's face it, there really is no such thing as a "strict" DGI strategy that has universal acceptance among DGIs.

In every article that is written about DGI, including my own, the commentary would suggest to me that each DGI practitioner has a somewhat unique set of "rules" including some that have "no rules."

Here's what I see as being part of my own DGI strategy and these guidelines are criteria that I've used pretty much as stated, over the years.

1. I look for companies that first and foremost are priced at a value, relative to their intrinsic worth.

This can present a problem for some as those critical of this metric will want to ask "how do you arrive at a definitive valuation?" That's a great question. Like every DGI has his/her own spin on how they approach the strategy, I think valuation is "in the eye of the beholder."

But, when I bought Safeway (NYSE:SWY) back in November of 2012, there were some that thought I was "crazy." Same was true for our interest in Staples (NASDAQ:SPLS), Western Union (NYSE:WU) and a small company, CA Technology (NASDAQ:CA).

How you define "value" is how you define value. Get it right and you will be, in effect, buying low. Get it wrong and...well, you know.

2. I look for companies that have a history of paying dividends and a habit of increasing those dividends on an annual basis.

Not to be splitting hairs, "on an annual basis" might not be in a calendar year. I look for the 5th dividend payout, after the first 4, to be an increase. Clear?

You might be looking at Intel and you might be saying that INTC "doesn't meet the metric." You know what? You would be right and a limit order to sell INTC has been placed. It will not be in the portfolio very long.

3. I look for companies that are increasing their dividends at a rate that is larger than inflation.

Again, whoops. There are two companies in this portfolio that have not been meeting that criteria. Verizon and AT&T are growing their dividends at a rate than is problematical relative to this criteria. However, they do pay a higher dividend than many of the usual suspects and have been increasing their dividends on a regular basis.

But, in my own world (and maybe your world as well) these two companies have demonstrated that they might not be companies that I want to continue holding, moving forward. There may be better alternatives for the portfolio and these two companies will receive further scrutiny in the immediate term.

Summary and Conclusion:

So far, this portfolio is doing exactly what we wanted it to do when we created it. That is, we wanted a source of income that is supplemental.

At first, the income was for my mother, to replace her CD interest income. Now, since she has passed, the income generated is used to fund Roth investments for my wife and myself and the balance being spent for other sundry purchases and events, the last being a two week trip to Alaska this summer.

Moving forward, we have a lot of potential options for this portfolio, but for now, we think that we will continue to use it as a Dividend Growth Portfolio. Being a taxable account, it would seem to me that using the account as a trading vehicle does not make a lot of sense.

So moving forward it is our intention to look for companies that we would like to add to the portfolio. In order to do that, we will rebalance the portfolio, taking some profits in order to build a temporary cash reserve and then take that money and reinvest it into new positions that will enhance the income stream.

At our current DGR, we should double our income every 9 years, based on the current 8% DGR that we have been getting. Our $15k would grow to $30k in 9 years; that would grow to $60k in 18 years and so on. I would like to accelerate that income growth and think that we might be able to get a doubling every 7 years. We'll see.

Disclosure: I am long ABT, ABBV, T, MO, KO, CL, KMB, VZ, RAI, INTC, MCD, CVX, PG, MSFT, XOM, CA, MSFT. 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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