Kang's Dividend Compounding Portfolio: 2014 Review

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Includes: ADP, ARLP, BMO, BNS, CAT, CL, CM, COP, CVX, DLR, GGN, GIS, GPC, HCP, JNJ, KHC, KMB, KMI, KO, LMT, MCD, MO, NSRGY, NVS, O, OHI, PG, PM, RY, SO, T, TEVA, TGH, WEC, WMT, WPC, XOM
by: Ong Kang Wei

Summary

My dividend compounding portfolio calls for a review at least once a year.

This time, I have removed some lower-yielding stocks temporarily to redeploy the funds into other higher-yielding dividend stocks.

The portfolio has kept to its targets according to the many metrics I used to measure performance, and looks all geared up for the new year.

Background

I started building a 25-stock dividend portfolio in 2012, which eventually developed into a portfolio of 30 dividend stocks in 2013. At the time of publication, I did not own all the stocks. As I stated in the articles, I was planning to buy the stocks gradually during pullbacks until 2014. Now, in late-2014, I have acquired almost all the positions in the portfolio, and I thought it would be timely for an update. As usual, here is a revision of the strategies and goals of the portfolio.

Strategy And Goals

Name

Kang's Dividend Compounding Portfolio (KDCP)

Mission Statement/Goal

To provide myself with capital appreciation and a steadily growing stream of predictable and reliable dividends to be reinvested into their respective companies. I also aim for a portfolio that will yield around 4%, and expect the compounding, along with the returns in the stock price itself, to be able to beat both inflation and the major indexes over the years.

The Strategy

In addition to reinvesting the dividends paid out by a company, I plan to add at least $400 to the account every month. This will ensure that at least some money is contributed regularly to the dividend account for compounding over time.

Portfolio Management

In terms of portfolio management, I plan to be an active manager. By "active", I do not plan to trade actively. Instead, I plan to keep myself on top of the news, looking out for any signs that may not be favorable to me, and researching about new stocks that may be a good pick for my portfolio at the same time. Examples of some stocks I found while researching this way are Textainer (TGH) and Alliance Resource (NASDAQ:ARLP). Both are still included in the dividend portfolio, and both have performed well in the dividend growth aspect, although Textainer shares have recently fallen in price due to worries about the shipping and container industry.

Number Of Positions

I plan to hold between 25 and 33 positions in the portfolio, with every stock representing around 3- 4% of the portfolio. This number may change in the future if I want to expand my portfolio of holdings, but I will stick to this figure for now due to the limited capital I have to invest.

General Goals

I aim to remain diversified across industries and across nations, while maintaining beta below 0.7 (at least 30% less volatile than the general market). All stocks must also be part of the Dividend CCCs list, which stand for Dividend Champions, Contenders and Challengers. This ensures that they have increased dividends for at least five consecutive years.

In terms of dividend growth, I require a company to keep dividends growing at a rate above 4% with the exceptions of stable utilities and already high-yielding REITs. Companies will also have to yield at least 2% (after withholding tax since I'm not American. Effective minimum yield is 2.8%). If not, I will redeploy the funds elsewhere.

In terms of dividend sustainability, payout ratios (based on either EPS or FFO for REITs and MLPs) for individual stocks have to stay below 90%, and EPS/FFO growth has to be sustained above the 2% mark.

I would also want the stocks in my portfolio to adhere to the Chowder Rule. Many dividend investors on Seeking Alpha should be familiar with this rule by now. Created and developed by fellow Seeking Alpha contributor Chowder, it simply states that the sum of the yield and the 5-year dividend growth of a company should exceed 8%. This ensures that one of my targets as a dividend investor- which is to receive a steadily rising income stream that outpaces inflation, are adhered to.

Do find more of my buying, selling and general guidelines here and here.

2014 Summary- Changes In Holdings

2014 has been a great year, with many companies keeping to their dividend growth trajectories, providing dividend growth rates outpacing inflation. Although this is the case, I am removing 6 companies from their portfolio, which consists of 5 companies and 1 fund. They are listed in the table below.

Company/Fund

Dividend Yield (%)

1-year Dividend Growth Rate (%)

5-year Dividend Growth Rate (%)

Teva Pharmaceuticals (NYSE:TEVA)

1.9

5.2

15.1

Colgate-Palmolive (NYSE:CL)

2.0

9.0

11.3

Genuine Parts Co. (NYSE:GPC)

2.1

11.1

7.0

Wal-Mart Co. (NYSE:WMT)

2.2 16.1 14.2

Automatic Data Processing (NASDAQ:ADP)

2.3 10.1 8.4

GAMCO Global Gold&Natural Resources Fund (NYSEMKT:GGN)

12.4 (-22.2%) -

Here are some of the key factors I considered when I removed these stocks from the portfolio.

Yield

As stated above, my minimum yield requirement is 2.80% (or 2% when it reaches me due to the fact that there is a 30% withholding tax on all my dividends). With the average yield of the 5 companies listed in the table above is 2.11%, I found it more sensible if I redeployed my funds elsewhere. Although they are all high-quality companies, they are not irreplaceable, and there are always better opportunities out there. As I will detail in this article later, I have added five more higher-yielding stocks in place of the aforementioned 5 stocks. Although I have removed these stocks from my portfolio, it is only temporary. Stocks removed from the portfolio will be placed on a separate watchlist. They will be considered again when I am looking for another stock to add into my portfolio, or when they meet my requirements once again. I will also reveal my watchlist later in this article.

Diversification

My portfolio was previously strongly overweight Consumer stocks (33% of portfolio) and Basic Material stocks (20% of portfolio). Hence, this was another reason, besides yield, why I removed Genuine Parts and Colgate- both consumer stocks, and the GAMCO trust- a basic material fund. One of the main factors I considered when adding stocks in my portfolio was also diversification.

Special Situation: Removal of GGN

Of all the stocks I removed from the portfolio this year, the odd one out must be the GAMCO Global Gold & Natural Resources Fund, or GGN. There are some reasons why I removed high-yielding GGN besides diversification problems. After decreasing its dividends twice in 2013, it has announced a dividend decrease of 22% from 2014 to 2015. Although it still yields 12% (having declined 15% year-to-date), I do not want to hold the fund aimlessly, watching it deviate from my portfolio's rules.

Stocks Added In The Portfolio

After announcing the stocks I have removed from the portfolio, here are five stocks that I have added in the portfolio, and the reasons to justify their addition.

1. Bank of Nova Scotia (BNS)

The Bank of Nova Scotia, yielding 4.1%, is one of the largest money-center banks in Canada. The stability of Canadian banks has been evident after the 2008-2009 financial crisis in the USA. During this period, while nearly every financial dividend aristocrat in the USA cut its dividends, the four major Canadian banks- Bank of Nova Scotia, Royal Bank of Canada (NYSE:RY), the Canadian Imperial Bank of Commerce (NYSE:CM) and the Bank of Montreal (NYSE:BMO) only halted dividend growth without cutting their dividends at all. In fact, as this WSJ article shows, Canada has never experienced a banking crisis at all since 1790, although the USA had experienced 12 in the same period.

Although the Bank of Nova Scotia's yield- the highest among its peers- played a part in my decision to pick it, its dividend growth performance during the recession was what struck me most. The table below:

Year

Bank of Nova Scotia ($)

Royal Bank of Canada ($)

Canada Imperial Bank of Commerce ($)

Bank of Montreal ($)

2007

1.74 1.82 3.11 2.72

2008

1.92 2.00 3.48 2.80

2009

1.96 2.00 3.48

2.80

2010

1.96 2.00 3.48

2.80

2011

2.05 2.08

3.51

2.80

2012

2.19 2.28

3.64

2.80

No. of dividend increases (2007-12)

4 3

3

1

2007-12 DGR

4.7%

4.6%

3.1%

0.6%

As shown in the table below, Bank of Nova Scotia was the only Canadian bank which raised its dividends between the arduous crisis years of 2007 and 2008, making it the only bank that increased its dividends 4 out of 5 times during the 2007-2012 period. It also grew dividends at a CAGR of 4.7% over the same period, making it the bank that grew its dividends at the fastest pace during the recession and in the post-recession period.

Besides this, Bank of Nova Scotia also provides me with a good chance to diversify my holdings. As mentioned above, diversification is important to me, and since I was underweight financial companies, a high-quality bank like BNS is a worthy addition to my portfolio.

2. Caterpillar (CAT)

Caterpillar, yielding 3.0% currently, is an manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives worldwide. This machinery segment accounts for 94% of its revenues, with the other 6% being generated from the financing provided to customers after they have purchased or leased from the company. Although Caterpillar faces the near-term threat of having lower mining equipment sales due to the depressed prices of natural resources like coal, oil and gas; and precious metals like gold and silver, it has held up well throughout these hard times, beating Earnings per share (EPS) estimates by a margin in excess of 10% for the first three quarters of 2014. Earnings per share are also expected to grow 12% between the trailing 12-months and the next 12 months. This is remarkable for a company facing near-term troubles.

Its 1-year dividend growth rate is also remarkably high at 19.4% as it starts to distribute more earnings to its shareholders. Although this is the case, I would expect dividend growth rates going forward to be closer to its 5-year dividend growth rate of 8.4%, as the company faces some near-term troubles.

3. HCP, Inc. (HCP)

The third addition, HCP, yielding 4.9% currently, is a healthcare REIT which has grown dividends for 29 consecutive years so far. This makes it the oldest healthcare REIT in the USA, and the only REIT included in the S&P dividend aristocrat index. It acquires, develops, leases and manages healthcare properties. Its healthcare properties serve the senior housing, life science, medical office, hospital and skilled nursing industries. I chose this stock for reasons beyond its steady dividend growth and its high yield of nearly 5%.

Firstly, healthcare is a recession-proof sector that is growing and will continue to grow, with an ageing population in the developed countries it operates in- the USA and the UK. In addition, HCP is engaging in long term partnerships with some of the largest and most stable healthcare operators in the country. For example, it recently engaged in a joint venture with Brookdale Senior Living (NYSE:BKD), the largest long-term senior care company in the country. Lastly, HCP is one of the largest healthcare REITs in the nation, giving it economies of scale over smaller competitors. This, coupled with its long operating history, gives it an extra competitive edge.

Although HCP is among the slowest dividend growers in the portfolio, growing dividends by 5% this year, its favorable industry prospects, its diversified portfolio and its high yield allows it to qualify a spot in my dividend portfolio.

4. W.P.Carey (WPC)

W.P Carey, yielding 5.2% at the moment, is another REIT. It leases properties to 215 companies (tenants) from a variety of industries, including retail, hotel, self-storage, warehouse and R&D properties. This diversification across industries and customers allows company growth to continue even if one industry experiences contraction, or if one of its customers terminate its lease with the company. Besides this, W.P. Carey has consistently kept the occupancy rate of its properties above 98%, doing so for every quarter of the past 3 years. This shows how the company has been maximizing returns by acquiring properties and building its customer base wisely, with its sights on the long term.

All these have allowed dividends to grow at an incredibly fast rate over the past few years, growing dividends by 13.8% in 2014 and in excess of 20% (compounded) over the past 3 years since it was converted to a REIT in 2012. Although this is the case, payout ratios (based on FFOs) are in the 80% range. Hence, I am expecting dividend growth to only slightly outpace dividends going forward. But, its high yield and its stable business model as a REIT will enable me to sleep well at night with this addition to my dividend portfolio.

Besides the above four additions, I am planning to add another reasonably high-yielding fund in place of GGN. This fund should either be a dividend fund, or a fund that is in one or more of the sectors that has a lower weighting in my portfolio (which are the Utilities, Technology, Services and Industrial Goods Sectors). Another update will be posted in the coming days. I may also publish more detailed analysis of the four new additions if I have the time.

Performance and Metrics

According to my previous dividend portfolio setup, the portfolio appreciated by 17.32% this year (not including dividends), outperforming major equities by a wide margin. The Dow Jones Industrial (NYSEARCA:DIA) increased by 8.8%, while the S&P500 (NYSEARCA:SPY) increased by 12.6%. The best performers being REITs such as Digital Realty Trust (NYSE:DLR), appreciating 42% year to date after being the worst performer of 2013; Omega Healthcare (NYSE:OHI), appreciating 40%; and Realty Income (NYSE:O), appreciating 39% year to date. Teva Pharmaceuticals and Genuine Parts , both exiting the portfolio due to low yields, also performed very well, appreciating in price by 46% and 32% so far to date.

In terms of yield, the portfolio started 2014 yielding 4.25% with a beta of 0.655. Currently, due to the removal of the high-yielding GAMCO fund, GGN, and the buyout of 7%-yielder Kinder Morgan Management (NYSE:KMR) by Kinder Morgan Inc. (a 4% yielder with higher expected dividend growth), the yield of the portfolio is currently lower, at 3.93%. Although this is the case, beta is still below my requirement of 0.7, at 0.674.

In terms of valuations, the average P/E (or P/FFO for some stocks like REITs) of stocks in the portfolio has increased from 16.1 when 2014 started, to 16.9 according to the new portfolio. Although the stocks has gotten more expensive, it is still within my comfort zone, as a whole.

The average yearly dividend growth rate stands currently at 10.8%, with the 5-year dividend growth rate at 10.6%, both achieving my targets of beating inflation hands down. The portfolio's average payout ratio also stands at a healthy 60.6%, implying further dividend growth into the future.

This concludes the portfolio review for 2014. The table below will show my dividend portfolio for reference.

Company

Sector

No. of Consecutive Div. Increases (Yrs)

Dividend Yield (%)

1-year Dividend Growth (%)

5-year Dividend Growth (%)

Payout Ratio (%)

Alliance Resource Partners

Basic Materials

12

6.0

9.7

12.5

43.1

Bank Of Nova Scotia

Financial

5

4.1

7.1

4.2

45.1

Caterpillar

Industrial Goods

21

3.0

19.4

8.4

39.7

ConocoPhilips (NYSE:COP)

Basic Materials

14

4.2

9.1

11.3

36.8

Chevron (NYSE:CVX)

Basic Materials

27

3.8

11.1

9.0

37.8

Digital Realty (NYSE:)

Technology

10

5.0

6.8

20.3

67.3

General Mills (NYSE:GIS)

Consumer Goods

11

3.0

11.8

11.5

65.7

HCP

Healthcare

29

4.9

5.0

2.9

72.2

Johnson & Johnson (NYSE:JNJ)

Healthcare

52

2.7

7.9

7.6

34.8

Kimberly Clark (NYSE:KMB)

Consumer Goods

43

2.8

8.6

6.9

58.5

Kinder Morgan (NYSE:KMI)

Basic Materials

4 (From merger of KMR and KMI)

4.1

12.5

10 (next 5y estimate)

71.5

Coca-Cola Co. (NYSE:KO)

Consumer Goods

52

2.8

9.8

8.1

65.3

Kraft Foods Group (KRFT)

Consumer Goods

2 (Spinoff from KFT)

3.4

4.8

-

66.6

Lockheed Martin (NYSE:LMT)

Industrial Goods

12

3.1

15.2

21.2

52.8

McDonald's (NYSE:MCD)

Services

39

3.6

8.7

13.9

63.3

Altria (NYSE:MO)

Consumer Goods

45

4.1

7.8

9.2

89.9

Nestle*(OTCPK:NSRGY)

Consumer Goods

18

3.0

4.9

9.0

72.2

Novartis* (NYSE:NVS)

Healthcare

17

2.9

6.5

4.1

43.1

Realty Income

Financial

20

4.5

21.2

4.8

84.3

Omega Healthcare

Healthcare

12

5.2

10.1

9.3

73.5

Procter & Gamble (NYSE:PG)

Consumer Goods

58

2.8

7.0

8.8

60.3

Philip Morris (NYSE:PM)

Consumer Goods

7 (Spinoff from MO)

4.8

10.4

28.4

61.9

Southern Co. (NYSE:SO)

Utilities

13

4.2

3.6

3.9

88.2

AT&T (NYSE:T)

Technology

30

5.5

2.3

2.4

56.0

Textainer (NYSE:TGH)

Services

8

5.4

12.3

15.5

55.3

Wisconsin (NYSE:WEC)

Utilities

11

3.1

20.4

21.8

57.3

W.P. Carey

Financial

17

5.2

35.6

10.4

83.0

Exxon Mobil (NYSE:XOM)

Basic Materials

32

3.0

12.8

9.7

33.2

AVERAGE

-

24.3**

3.9

10.8

10.6

60.6

*Dividend information denominated in the Swiss Franc (CHF)
**This number excludes the special situations listed- Philip Morris, Kinder Morgan and Kraft.

Disclosure: The author is long ARLP, KMI, COP, CVX, XOM, PM, MO, KRFT, GIS, KO, O, JNJ, TGH, MCD, T, DLR, SO, WEC, OHI, PG, HCP.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.