My Dividend Growth Portfolio: 2014 Review And 2015 Preview

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Includes: JNJ, KMI, PEP
by: David Van Knapp

Summary

My Dividend Growth Portfolio is a real portfolio designed to demonstrate dividend growth investing in action.

The main goal of the portfolio is to generate growing dividends from excellent companies that raise their dividends regularly.

2014 was a good year for the DGP. Its dividend income increased 15%.

Now over 6 years old, the DGP is on track to meet its 10-year income goals.

Background

Once again, I will open the year on Seeking Alpha with a report on my Dividend Growth Portfolio [DGP].

I created the DGP in 2008 to demonstrate dividend growth strategies and techniques. From its inception, it has been real in all aspects: The portfolio exists at E-Trade, and it contains real stocks managed in real time. Thus, it stands as a live counterpoint to back-tests and "you coulda" suggestions made with 20-20 hindsight. Decisions in this portfolio were actually made, and continue to be made, with my own money at risk and an eye toward achieving specific goals. A monthly report on the portfolio can be found here.

I do not present the DGP as the best of its kind or a model for anyone. Rather it shows how an actual dividend growth portfolio is working out in real life. The DGP's starting value was $46,783, and no new money has been added since inception. That simplifies many calculations for demonstration purposes. All capital gains and income have been generated as a result of the original amount invested.

The DGP now has more than 6 years under its belt. For me, it has become a great learning tool as well as a money-making enterprise. I have benefited greatly from comments and suggestions about the portfolio over the years. Thanks in advance for your comments on this article.

Objective

The goal of the Dividend Growth Portfolio is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies. The numerical target is to deliver income that rises to 10 percent yield on cost within 10 years of inception.

This objective is different from what some readers and many investment advisors would say that I ought to have, which would be to accumulate the most wealth possible in 10 years. I am more interested in the ability of this portfolio to produce income than its sheer size. The goal of maximum wealth is understandable for many investors, but it is not the goal here. This is an important distinction, because the goal influences both the type of securities that I buy as well as how I manage the portfolio.

The 10-by-10 yield on cost target translates easily to dollars. I want the DGP to have an annual dividend run-rate of $4678 by June 1, 2018. The two targets are mathematically identical.

2014 Performance Review

The DGP had a very good year in 2014.

  • Its dividend income increased 15%.
  • Its dividend growth remains on track to hit the 10-by-10 target.
  • Its total value increased 16%.

Let's look at these results in more detail. The following table shows the income received each year since the DGP's inception.

As you can see, the income in 2014 exceeded 2013's income by 15%, and the amount represents a 6.3% yield on the original cost of the portfolio ($46,783).

No stock in the portfolio increased its payout by at least 15% in 2014. The reason that the portfolio's total income increased by that much is because of compounding.

I let incoming dividends accumulate in cash until the total hits $1000, then I reinvest that money. Thus shares of stocks are being periodically added to the portfolio in a relentless collection process. The new shares, of course, generate dividends of their own (which will be reinvested). The result is that the dividend growth rate of the portfolio exceeds the dividend growth rate of the individual stocks in it.

The result of this process year after year is an upward-curving line that illustrates compounding perfectly. The following graph shows my 10-by-10 goal line in red and actual dividends received in blue.

The goal line has been calculated as a smooth CAGR (compound annual growth rate) that takes me from the dividend run-rate on the day that I started the portfolio in 2008 to the goal of $4678 in 2018. The numbers are 2008 = $1400, 2018 = $4678, and CAGR = 12.8%, as shown in this calculator.

(Source: moneychimp.)

The blue line shows the actual run-rate on June 1 each year. Of course, the blue line is not smooth, but you can see that actual results are closely hugging the goal line. That tells me that I am on track to achieve the 10-by-10 goal.

The chart also shows my first projection for June 1, 2015. It falls a little short of the goal. As I add stocks to the portfolio via reinvestments, and companies announce dividend increases, the blue line should pull close to the red goal line by June 1. The run-rate last June 1 was $2891 per year. The target for this June 1 is $3257. That requires an increase of 13% year-over-year. My current projection for June 1 is $3120.

The dividend delivery rate actually took a step backward late in 2014. That is when Kinder Morgan reorganized, and my Kinder Morgan Energy Partner (NYSE:KMP) shares were replaced by Kinder Morgan Inc. (NYSE:KMI) shares. My portfolio experienced about a 20% decline in the income run-rate from that position. I expect that setback will be made up over the next year or two, as KMI has indicated an intention to increase its dividend 16% in 2015 and 10% per year over the following few years. They pay quarterly and typically increase each quarter. I like that. I may even buy more KMI.

Remembering that total returns are just a secondary goal of this portfolio, the DGP had slightly better total returns than the S&P 500 (NYSEARCA:SPY) with dividends reinvested in 2014. I compare the DGP to the S&P 500 for my own general interest, and because lots of readers seem to appreciate the comparison. Beating the S&P 500 -- what many call alpha -- is not a specific goal. Here is the complete history of that comparison.

If I had invested $46,783 into SPY at the close on May 30, 2008 and reinvested dividends, it would be worth $79,063 (a total increase of 69%). The DGP is worth $81,694 (a total increase of 75%). (Source of SPY returns: ETFreplay.)

Changes in 2014

I made more transactions last year than usual, as situations arose that I wanted to address.

In January, I sold my stake in Intel (NASDAQ:INTC), having waited longer than I wanted for the company to increase its dividend. (See this article for a complete discussion of this decision.) I used the proceeds from the sale to buy shares in Coca-Cola (NYSE:KO), thus opening a new position, and Phillip Morris (NYSE:PM), which added to an existing position.

In March, I sold my stake in Darden Restaurants (NYSE:DRI) because of deteriorating business conditions that I thought might jeopardize their dividend increases. (See this article. Sure enough, Darden froze its dividend, and it has not been increased since.) With the proceeds, I bought more KO and started a position in Procter & Gamble (NYSE:PG).

In July, I sold Lorillard because of their announced acquisition. (The sale is discussed in this article.) I used the money to start a new position in HCP (NYSE:HCP).

Each instance of starting a new position aligns with a program I have had for a couple of years, which is to increase the number of positions in the portfolio from 10 to a target of 20-25. I thank Seeking Alpha readers for that strategic shift. Your comments on this portfolio led me to decide that a more diversified approach would be safer and probably lead to results that are just as good as my original "best ideas" approach.

December, as described earlier, brought the forced sale of KMP and replacement by KMI. I also received cash in that deal, which I used to purchase more shares of KMI. The end result was that I have about as much invested in KMI as I used to have in KMP.

Finally, I made three dividend reinvestments in 2014.

  • In January, I opened a new position in Microsoft (NASDAQ:MSFT).
  • In May, I opened a new position in Ventas (NYSE:VTR). You can read an article about the purchase here.
  • In September, I added to the stake in PG. My reasoning is described in this article.

That makes a total of 12 transactions in 2014. One (the exchange of KMI for KMP) was forced upon me, and three (the dividend reinvestments) did not represent turnover. The others did represent turnover. Most years there will be fewer turnover-type transactions.

The Portfolio Right Now

This table shows the DGP as it stands at the end of 2014. The portfolio is now up to 18 positions.

The current yield shown at the bottom is weighted. It is the current dividend run-rate of the portfolio ($2966) divided by its current value ($81,694). At 3.6%, it is at the lowest level that I can remember. The main reason, of course, is the strong upward price move in 2014. Typically, depending upon all the variables, the current yield for this portfolio moves around in a range of about 3.6% to 4.2%.

For interest, the portfolio delivered an actual yield of 4.2% in 2014. That is calculated as the full year's dividends ($2970) divided by the portfolio's value at the beginning of the year ($70,485).

Looking Ahead to 2015

As stated earlier, I reinvest the dividends in this portfolio, but I don't drip them. I accumulate to $1000 cash, then buy a stock I am interested in. (See this article for a discussion of why I reinvest in this fashion. It comes down to valuation.)

As the new year opens, there is just under $1000 cash already, so I will make the first reinvestment this month. It could be more of a stock that I already own, or it could be a new position.

This could be the first year that I make four reinvestments, another result of the increasing cash flow each year. I love to go shopping, although high valuations are reducing the choices of attractive stocks. I am sure that I will find something suitable, however.

At the end of 2014, I changed the DGP's business plan in furtherance of the diversification program. I reduced the maximum position size from 15% to 10% of the portfolio. A couple of positions (JNJ and PEP) exceed this new maximum, so I intend to trim them and use the money to purchase other stocks. By that point, I may be up to the target of 20 positions.

Obviously, I am making a value judgment here. Both JNJ and PEP are extraordinarily good dividend growth companies that I would not normally think of trimming. But I am exercising a risk-mitigation principle that I believe is even more important. Neither company has a great yield right now (both around 2.7%), so I do not expect to encounter any trouble in replacing, if not increasing, the annual income from the portfolio after the transactions are completed.

By the way, if I were adding new money to this portfolio, I would "reduce" those positions by simply directing the new money elsewhere. I would not trim either JNJ or PEP.

On the dividend front, I expect 2015 to be pretty similar to 2013 and 2014. I think the DGP will have another double-digit increase in cash flow. Most companies with long dividend-increase streaks will maintain them, and there will probably be a couple of surprises, because there usually are. If any of the surprises impact my portfolio, I will figure out what to do under the guidelines of my business plan. If not, I will leave things alone except for adding more shares via dividend reinvestments.

Thanks for reading, and I look forward to your comments.

Disclosure: The author is long KO, HCP, MSFT, SXL, PG, VTR, KMI, PM.

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.

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