Our Dividend Strategy: Sector Definables With Lifetime Staying Power

Includes: F, FDX, GE, PFF, SBUX
by: Orange Peel Investments


We are working on revamping our dividend portfolio.

We look for companies with good balance sheets, sector definable brands, and staying power over the course of a lifetime.

Here's how we started and where we're heading.

By Parke Shall

If you've been reading our articles over the last few months, you know that we've continued to mention companies that we think are great long-term buy and hold candidates, specifically ones that pay dividends. When we began to rebuild our dividend portfolio last month, we started with Ford (NYSE:F) and iShares US Preferred Stock ETF (NYSEARCA:PFF). Since then, we've added a couple of companies like Starbucks (NASDAQ:SBUX) and General Electric (NYSE:GE).

To read more about why we added Ford for the long term, you can read some of these articles. We added the iShares Preferred Stock ETF not because we expect the underlying equity to rise in value, but to have small exposure to the 6.1% yield it pays. Despite not wanting to position a lot of our portfolio in ETFs and equities that aren't really going to rise on their own (like REITs), we do want some small exposure to a larger dividend. This article details the credit risk of owning PFF, which we advise readers to take a look at before considering an investment into the ETF.

We wanted to share with the general investing public the criteria we are using to pick our dividend holders going forward:

1. We look for investments that we think are going to be around until we die. We think companies like Starbucks, Under Armour (NYSE:UA) (despite not being a dividend payer), and UPS (NYSE:UPS) are perfect examples here. These are companies that are going to be around for as long as we are, in all likelihood.

2. We look to compound and add to the names that we'd buy at any price. If FedEx were at 5x earnings or 30x earnings, we'd still be buyers. We think the long-term outlook for companies like FDX and GE is so promising, we don't mind automatically scraping up new shares as each quarter passes.

3. We look to hedge by what we own. Everything in our dividend portfolio pays out regularly, the ETFs, the companies, and the REITs. We diversify this portfolio by making sure we include multiple sectors in equities as well as holding different financial instruments.

4. We try and buy "sector definables," which is what we call stocks that define their sector. Starbucks, to us, defines the retail coffee sector. FedEx is now used interchangably with "send something" as a verb. We try and find not just the best in each sector, but the companies that define their sectors.

If you're an investor, you likely already have a portfolio of your own that you manage. Friends of ours have portfolios that they actively manage on a daily basis, but don't have a "dividend only" portfolio. We were in the process of managing and re-doing our entire dividend portfolio when it became clear that the benefits of having such a portfolio should be shared with the investment community. It seems like it's part of the basics, to buy dividend stocks and never stop, but a lot of investors like us skipped over this in favor of the brash and aggressive long/short actively managed portfolios. This is why we keep our dividends separate. Here's a reason why buy and hold is a pertinent strategy for the long term:

^DJI Chart

^DJI data by YCharts

Lots of traders move in and out of stocks on a weekly or monthly basis. That's fine, we do that too. But we think there is a great case for adding a second portfolio, strictly for dividend growth.

1. Invest for a lifetime - Many investors that already have dividend portfolios use it as their primary portfolio or find themselves actively managing it too much. While there's no harm in knowing what your companies are doing (i.e., you want to take off a J.C. Penney (NYSE:JCP) or a RadioShack (NYSE:RSH) before it implodes in your portfolio), there's a case to be made for picking companies that you think will far outlive you. This is the way we look at long-term dividend investing. In addition if you have no investment experience at all, a dividend portfolio is a great place to start.

2. Compound into companies you'd happily own at any price - Dividend portfolios should be comprised of stocks with long histories like Procter & Gamble (NYSE:PG), Johnson & Johnson (NYSE:JNJ) and 3M (NYSE:MMM). Staple stocks should be the core holdings in a dividend portfolio. Stocks that have a history of rising with the markets and upping their dividends continually. Then, we suggest putting all of your holdings into a dividend reinvestment program (NYSEARCA:DRIP). In addition, we also suggest putting a set amount of money (whatever you can afford) into this portfolio and buying companies that you like, regardless of what the market is doing. If you contribute $1,000 a month to a portfolio like this, willfully spend that money buying companies that you like and use (and of course, that pay dividends and have long track records of growth). The stock market has been around for almost two hundred years and isn't going anywhere anytime soon. No matter how big the panic has been, it's never gone to zero.

Taking a dividend portfolio and adding to it (even if just $200-$300 monthly) on a consistent basis, you should start to see growth taking place over the course of a couple of quarters. The more you grow and compound, the more future growth stacks up. It's a fantastic cycle once it gets moving, in any market environment.

3. Hedge by broadening the scope of what you hold - The benefits of running your own dividend portfolio are that you can pick and choose a hedge to put into it as well. We like gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) in addition to equities to try and balance things out. We'd commit about 10% of a portfolio to this. Also, bond funds and preferred stock ETFs fit good, as do a couple of REITS. Here's an example of how we'd invest $20,000 for a starter portfolio:

  • $1000 each of 12 staple stocks, companies like Coke (NYSE:KO)
  • $3000 into commodities and goods
  • $1000 into 2 REITS
  • $1000 in bond funds
  • $1000 in preferred stock ETFs
  • $1000 in speculative large cap dividend payers

Here is what a decent portfolio at 3.5% will yield over 20 years. This is without monthly contributions added in. In addition, you hope for 5-10% annually from most of the equities you hold and buy through the process. This also isn't added in. You can see that over 20 years your total returns are almost 100%.

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The nice thing about this portfolio is you should be happy when the market goes down. Because you're adding monthly with no plans in sight to stop, a down market just means cheaper prices for you. This is all part of a 20-30-year buy and hold strategy that only works over time. Why?

This is where things get a little Warren Buffett.

4. Invest in sector definables - 401ks and mutual funds are fun because someone does all of the management for you. The benefits of running your own dividend portfolio is that is allows you to bet on the products and services that you use on a daily basis. This is how we recommend managing this type of portfolio. Switch from Crest to Colgate because you like it better? Make it so in your portfolio. Got a reason to switch from Comcast (NASDAQ:CMCSA) to Verizon (NYSE:VZ)? Again, the same.

Another reason is that ETFs and 401k funds are way more diverse than this type of portfolio. Remember, you can incorporate a couple ETFs in the portfolio you manage, but too much diversification isn't necessarily a great thing.

"Diversification is a protection against ignorance. It makes very little sense for those who know what they're doing." - Warren Buffett

With you in the driver's seat, you control the level of diversity.

It's a cheery feeling when you got to make your "must-have" purchases every month and you know that the couple hundred bucks you spend are zapping up to the top line of the companies that you are invested in. It's kind of like a very, very, very small rebate on your purchases. You buy because the product you use has an advantage to you.

"The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage." - Warren Buffett

Over time, this type of portfolio should also help you balance the way you manage your other portfolios. It'll provide guidance, color and research into names that you also may be able to use for short-term trades like earnings plays or options spreads. The continued payout of dividends no matter what the rate environment should give investors a nice, warm feeling at all times. Know that if your primary holds aren't performing, you're getting kicked back somewhere in the form of dividends.

We plan on writing about the companies that we're planning to buy and hold eventually. Some, like FedEx (NYSE:FDX), we've already written about. We look forward to writing more about these holds, and we encourage investors to think about the prospect of buying dividend stocks today, and never stopping.

Disclosure: The author is long F, UPS, SBUX, GE, PFF.

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.