A Real Dividend Growth Machine: 2016 Portfolio Review

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Includes: GILD, NVO, TROW
by: Dividend Growth Machine

Summary

Fourth-quarter and annual review of results from a real dividend growth stock portfolio.

Discussion of recent portfolio changes and goals for 2017.

Example of how a dividend growth investor manages his portfolio.

Introduction

The purpose of this article is to review my investing progress in 2016, which was my fifth full year as a dividend growth investor. I follow a value-oriented dividend growth investing strategy that involves buying attractively valued stocks of companies that consistently pay and grow their dividends. My investing strategy is guided by two overarching goals:

  1. Build a sustainable and rising dividend income stream that beats inflation. I seek to achieve this goal by creating and maintaining a diversified portfolio of dividend growth stocks (my dividend growth machine).
  2. Preserve and grow my capital by attaining a satisfactory total return on my investments. I seek to achieve this goal by purchasing the stocks of high-quality companies at attractive valuations.

I think the two goals are complementary and can be achieved concurrently. I pursue these goals in order to be in a financially secure position when I eventually retire. I am currently a 35-year-old professor at an early stage of my career and I plan to work for several more years; however, by following a sensible investing strategy (which is what I consider dividend growth investing to be), I think I will position myself for early retirement.

In this article, I will provide an update on my progress toward achieving these goals since my last review, highlighting events that occurred in the fourth quarter of 2016. As always, I will be presenting real results from a real portfolio involving real money.

Input To The Machine

New capital represents the input to my dividend growth machine and allows me to buy stocks. The figure below shows quarterly contributions of new capital to my investment accounts since 2012:

Thanks to a large influx of $11,850 in Q4, I ended 2016 with a total of $18,500 in new capital invested, matching my total in 2015. Note that $5,500 of that was invested in my Roth IRA, with the remainder going into my taxable account. Given that I have no major expenses on the horizon, I anticipate that I will be able to invest more money going forward, with most of the contributions coming in Q1 and Q4 (as a consequence of being paid during the academic year but not during the summer, unless I manage to obtain a research grant at some point).

Parts Of The Machine

Dividend growth stocks represent the parts of my dividend growth machine. The table below shows the composition of my portfolio at the start and the end of Q4 2016, with various changes highlighted.

A breakdown of all transactions in 2016 is provided in the following table:

My investing activity was modest in Q4 and not all that different from Q3. No transactions occurred in December because I was busy with end-of-semester work and then away for the holidays, so I did not have much time to devote to investing. Below I will briefly discuss my portfolio decisions:

  • I aggressively increased my position in Danish healthcare company Novo Nordisk A/S (NYSE:NVO), which focuses primarily on diabetes care. Its stock price continues to be depressed, most recently because management cut its long-term profit guidance (from 10% to 5% operating profit growth) due to more challenging market conditions in the United States. However, it is still a well-run company with an active R&D pipeline; great products supported by demographic trends; strong earnings, free cash flow, and dividend growth; and an attractively valued stock, especially in comparison with the broader stock market. I am probably not done adding to my position because I think the stock is one of the best investment opportunities currently available. All shares are held in my taxable account because of the foreign withholding tax on dividends, which I can claim when I file my tax returns.
  • I made a small increase to my position in large-cap biotech company Gilead Sciences (NASDAQ:GILD), as it continues to be in the doghouse on Wall Street. I have seen reasonable estimates that the company's growing HIV business alone is worth about $75 per share, which means that investors are getting the substantial (though declining) cash flow from the HCV business and other lines for free at the current share price. I have read a lot of speculation about what the company may or may not do in 2017, especially with respect to acquisitions, and I am aware that many (former) investors have lost patience with management. As a long-term investor, I am willing to remain patient for a while longer, so I currently have no intention of selling my shares. In fact, I might make another small purchase, although I am reluctant to give the stock more than 5% weight in my portfolio, simply due to risk and diversification considerations.
  • I also made a small increase to my position in investment firm T. Rowe Price (NASDAQ:TROW), which continues to be a well-run company with no long-term debt. Thanks to progressively averaging down over time, I lowered my cost basis to the point where I actually ended 2016 in the green. I am satisfied with my position now, so it is unlikely I will add to it in the near future, barring any dramatic price drops.

In summary, I made four purchases and zero sales during Q4, keeping with my desire to have low portfolio turnover. Transaction fees averaged 0.35% of my total costs in 2016, below my targeted maximum of 0.5%. (Note that this is not comparable to the expense ratios of index or mutual funds because it is based solely on transaction amounts, not assets under management.)

Besides adding or removing parts of my machine, I want to make sure all the parts are running smoothly. I monitor the operating results of my companies and stay on the lookout for dividend increases (or decreases). The figure below summarizes the dividend changes that took effect in 2016:

Dividends increased for 36 of the 37 stocks in my portfolio. The mean and median increases were 8.7% and 7.1%, respectively. The lone holdout was one of my railroads, Norfolk Southern (NYSE:NSC), which kept its dividend steady due to lackluster operating results over the past year. However, I think investors might see a modest dividend increase from the company in 2017. Overall, I am satisfied with the dividend growth that occurred among the stocks in my portfolio.

Output Of The Machine

Dividends and capital gains represent the output of my dividend growth machine, all of which is selectively reinvested when sufficient funds are available. As mentioned earlier, my primary goal is to build a sustainable and rising dividend income stream. The figure below shows the dividends I have received.

I received $1,538 in dividends in Q4, which contributed to a total of $6,290 in 2016, representing a 5.0% increase over the total of $5,991 in 2015. You might be wondering: Why did my dividend total grow less than the mean dividend increase for the stocks in my portfolio? The reason has to do with sales. As noted above in my transactions table, I sold off all my shares in Kinder Morgan, Inc. (NYSE:KMI) and HCP, Inc. (NYSE:HCP) earlier in the year, for reasons discussed in previous reviews. Those two stocks were prominent contributors to my dividend total in 2015 and the replacement investments did not yield as much as both stocks (prior to their dividend cuts).

At the end of Q4 2016, my forward 12-month dividend total was $6,674, which would already represent a 6.1% increase over my 2016 total. Given that I will be investing new capital and getting many organic dividend increases throughout the year, I anticipate that the next year-over-year increase in my dividend total will be considerably higher than what I experienced in 2016.

My secondary goal is to achieve a satisfactory total return on my investments. The figure below shows end-of-month portfolio values and the cumulative amount of new capital added since the start of 2012.

Overall, my portfolio value did well in 2016, reaching $260,431 at the end of Q4. This represents a 22.1% increase over my portfolio's value at the start of 2016. The increase is attributable to a mix of organic dividend growth, capital gains, and new capital. One estimate of my annualized total return in 2016 (which does not count new capital as investment gains) is 13.1%, which I consider to be satisfactory. The same estimation method gives me an annualized total return of 11.4% since the start of 2012. Note that these numbers cannot be compared directly with the S&P 500 index (or a similar benchmark) unless my contributions of new capital are factored into the benchmark return calculation.

For completeness, I will also summarize the investments outside of my dividend growth machine. I participate in two retirement plans with my employer, for which I have allocated 100% of all contributions to the Vanguard Institutional Index Fund (MUTF:VINIX), tracks the S&P 500 index and has an expense ratio of 0.04%. The combined value of both plans was $50,787 at the end of 2016. I also having a Health Savings Account [HSA], to which I contribute each year and it ended with a value of $10,035. Thus, if you add up the values of all my investment accounts, the year-end total was $321,252.

Outlook And Goals For 2017

I am now in my sixth year as a dividend growth investor. It should come as no surprise that my investing strategy and portfolio will not see any major changes in 2017. I will continue monitoring the operating results of my companies, researching new candidates for my portfolio, and making occasional stock purchases throughout the year (no sales are currently planned). I expect to max out my Roth IRA in Q1, after which time new capital will go into my taxable account.

I do not have specific goals (i.e., numbers) for organic dividend increases or total return because I have no direct control over them (dividend policy is at the discretion of company management and total return is subject to the whims of Mr. Market). However, it is reasonable to propose numbers for some other items over which I have some control. Here are three goals for my investing in 2017:

  1. Invest a total of $25,000 in new capital. This might seem like an unattainable goal, based on my totals for 2015 and 2016. However, readers of previous reviews may recall that I channeled considerable new savings into a house down payment fund from mid-2015 to early 2016. Given that I do not currently have an alternative savings target of that sort, nor any major (anticipated) expenses, I think I should be able to invest a lot more money in 2017.
  2. Reach a forward 12-month dividend total of $7,500 by the end of the year. If I do manage to achieve my goal for new capital, then the invested money should allow me to achieve this dividend goal, which would represent a 12.4% year-over-year increase.
  3. Keep my transaction fees to an average of 0.4% or less of my total costs (previously I aimed for 0.5%). I was at 0.35% in 2016, so I already know I am capable of achieving this goal through a disciplined combination of appropriately sized transactions and low portfolio turnover. One of the reasons for having this goal is that it will lead me to make fewer (but larger) purchases, which means I will be more focused on my better investing ideas.

As indicated in my portfolio table, I ended 2016 with a modest amount of cash in my taxable account, and the year will start with contributions to my Roth IRA, so you will likely read about a handful of purchases in my Q1 review. Until then, good luck with your investing and thanks for reading!

Disclosure: I am/we are long ALL STOCKS LISTED IN PORTFOLIO TABLE.

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.