A Dividend Portfolio Built From The World's Best Dividend ETFs

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Includes: CVX, DGRO, GE, HDV, IBM, INTC, JNJ, JPM, KO, MCD, MSFT, PEP, PFE, PG, SCHD, T, VIG, VYM, VZ, WFC, XOM
by: ETF Monkey

Summary

While my work here on Seeking Alpha primarily revolves around ETFs, I am well aware that many investors prefer to build their portfolio primarily or exclusively using individual stocks.

In particular, when it comes to dividend investing, might there be an opportunity to unite the two points of view, to harness the power of ETFs to select individual stocks?

In this article, I will attempt to do just that. I will explain my methodology, the resulting selections, and backtest to see how these selections have historically performed.

Along the way, I will offer links to the Excel files I used to do my work.

Since my first article using the pseudonym ETF Monkey was published on Seeking Alpha on June 3, 2015, my main focus has been to demonstrate that it is possible for almost anyone to harness the power of ETFs to build low-cost, diversified portfolios that allow them to access the power of financial markets without incurring hefty, ongoing fees for financial "advice."

At the same time, I have read many great articles both here and on other sites with respect to building great dividend growth portfolios by directly selecting individual stocks. And that led me to an idea.

The Idea

A month or so ago, I started to seriously ponder the concept of exploring uniting the two concepts; namely to attempt to build a top-quality dividend producing portfolio from a manageable number of individual stocks, using the world's best dividend ETFs to help me find them.

Why might this approach be worthy of your consideration? Well, let's say you want to add some top-quality dividend paying companies to your portfolio. You want to keep the number small to keep the portfolio manageable and your trading commissions low. At the same time, you need to think in terms of companies that you would be willing to hold for the proverbial "forever."

One approach would be to attempt to find these stocks on your own. You could start with a review of the research section on your brokerage's website. From there, you could then pore over analyst reports, weighing various companies one against the other. Likely, the way this would play out is that you would start with perhaps 25-50 stocks. For the reasons listed above, we will stipulate for sake of argument that your ultimate goal is to winnow the number down to perhaps something along the lines of 12-15 stocks.

Wait a minute, though. Might there be an easier approach? I posit that there might be. In the course of my research and writing as ETF Monkey, I have reviewed the following ETFs:

  • iShares Core Dividend Growth ETF (NYSEARCA:DGRO)
  • iShares Core High Dividend ETF (NYSEARCA:HDV)
  • Schwab US Dividend Equity ETF (NYSEARCA:SCHD)
  • Vanguard Dividend Appreciation ETF (NYSEARCA:VIG)
  • Vanguard High Dividend Yield ETF (NYSEARCA:VYM)

Of these, DGRO and VIG focus on dividend growth, while HDV, SCHD and VYM focus on high current dividend yield. What I have learned, though, in the course of my research is that all of these ETFs have stringent selection processes. Briefly, allow me to share an overview of the criteria used by each ETF to decide which companies are included. Please note that, in each case, the link is to a previous article I have written on that ETF, typically with further links to the provider pages as documentation:

  • DGRO - Stocks that have a 5-year history of increasing their dividend payments, display positive consensus earnings forecasts from the analyst community, and pay out no more than 75% of their earnings in dividends. Further, as a safety measure, stocks with an indicated dividend yield in the top 10% of the universe are eliminated.
  • HDV - Two Morningstar measures that identify the size of a company's "moat," or competitive advantages, as well as gauging their probability of default.
  • SCHD - The index screens both for a 10-year history of paying dividends as well as strong financial ratios.
  • VIG - A history of at least 10 consecutive years of increasing annual regular dividend payments.
  • VYM - This index is comprised of stocks characterized by higher than average dividend yields. It does not include REITs, and also eliminates stocks forecast to pay zero dividends over the next 12 months.

So here's the idea. What if, instead of starting from scratch to pick out our 12-15 companies, we used the combined power of the selection process used by these ETFs to do it for us? If you could find a group of stocks that had passed the varying selection criteria for most or all of these ETFs, might this not yield (pardon the pun) a pretty impressive portfolio?

That was what I decided to do. Starting with the next section, I will outline the approach I chose.

The Method

One beautiful feature of ETFs is that you can typically visit their official websites and download a spreadsheet containing their complete portfolio holdings. So I started by doing that. Here, for your convenience, from my official ETF Monkey OneDrive shared file folder, are the respective downloads from DGRO, HDV, SCHD, VIG and VYM.

Next, I copied the Top 25 stocks from each file into a common spreadsheet. Since the files came from three different ETF providers, they were structured slightly differently. So, I had to spend some time lining up the fields when bringing them into a common format, but that was not difficult at all.

As you will quickly grasp, while each ETF contains somewhere between roughly 80 - 400 holdings, the Top 25 holdings constitute a substantial portion of that weighting. In fact, for you numbers freaks, here are the respective weightings of the Top 25 holdings of each ETF as of the date I grabbed the files:

ETF Weight of Top 25 Holdings
DGRO 47.47%
HDV 84.63%
SCHD 78.62%
VIG 53.58%
VYM 54.88%

In other words, in terms of an overall average, we are selecting from the stocks that comprise 63.84% of the 5 selected ETFs.

With that exercise complete, I now had a spreadsheet with 125 rows. From there, I simply used Excel's sorting and summing formulas to come up with the stocks that had the highest cumulative weighting, and also a count of how many ETFs contained each stock.

I bet you're dying to see the results. OK, let's get on with it.

The Results

Here are the Top 25 companies, cumulatively, to emerge from this exercise.

Let me use Johnson & Johnson, the top-ranked stock, to help you understand the sheet. In the sheet above, I collapsed the detail rows for each stock to present this summarized format. Here is the exploded detail for Johnson & Johnson:

  1. The first step was to sum the cumulative %. If you do the math for yourself, you will see that Johnson & Johnson's weighting across all ETFs in which it was found sums to 20.9366%.
  2. From there, I simply sorted on these totals to rank the stocks. Returning to the main sheet, you will note that Exxon Mobil Corp. came in second, with a cumulative weighting of 19.1742%.
  3. Finally, I decided to include the ETF count, so you could determine how many sets of criteria the stock met. In the case of Johnson & Johnson, it proved to be all 5.

With that background, go back and take one more look at that Top 25 list. Take a few minutes to ponder the results.

The Winners

As you pondered the graphic, it probably did not escape your notice that exactly 12 stocks are highlighted in green. As it turns out, these are the 12 stocks I propose you should select for your dividend-paying portfolio, based on the combined "wisdom" of the selection process of 5 world-class ETFs.

We'll analyze the reasons why, and some interesting details about the portfolio, in just a minute. First, though, for purposes of tagging the ticker symbols for this article as well as easy readability, here is a table containing the Top 12 stocks from that analysis.

Symbol Name Sector Rank Cumulative % ETF Count
JNJ Johnson & Johnson Health Care 1 20.9366 5
XOM Exxon Mobil Energy 2 19.1742 4
MSFT Microsoft Technology 3 17.1494 4
KO Coca-Cola Consumer Staples 4 15.3969 5
PG Proctor & Gamble Consumer Staples 5 14.6237 4
PFE Pfizer Health Care 6 14.5490 4
PEP Pepsico Consumer Staples 7 13.9026 5
VZ Verizon Telecom 8 13.2541 3
CVX Chevron Energy 9 12.3562 3
IBM International Business Machines Technology 10 10.8346 4
T AT&T Telecom 11 10.6977 2
MCD McDonald's Consumer Discretionary 12 9.9937 5

The first detail that I would like you to take note of is that the 12 companies are pulled from six different sectors, as follows:

  1. Consumer Discretionary
  2. Consumer Staples
  3. Energy
  4. Health Care
  5. Technology
  6. Telecom

Let's next talk briefly about the question of how I ultimately settled on 12 stocks for the portfolio. Initially, I considered building the portfolio from the cumulative Top-10 stocks that fell out of this analysis. I ultimately decided to expand the portfolio to 12 stocks for the following two reasons:

  1. Adding those two extra stocks took us just a little deeper into the overall percentage of the ETFs that we are capturing. I decided on 12 as the cutoff because, coincidentally, that was the break point of stocks which amassed a 10% cumulative position (OK, 9.9937% for MCD but what's a couple of thousandths between friends?)
  2. In T, I was able to capture what ultimately is the highest-yielder in the portfolio. In MCD, I captured a stock in the consumer discretionary sector, increasing the number of sectors represented in the portfolio from 5 to 6.

Yes, even though the portfolio contains a mere 12 stocks, it has a fairly broad scope of diversification. Further, the combined portfolio combines what could be described as defensive sectors (consumer staples, health care) with at least a nod to the adventurous (technology). Telecom and energy round out the group, contributing some of the highest dividend payouts.

For more on those dividend payouts, take a quick peek at the following table.

Assuming an equal weighting in each stock, you can see on the final row of the above graphic that your overall dividend income would come in at 3.45% as of the date I pulled the numbers to produce this article.

A Variant You May Wish To Consider

As I put the portfolio together, I thought about the possibility that some investors might like to include a few more stocks to increase their level of diversification. Using my approach, clearly one way such an investor could do so would be to purchase all of the Top-25 stocks from my list. Alternatively, you could use the work I did to expand to perhaps 15 - 20 stocks. I decided to take a little time and think about a second variant, with 15 stocks.

For this variant, I diverged slightly from pure mathematical analysis. For the Top-12 stocks, the only "analysis" performed is that these were the highest-weighted stocks that flowed through the combined criteria of the 5 ETFs. Period.

In the case of the variant, I allowed myself to use a little discretion. Here are the 3 stocks I picked.

Symbol Name Sector Rank Cumulative % ETF Count
INTC Intel Technology 13 9.8440 3
WFC Wells Fargo Financial 22 5.6665 2
GE General Electric Industrials 30 3.0610 1

A few comments on each.

  1. Intel - Intel, as it turned out, was in 13th place in the cumulative rankings. While we already have two technology holdings, MSFT and IBM, Intel's focus on semiconductors makes it a little different animal than the other two. A combination of those two factors led me to include it.
  2. Wells Fargo - Simply put, Wells Fargo adds exposure to a 7th sector; financials. I pondered both Wells Fargo and JP Morgan (NYSE:JPM) and, in the end, settled on Wells Fargo both for its higher dividend and the fact that recent scandals have left its price slightly softer than JPM.
  3. General Electric - Venerable GE adds exposure to an 8th sector; industrials. And, while it was only in one ETF, that ETF was the Vanguard High Dividend Yield ETF. Its recent price struggles, and a handsome dividend of 3.14%, made it my "dark horse" pick to round out the 15-stock variant of the portfolio.

Briefly, how does the portfolio look with these 3 stocks added? Have a look.

Overall dividend income drops very slightly, from 3.45% to 3.34%. At the same time, the addition of two sectors offers some nice benefits in terms of diversification.

Of course, you are free to add to the base 12 stocks as you see fit. This was simply my attempt to get you off to a good start and offer a possible thought process you could use.

Backtesting The Two Variants

For those of you who love this sort of stuff, here are 3-year, 5-year, and 10-year backtests for both variants of the portfolio. In each case, Portfolio 1 is the base variant with 12 stocks, Portfolio 2 the expanded variant with 15 stocks, and the comparison point is the S&P 500.

3-Year:

5-Year:

10-Year:

I found the backtests very interesting. First, let's talk about the overall results for both portfolios when stacked up against the S&P 500. The 3-year backtest looks extremely favorable, the 5-year backtest a little less so. But that 10-year backtest, to me, is the one really worth pondering! Not surprisingly, the backtests appear to reveal that, during periods in which the markets surge, our relatively conservative portfolio will tend to slightly underperform. At the same time, it becomes evident that it held up extremely well through the market collapse of 2007-2009. As you contemplate the many current articles suggesting that market valuations appear to be stretched very thin once again, this could bode well for our portfolio moving forward.

Secondly, with respect to the comparison between 12-stock Portfolio 1 and 15-stock Portfolio 2, once again the results appear to be a mixed bag. In the shorter-term backtests, Portfolio 2 comes out the winner, and quite noticeably so over the 5-year term. Once again, though, when the backtest is extended to 10 years the results reverse and Portfolio 1 comes out on top, albeit by only a small margin.

Summary and Final Thoughts

This has been one of the most enjoyable projects I have undertaken as a Seeking Alpha author. It began as an intellectual curiosity and ultimately turned into a most interesting practical exercise and set of results.

Finally, a last thought about blending, or integrating, the concept put forth in these articles with my baseline focus on ETFs. Specifically, I am proposing that this basket of individual holdings could take the place of a dividend-growth or high-dividend yield ETF in your portfolio. However, I would suggest supplementing it with a world-class U.S. Total Market ETF to give yourself a truly diversified portfolio. Would you like some suggestions? Here are three of my favorites. I'll leave it up to you as to what relative percentages of each you would choose to allocate.

In addition, I would further suggest considering adding some international stocks, REITs and bonds. One benefit of including at least a few ETFs is that they can prove to be very useful tools to rebalance your portfolio. As you consider which ETFs to include, keep your expenses low by paying attention both to expense ratios as well as ETFs that you can trade commission-free.

And now, it's your turn. I can't wait to read your comments on everything I have covered in these past two articles.

Until next time, I bid you . . .

Happy investing!

Author's note: At the top of this article, next to my name, you will see a "Follow" button. If you like my work, I would be profoundly grateful if you would take a minute to do this, as well as feature my work to friends, colleagues and/or relatives who may be interested in the subject matter. Growing one's readership base is critical to any author and I am no exception. Your support will enable me to continue my efforts.

Disclosure: I am/we are long HDV, T, VYM, VZ.

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.

Additional disclosure: I am not a registered investment advisor or broker/dealer. Readers are advised that the material contained herein should be used solely for informational purposes, and to consult with their personal tax or financial advisors as to its applicability to their circumstances. Investing involves risk, including the loss of principal.