Repairing The Foundations Of The Dividend House And Millennial Millions DGI Portfolios

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Includes: ABT, ADM, AVA, CAH, CVX, D, DEO, DUK, ED, EMR, GIS, GPC, JNJ, KMB, KO, LEG, MMM, MO, OMI, PG, PM, SCG, SO, T, UL, UTX, VZ, XEL
by: Dividend House
Summary

I am re-evaluating which stocks belong in the foundations of the Dividend House and Millennial Millions portfolios.

The stocks in my DGI portfolio foundations should be ones in which I feel most confident – I rely on them to produce more than 50% of portfolio income.

Due to its recent price decline, I am no longer comfortable with Owens Minor as a core (foundational) stock.

On the other hand, Diageo and Unilever both qualify as foundational building blocks in my DGI portfolios.

I hope this article helps you think about the construction of your own DGI portfolio, including how you determine your bedrock choices.

A couple of months ago, I wrote an article that updated the progress of our daughter's retirement portfolio entitled, "Millennial Millions - A DGI Portfolio Update." In the discussion stream, RoseNose and others mentioned that I might want to reevaluate which stocks belong in the foundation of the Millennial Millions portfolio.

As always, the readers of my articles (and, my friend, RoseNose!) have a point. It's been awhile since I evaluated the categories in which stocks are placed in either of the two DGI portfolios that I manage. Because the foundation of the smaller Millennial Millions portfolio is a subset of the foundation of the larger Dividend House portfolio, I decided to reevaluate which stocks belong in the foundation of the broader Dividend House portfolio. The Millennial Millions portfolio will benefit from this analysis as well.

In my Seeking Alpha article, "How to Build a Dividend House: Which Stocks Go Where?" I describe how I decide where a DGI stock belongs in the Dividend House portfolio - whether in the foundation, walls or roof. This is important because I set portfolio goals for the stocks in each area of my Dividend House. For example, the stocks in the Dividend House foundation in aggregate should provide at least 50% of my portfolio's income.

Are There Cracks in the Foundation of the Dividend House Portfolio?

The stocks located in the foundation of my DGI portfolio should be ones in which I feel most confident. In other words, my foundational (or core) stocks should be the ones I think are most likely to provide a stable, growing income stream. These core holdings should be my "buy-and-hold" forever stocks. I expect them to deliver a reliable, growing dividend stream year after year, decade after decade without a lot of oversight or worry on my part.

A stock with a long history of dividend growth is usually the best bet for a foundational DGI stock, particularly if it grew its dividend during the Great Recession and the 2001 market pullback. A stock that grows its dividend over a long period of time - including during tough economic conditions - demonstrates management's commitment to the dividend. And, that helps me sleep better at night.

Due to the consistent long-term dividend growth record they can produce, defensive sectors (such as utilities, consumer staples, healthcare and telecom) are over-represented in our foundation. Dividend stalwarts such as Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG), Kimberly Clark (NYSE:KMB), Coca-Cola (NYSE:KO), Altria (NYSE:MO), AT&T (NYSE:T), and Consolidated Edison (NYSE:ED) are natural building blocks for a Dividend House portfolio foundation.

The Dividend House portfolio currently has 30 stocks in its foundation - 9 are utilities, 9 are consumer staples, 3 are healthcare companies, 2 are telecoms and 7 are from non-defensive sectors (industrials, energy and consumer discretionary). Combined, these 30 holdings contribute 55% of our portfolio's dividend income. This meets our portfolio construction guideline that at least half of our dividend income should come from foundation stocks. But, are the right stocks in our foundation?

Ideally every foundational stock fulfills the following four criteria:

  1. Dividend Champion - consistent dividend growth history of at least 25 years
  2. Investment grade credit rating of BBB+ or better
  3. Dividend payout ratio less than 80%
  4. Long-term debt-to-capital ratio less than 50%

However, some of our foundational holdings deviate from the ideal guidelines above. Below is a table that shows how each Dividend House foundational stock measures up to the guidelines above. The stocks highlighted in green meet all four guidelines. Where a holding doesn't meet a guideline, it is highlighted in orange. To remain a foundational stock, a holding should exceed only one of the four criteria.

The good news is that 9 stocks meet all four guidelines for a Dividend House foundational stock. They are: Leggett & Platt (LEG), Coca-Cola, Procter & Gamble, Archer Daniels Midland (ADM), Johnson and Johnson, Emerson Electric (EMR), Genuine Parts (GPC), MMM (MMM), and Consolidated Edison. LEG is a new addition to the Dividend House portfolio due to its rock-solid dividend growth characteristics. (By the way, LEG is a good buy right now!)

The bad news is that twenty-one of my Dividend House foundational stocks do not meet all four criteria. Should any of these be "demoted" to a supporting or auxiliary role? Scanning the list, nine stocks (of the twenty-one) have violated not just one, but two, of the above guidelines. I consider them the most likely to fall out of the foundation. They are: General Mills (GIS), Owens & Minor (OMI), Abbott Labs (ABT), Verizon (VZ), and five of the nine utilities - Southern Company (SO), Duke Energy (DUK), Dominion Resources (D), Avista (AVA) and Xcel Energy (XEL).

Of these, Owens & Minor looks like a potential candidate for being kicked out of the Dividend House portfolio today. First, at BBB-, OMI has the worst credit rating of any Dividend House foundational holding. Second, the value of my position in OMI has plummeted to less than half what I paid for it. (I'm 54% down to be exact.)

Should a Stock Price Decline Knock a Stock out of the Dividend House Foundation?

You will note that my foundation stock guidelines do not include any mention of stock price. OMI has suffered an astonishing (at least, to me) price decline over the last year. Should this fact knock it out of my foundation?

You will recall that I expect my foundation stocks to generate a reliable, growing dividend stream year after year, decade after decade without a lot of oversight or worry on my part. Should I worry about a stock whose price has declined more than 50% since I purchased it but has not cut its dividend in over 35 years? (OMI did freeze its dividend in 1990, 1996 and 1997.) The short answer is yes.

OMI is currently trading at 15-year lows. Even though I don't plan to sell it, I now have to watch it. A stock with this level of volatility is not a SWAN (sleep well at night) stock in my book. So, it doesn't belong in my foundation. Supporting this position is the fact that OMI is a medical distributor with razor thin margins, operating in the same competitive space as its larger competitor Cardinal Health (CAH). I have CAH as a supporting stock and this is where I think OMI now fits as well.

New Building Blocks for the Dividend House Foundation?

We've talked about which stocks are candidates for leaving the Dividend House foundation. Now, let's see if there are any holdings in my walls or even my roof that should be considered for entry into my foundation.

I scanned my walls (supporting) and roof (auxiliary) stocks for long dividend histories. I found five potential candidates to move to the Dividend House foundation: Diageo (DEO), Unilever (UL), United Technologies (UTX), Chevron (CVX), and Philip Morris (PM).

Of these, Diageo and Unilever look stable enough for me to consider for the Dividend House foundation. While Diageo's dividend in US dollars has only one year of dividend growth, in British pounds (its home currency), Diageo has never cut or frozen its dividend since its inception in 1997. That's 19 years of uninterrupted dividend growth in Britain. Furthermore, I am comfortable that folks will be drinking alcohol in the decades to come, in good times and bad.

Similarly, while Unilever's dividend in US dollars shows only one year of dividend growth, in British pounds (one of its home currencies), UL has grown its dividend for the last 21 years. Even better, UL hasn't cut its dividend since 1966 - that's 51 years! Furthermore, as a defensive consumer staples company, UL is a good fit for the Dividend House foundation.

As a result, I am moving both DEO and UL from the Dividend House roof to the foundation.

Conclusion

My investigation found one clear foundational crack in the Dividend House portfolio - OMI. In less than a year, OMI's stock price has declined more than 50%. This doesn't qualify it for a SWAN stock. I am not selling OMI, but I am "demoting" it to a supporting stock (in the walls of the Dividend House portfolio) where it joins its fellow competitor, CAH.

To patch the crack in my foundation, I found two deserving holdings. Ironically, both were on my roof - Diageo and Unilever. DEO has grown its dividend consistently for 19 years in its home currency of British pounds. Similarly, UL has grown its dividend consistently for the last 21 years in British pounds. Both of these stocks are ones I don't feel I need to watch closely, even though their dividends may not grow every year in US dollars (due to the vagaries of currency fluctuations).

Below are the Dividend House and Millennial Millions portfolio after these adjustments.

As you may recall, one of my portfolio guidelines is that the stocks in the Dividend House foundation in aggregate should provide at least 50% of my portfolio's income. With these changes, 56% of the Dividend House's dividend income is produced by its foundation holdings and 53% of the Millennial Millions portfolio income is produced by its foundational stocks.

Glancing over the walls and roofs of the Dividend House portfolio and the Millennial Millions portfolio, I notice that I may need to reconsider the placement of select stocks there as well. Stay tuned!

I would love to hear your thoughts on this or on what you are considering investing in right now.

  • Do you agree that OMI should be moved out of the foundation due to its massive price decline? Or, would you keep it in your foundation because of its long dividend growth history?
  • Do you use additional/other guidelines to determine your core (foundational) stocks?
  • Are there stocks in my walls that should be elsewhere? Are the right stocks on my roof?
  • With my sale of Scana (SCG) and my impending sale of Avista, I would like to add a utility stock or two to my portfolio. Which utes look most attractive to you?

Coming up, I will let you know if I make any changes to my walls or roof positions. In addition, I plan to take a hard look at utilities to determine if there are one or two utes I should add to the eight long-term holdings I already have in our Dividend House portfolio.

I look forward to hearing from you!

Disclosure: I am/we are long ABBV, ABT, ADM, AMGN, AVA, BBL, BMY, CAH, CBRL, CLX, COP, CSCO, CVX, D, DEO, DLR, DUK, ED, EMR, EPD, GE, GILD, GIS, GPC, HCP, IBM, JNJ, KHC, KMB, KMI, KO, LEG, LMT, LNT, MCD, MMM, MMP, MO, MRK, MSFT, NEE, O, OHI, OMI, PEP, PFE, PG, PM, SEP, SO, SYY, T, UL, UPS, UTX, VTR, VZ, WEC, WPC, XEL, AND XOM. 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.