March To Freedom Fund Mid-Year Review

|
Includes: AAPL, ABBV, ABT, AFL, BA, CMI, COST, CSCO, CVS, CVX, D, DG, DIS, GIS, HON, JNJ, JPM, KO, LMT, MA, MKC, MMM, MO, MSFT, NKE, O, PEP, PG, PM, QCOM, SBUX, SO, T, V, VFC, VTR, VZ, XOM
by: The Dividend Bro
Summary

The first half of 2018 is already over, so it is time to look back at how our portfolio performed, the purchases we made and to check our income growth.

Our total return trails the S&P 500 slightly, but our dividend yield is significantly higher.

We made 13 purchases and sold 1 position since our February update.

Dividend income continues to surpass prior year's totals.

It has been a long time since I’ve updated how the dividend growth portfolio of my wife and I has performed. Apparently, one-year-old boys have two speeds: fast and very fast. I haven’t had much time to write updates because I spend most of my time chasing the Lil Dividend Bro around the house, teaching him the rules to baseball and why, as a “Michigan Man,” he cannot attend the Ohio State University when he grows up (though I have managed to pen a few articles for Sure Dividend, which you can read here and here).

Since the year is half over, I thought it would be a good time to check back on how our portfolio has performed year to date, examine some of the purchases we have made since the last update and, most importantly, take a look at how our dividends have grown.

I call this portfolio the March to Freedom Fund, because dividend growth investing isn’t a sprint. It takes time to acquire capital to invest for retirement. It takes time to research quality companies to determine where that capital is allocated. It takes even more time for those reinvested dividends to acquire new shares. But once this income-producing ball gets rolling downhill, the dividends really start to add up, as we will see in a bit.

1st Half Results

Including dividends, our portfolio is up 0.75% through the end of June. The S&P 500 has returned 1.67% over this same time frame. Neither returns are much to brag about. Since 2015, when I began to track our investments much more actively, our total return is 42.36% versus the S&P 500’s total return of 32.5%. While the market has us beat in 2018, we’ve outperformed the index over the last 3.5 years. Our portfolio yields 2.9%, above that of the S&P 500 (1.84% at the end of June) and just barely above that of the 10-year Treasury Bond (2.85%).

Let’s look at the best and worst-performing stocks in our portfolio did during the first half of 2018. I like to do this not to pat myself on the back (or kick myself in the pants) so I can get a sense of what seems to be working and what isn’t in the market these days. We are long-term investors, but maybe by examining our winners and losers, we can find a bargain or take some profits in an overheated stock.

Mastercard (MA) has one of the best returns in the market over the past several years. After growing 46.6% last year, the stock is up 29.84% in 2018. The stock has actually moved up even more since the beginning of the July. MA trades with a P/E well north of 30 based on EPS estimates of $6.34. While I am not adding here, I am not selling either as Mastercard is capitalizing on the shift from cash to plastic that is taking place in society. Mastercard is already a full position for us, but at a lower price, I’d consider buying more.

Nike (NKE) jumped into our top 5 performers based on 4th quarter of fiscal 2018 earnings that were released on June 28th. After showing declines in North American sales for the past several quarters, Nike had double-digit growth in this region. China (up 25% year over year) continues to be a good story for the company, but it is N.A. sales that sent the stock to an all-time high of $81.

After many claimed that brick and mortar retailers were dead, Target (NYSE:TGT) has proven that isn’t necessarily the case. The stock is up 16% year to date. Target had 3% growth in same store sales in Q1 and the company posted a 3.7% gain in traffic during the most recent quarter, its strongest gain in more than a decade. We added to our holdings at the end of June.

Like its peer Mastercard, Visa (V) is having a very nice 2018, with the stock up 16.2% since the first trading day of the year. Shares are up more than 62% since 2017. Paying with plastic is here to stay as we move into more and more of a cashless society. Both Visa and Mastercard are in a prime position to succeed. Though Mastercard is currently the larger position, I don’t consider that stock to be a core holding. Visa, however, is a core holding for us due to its sheer size of its network.

Microsoft (MSFT), up 15.28% this year, continues to be one of the strongest stocks in the market. At the end of April, the company posted earnings per share growth of 36%, revenue climbed 16% and the company had a cash position of $132 billion. Microsoft is our second largest position.

Like many companies it competes against, General Mills (GIS) continues to struggle. The stock has declined another 10% since our February update for a total of 25% in losses for the year. The packaged food company has made efforts to move away from the processed meals that consumers seem to be avoiding these days, but gaining traction with investors has been tough.

General Mills did agree to purchase Blue Buffalo for $8 billion in an effort to enter the pet food business and diversify away from packaged foods. Americans spend a lot of money on their pets, but so far, the market doesn’t seem to value this deal. We purchase a small amount of GIS through shareowneronline.com each month.

Like other industrials, shares of Cummins (CMI) seems to be stuck in retreat. Cummins produced solid results for the 1st quarter. Revenues were up 22% while earnings grew almost 40%. With results like that you would think Cummins would be up 25% for the year, instead of being down that much. Talks of a trade war with China and other trading partners have weighed on the stock. Another issue impacting Cummins is that the company may have to set more capital aside than anticipated for upgrades to vehicles that failed emissions tests. We purchase Cummins each month through shareowneronline.com.

Philip Morris (PM) and Altria (MO), down 23.58% and 20.47% respectively in the first half, have been hit hard as tobacco volumes have declined. MO released Q1 earnings at the end of April and headline numbers were solid. 30% growth in EPS and a 1.7% increase in revenues. What sank the stock was Altria saw a 0.8% decrease in smoke-able products. Philip Morris struggled because its e-cig iQOS product failed to show significant growth.

Cigarette consumption continues to decline sector wide and the market seems to have just realized this now. All the tobacco stocks have been hit hard. This coincides with a rising 10-year Treasury Bond and many of the bond proxy stocks have declined. Still, PM yields 5.5% while MO’s yield is just below 5% currently. Both stocks are large core holdings for us. I am waiting to buy more of each until I see how Q2 results for more clarity in how the two companies are performing.

AT&T (T) rounds out our bottom 5 performers, with a loss of 17.4% for 2018. Again, the safety of higher treasury yields and quest for more growth have likely driven some shareholders from this company. With the merger with Time Warner (TWX) allowed to proceed, AT&T will be adding a large amount of free cash flow to its balance sheet, which should make the large 6.23% yield safe. The company can also use this extra cash to pay down its substantial debt levels. We added to AT&T in April.

Recent Purchases

We have been very active since our previous update. We’ve made 13 purchases and sold 1 position in the last 3 months.

Our first purchase was McCormick & Company (MKC) on March 28th at $106.05. McCormick agreed to purchase Frank’s Red Hot, French’s Mustard and other condiments, known collectively as RB Foods, from Reckitt Benckiser Group (OTCPK:RBGLY) last July for more than $4 billion.

The top-selling spice and seasoning company in the world reported monster second quarter earnings on June 28th, largely due to growth from this acquisition. Overall, earnings per share grew 24.4% and revenue climbed 20% higher. RB Foods contributed 13% sales growth in Q2 after adding 12.4% to revenue in the previous quarter. The stock ended June at $116, 9.5% above our purchase price.

On April 13th, we added to our Johnson & Johnson (JNJ) position. With a balance between pharmaceuticals, medical devices and consumer products, Johnson & Johnson is very diversified. This has helped the company grow earnings in 9 out of the last 10 years. The company also has 55 years of dividend growth, one of the longest streaks available to investors. We bought JNJ at $130.07. Though shares are down 6.7% since our purchase and the company is our fourth largest holding, I wouldn’t mind adding more Johnson & Johnson this year as I consider it to be one of our most important core holdings.

6 days later we added to another popular dividend stock when we bought AT&T at $35.03. As I said previously, the closing of the Time Warner acquisition will be a positive for the company going forward. The company has paid a dividend for 34 years and has a very healthy dividend yield. AT&T is our fifth largest holding, but like with Johnson & Johnson, I’d be happy to add more even as the share price has dropped since our purchase.

Our next buy was Lockheed Martin (LMT). We purchased the world’s largest aerospace and defense company on April 25th at a price of $328.20. Since then Lockheed has seen its share price drop almost 10%. Timing could have been better, but I liked what I saw on the company’s first quarter earnings, which was released the day before our purchase. EPS of $4.02 was a 54% improvement year over year and blew away estimates by $0.60.

Revenue improved 4% as all of the company’s divisions, except for Space Systems, saw growth. Lockheed also increased its guidance thanks for demand for products in Q1. The world remains a dangerous place and government spending on defense is on the rise, which should make Lockheed Martin attractive to investors.

On May 2nd, we added to Verizon (VZ) position. While the dividend yield and track record aren’t as generous or as extensive as the telco company’s rival AT&T, a 4.7% yield and 13 years of dividend growth are still impressive. Revenue for the 1st quarter grew 6.6% to almost $32 billion while EPS topped estimates by $0.06. The company added 220,000 net smartphone subscribers while unsubsidized phone plans made up 81% of phone base, up from 72% a year prior. While higher treasury yields seem to have an impact on some high yield stocks, Verizon is bucking that trend, having increased in value almost 5% from our $48 purchase price. Verizon has become our 8th largest position.

On May 8th, we jettisoned Gilead Sciences (GILD) from our portfolio. We had added to the name in September 2017, but we decided to part ways with Gilead due to earnings declines associated with his hepatitis C drugs. Gilead proved very successful at curing patients.

While that is great news for these folks, it hasn’t been for the company as the pool of patients with this disease has dwindled. And with it, the company’s earnings. Of course, shares are up more than 12 points since we sold at $64.80. Perhaps we weren’t as patient with the stock as we could have been, but I wasn’t convinced that Gilead had a clear path to return to growth. For that reason, we sold our stake in Gilead.

We were able to add to two dividend champions using the proceeds from closing our Gilead position. First, we bought Chevron (CVX) at $129.92 on May 11th. Energy prices have increased this year as demand as outweigh supply. While there has been chatter about OPEC releasing more supply, so far that hasn’t been the case. Unlike several large energy companies, Chevron was able to keep paying its dividend during the most recent oil price collapse.

While dividend growth hasn’t been all that sexy (a 3.7% raise for the March payment), an increase is still an increase. Chevron earned $1.90 per share in the most recent quarter, $0.41 above what analysts were looking for. Sales grew 13.1% to $37.8 billion. I’ve wanted to increase the size of our position in Chevron for some time. Due to the dividend yield and the fact that their payments survived when oil dropped, I decided that this was a good time to add. Chevron has increased its dividend for the past 31 years.

With the remainder of our Gilead proceeds, we added to Coca-Cola (KO) at $42.08 on May 14th. Coke’s earnings for the first quarter were released on April 24th. Due to refranchising, Coke saw a 16% decline in total revenue. The company had organic sales of 5% in the quarter and unit case volume grew 3%. On top of that, only 10 other companies can say that they have a dividend growth streak that is as long or longer than Coke’s 56 years of increases. That is an impressive stat.

On May 15th, I did what I thought I never would do as an investor, buy shares of a company that has stated that it is freezing its dividend, but that is just what I did when I added to our CVS Health (CVS) holding at $65.35. CVS is buying health insurance company Aetna (AET) for $77 billion, including debt. Adding Aetna, which won’t be challenged by the U.S. Department of Justice, will add millions of new patients to CVS’s client base, all of which will need their prescriptions filled at some point.

The company had to take on $45 billion in new debt and $21 billion in new equity to be able to make the purchase. Until the company is able to bring its leverage ratio below 3x (it is above 4x currently), the dividend will be paused. That being said, CVS ended the first half of the year with a multiple below 11 and the company saw growth across the board in the first quarter. A low valuation, positive recent results and more new clients outweighs the dividend pause.

Walt Disney (DIS) was our next purchase on our May shopping spree. The company’s $1.84 in earnings per share for Q2 was $0.14 above the average estimate. Revenue grew 9.4% to $14.6 billion, almost $500 million above expectations. Revenue from Media Networks, instead of being weighed down by ESPN as it had in the past, was up 3%.

Operating income was down 6% for this segment, but that is better than in previous quarters. Parks and Resorts (up 13%) and Studio Entertainment (up 21%) continue to shine. With Parks generating revenue at a healthy clip and each movie release seeming to top the previous one, Disney is performing well even with the subscription losses related to ESPN. We bought Disney at $104.70 on May 21st.

On June 6th, we added to two retailers. The first was Costco (COST). Costco has been on my watch list for an additional purchase for some time, but the valuation always seemed to be very high. We added to our holding after the company reported Q3 earnings on May 31st. The company earned $1.70 per share, $0.01 above estimates and a 17% improvement from the previous year. Revenue improved 12% to $31.62 billion.

Comparable same store sales grew 10.2%, above estimates of 8% as online sales increased 37%. Online sales are still just a very small portion of the company, but Costco is starting to invest in this heavily, aiming to offer same day and two-day shipping on many of its products in most of its U.S. stores by the end of 2018. We paid $197.41, which seemed expensive at the time, but Costco hit a high of more than $213 recently.

That same day, we added Dollar General (DG) to our portfolio. This is our first and only new position so far in 2018. Dollar General has only been a public company since 2009, has only paid a dividend since 2015 and yields less than 1.2%, but I’ve been interested in the company for some time. Dollar General has increased comparable same store sales for almost 3 decades. I can’t find another retailer that can make that claim.

Dollar General operates more than 14,700 stores in the U.S. and plans to open as many as 900 new ones in 2018. The company is also renovating many of its locations in order to add fridge and freezer space. These additions are being made in order to drive growth in ticket size, currently ~$13. Dollar General’s business of keeping prices low (many products are below $1), sales history and new and remodeled stores should drive earnings and revenue growth in future years. It’s performance in all types of economic conditions is also very attractive.

Sticking with the retail theme, we purchased our third batch of Target shares on June 25th. Increased store traffic and same store sales tell me that the company is starting to turn the corner. We may have missed out on some of the share price gains this year, but I wanted to see evidence that the company was turning the corner before adding more. After the most recent earnings, I feel that the company is on the road to doing that. Target has increased its dividend for 50 years. The stock yield almost 3.4% at our purchase price of $76.31.

Our last purchase of the first half was made on the last trading day of the first half when we added to our Dominion Energy (D) holding. We paid $68.23 for shares of Dominion on June 29th. Shares of the utility company have declined almost 16% this year. The company earned $1.14 in the first quarter, $0.08 higher than estimates.

Dominion grew earnings per share by 17% year over year in Q1. Revenues grew 2.7%to $3.47 billion, though this missed estimates slightly. The company’s Cove Point LNG project in Maryland has started and has contracts for natural gas for the next 2 decades. Dominion is targeting annual dividend growth of 10% through 2020. Shares of Dominion yield just under 5% currently.

Current Positions

After this month’s activity, our portfolio now consists of the following 39 companies:

3M (MMM), Abbott Laboratories (ABT), AbbVie (ABBV), Aflac (AFL), Altria, Apple (AAPL), AT&T, Boeing (BA), Chevron, Cisco (CSCO), Coca-Cola, Costco, Cummins, CVS Health, Disney, Dollar General, Dominion Energy, Exxon Mobil (XOM), General Mills, Honeywell International (HON), Johnson & Johnson, JPMorgan Chase (JPM), Lockheed Martin, Mastercard, McCormick & Company, Microsoft, Nike, PepsiCo (PEP), Philip Morris, Procter & Gamble (PG), Qualcomm (QCOM), Realty Income (O), Southern Company (SO), Starbucks (SBUX), Target, Ventas (VTR), Verizon, V. F. Corp (VFC) and Visa.

1st Half Dividends And Update In Strategy

If you managed to make it through the purchase section, you probably realized that most of our purchases this year have been of stocks with yields above the 10-Year Treasury yield. That hasn’t been an accident. With the rise in treasury yields, high yield stocks have seen declines. Some of these stocks are ones that I have been chasing for some time, but always seemed to be higher than what I wanted to pay.

That has changed as many names have come down. I’m happy to add more yield as investors trade these stocks in for the safety of treasuries. Could these prices go down further? Sure, and we’ll add more of them as they do. We are 20 years or so from retirement so short-term price variance doesn’t bother us all that much.

Listed below are how much our dividend income grew for the months of March, April, May and June versus the same time frame in previous years.

Previous March

Year Over Year Increase

Year to Date

Year Over Year Increase

March 2014

427.58%

2014

249.90%

March 2015

218.86%

2015

156.79%

March 2016

101.95%

2016

87.05%

March 2017

30.48%

2017

33.64%

Previous April

Year Over Year Increase

Year to Date

Year Over Year Increase

April 2014

126.34%

2014

210.67%

April 2015

68.25%

2015

128.92%

April 2016

53.91%

2016

78.18%

April 2017

30.08%

2017

32.80%

Previous May

Year Over Year Increase

Year to Date

Year Over Year Increase

May 2014

217.05%

2014

217.05%

May 2015

125.67%

2015

125.67%

May 2016

81.14%

2016

81.14%

May 2017

30.02%

2017

65.08%

Previous June

Year Over Year Increase

Year to Date

Year Over Year Increase

June 2014

227.32%

2014

247.20%

June 2015

137.58%

2015

133.94%

June 2016

83.74%

2016

81.82%

June 2017

36.97%

2017

29.09%

As you can see, dividends for the first half have crushed all of our previous records. Each month was up at least 30% compared to just last year. We have now received more dividends in the first 6 months of 2018 than we did in all of 2015 and 2014. By the end of August, I estimate that we will top 2016 entire income haul.

Our total dividends started off quite small and I didn’t think too much about them at the time. Within just a few short years, that income has grown by leaps and bounds. These dividend increases are just from new purchases, reinvested dividends and dividend increases that companies gave shareholders. Simply buying shares of companies that pay and raise dividends on an annual basis has led to these increases in the income that will fund the retirement of my wife and I.

Speaking of retirement, my wife has decided to resign from teaching after being in the classroom for the past 12 years. She is going to pursue other opportunities and will also be able to stay home with our son. As such, our income is going to drop for at least the next year. This will likely keep us from putting away as much money as we normally do for retirement. For that reason, we have decided to turn off the automatic reinvesting of our dividends and instead take them as cash. This will give us extra capital to deploy when the market presents opportunities.

Conclusion

It has been far too long since I posted an update on how the March to Freedom Fund is doing. Our portfolio lags the S&P 500 in total return for the year, but that is not the most important thing. A steadily rising dividend stream is what I am most concerned with and our portfolio continues to churn out more and more income each month. We have focused most of our purchases this year on high yielding stocks that we already own in order to generate more income . What do you think of our purchases? What have you been buying in the first half of this year? Feel free to leave a comment below.

Disclosure: I am/we are long ABBV, AFL, CMI, CVX, GIS, HON, JPM, KO, XOM, MA, MMM, MO, MSFT, PG, PM, QCOM, T, TGT, V, VFC, VTR, AAPL, BA, CSCO, CVS, DIS, JNJ, O, PEP, SBUX, VZ, NKE, LMT, D, COST, ABT, MKC, SO, DG. 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.