RetirementRx's Mid-Year Review

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Includes: ABT, CMI, FDX, IBM, JNJ, SJM, T, WBA, XOM
by: Mike Wald
Summary

RetiremextRx’s dividend income is on track through the halfway mark of 2018.

The four transactions (2 buys and 2 sells) from 2Q18 are reviewed.

Progress on 2018’s goals are discussed.

Ideas for future investmentare presented and discussed.

Introduction

I am a dividend growth investor. My focus is on generating a dividend income to facilitate a smooth transition into retirement. I actively manage a real-life dividend growth portfolio called RetirementRx. RetirementRx, a plan and portfolio, was started in 2013 with a target retirement income equal to my 2013 salary ($120K) adjusted for 2% inflation. To achieve this dividend income, I must grow my organic dividend income by 8% YoY and support a 4% yearly increase in the cash contribution to the portfolio. This article serves as my 2018 mid-year progress report. I hope my strategy, thoughts, and results help others plan for their own retirements.

Transactions in 2018

Over the first half of 2018 starting on Jan 3rd through June 30th, I made 1 buy and 2 sales in my after-tax account, and 1 buy in my Roth IRA. The transactions listed for Jan 2018 will not be discussed here as they were covered in my 2017 review. My primary purchase in 2018 was 33 shares of JNJ on 5/31/2018. Prior to this purchase I sold my position in ABT and a partial position in IBM. I sold ABT because of its high valuation and relatively low dividend growth rate. I considered the swap to JNJ to be prudent for dividend yield, dividend growth, and relative valuation. FAST Graphs showing operating earnings for the past 15 years for ABT and JNJ are shown below with a red dot indicating 5/31/2018. When forecasting total returns over the next 2.5 years assuming both companies trade at their lowest PE ratios from over the past 15 years (PE=17 for ABT and PE=15.2 for JNJ), JNJ is a clear winner with a 6.5% annualized return relative to ABT’s paltry 0.5% annualized return. Another way to look at this is that the market expects a higher growth rate for ABT of 12.9% versus JNJ’s of 6.7% and has therefore valued ABT at a higher PE of 23.3 vs 16.2. If we assume that in 2.5 years both companies trade at their historical valuations (PE=17 for ABT and 15.2 for JNJ), then JNJ is the better investment in terms of capital appreciation. It also will outperform on dividend income due to the higher starting yield and similar DGR. Finally, since the expectations for ABT are high, they are also riskier.

Year

Month

Purchases

Sales

2018

Jan

13 FDX @$257, 200 BAC @$30, 50 MDT@$82, 100 KR @$28, 50 SO@$47, 20 XOM @$85

Feb

-

March

-

April

May

33 JNJ @121

21 ABT @ $62, 14 IBM @142

June

3.3 FDX @ 250

July

August

Sept

Oct

Nov

I also sold part of my IBM stake and used the proceeds, along with dividends and the funds from the ABT sale to buy JNJ. I am still a believer in IBM, but I am not as convinced as I once was. They key growth driver is pairing Watson with cloud services. Since IBM is third in cloud infrastructure services and losing ground to 4th place Google, I worry they are not going about cloud in the right way. I continue to be excited by the potential for Watson Health services. I believe there is a huge market for distributed healthcare in which telemedicine can be leveraged to make diagnoses, recommend treatments, and reduce costs by eliminating unnecessary procedures and standardizing care across geographies with varied resources. My concern here is that I have not seen enough in the way of results thus far and am unconvinced IBM will be the leader in this field as they continue to spread themselves across many industries like investment banking and human resources. I will continue to watch IBM’s progress and maintain a 17-share position.

The final purchase was made using the new commission-free dividend reinvestment option in Motif Investing which houses my Roth IRA. Using this tool, I have purchased 3.3 shares of FedEx (FDX) in using incoming dividends. FedEx is well positioned to benefit from continued growth in ecommerce and has invested heavily in logistics and ecommerce solutions. Even if Uber-style shipping services gain market share in the package delivery space, FedEx will be needed to move the shipments long distances and to deliver high value shipments. These are the high margin items FedEx wants. Another tailwind is globalization. While globalization is being fought by local governments every day, the force behind it, namely- the optimal allocation of resources, is far too strong to see this as more than a hiccup.

Portfolio Composition

As of June 30th 2018, RetirementRx consists of 44 stocks across a Traditional IRA (T), Roth IRA (R), and an individual after-tax account (AT). Forty-two of the 44 companies are dividend payers. Celgene (CELG) and TEVA are the exceptions. There are 38 companies actively growing their distributions year-over-year with EBIX, CDLT, CVS, and SLB as the exceptions. The following list ranks the stocks in RetirementRx by % allocation and uses red highlighting to identify stocks that either have not raised their dividend payments in the past year or whose last dividend raise was less than 5%. Omega Healthcare Investors (OHI) has suspended their penny per quarter increase policy as of 1Q18, but will still have a year-over-year increase until 1Q19. Blue highlights upcoming dates for expected dividend increase announcements.

Rank

Company

Ticker

Industry

Account

Date of Last Dividend Change

% Change in Dividend in TTM

% of Portfolio Cash Flow

% Portfolio Market Value

1

Walt Disney Company (THE)

DIS

Consumer Discretionary

T, R

12/8/2017

7.69%

3.01%

5.71%

2

AMGEN INC

AMGN

Healthcare

AT, T, R

12/15/2017

14.78%

5.32%

5.48%

3

APPLE INC

AAPL

Consumer Discretionary

AT, T, R

5/1/2018

15.87%

2.25%

4.89%

4

LOWE'S COMPANIES

LOW

Consumer Discretionary

T

6/1/2018

17.07%

3.02%

4.53%

5

Medtronic plc.

MDT

Healthcare

T, R

6/27/2018

8.70%

3.18%

4.39%

6

CVS CAREMARK

CVS

Consumer Staples

T, R

1/21/2017

0.00%

4.38%

4.08%

7

Toronto Dominion

TD

Financial

AT, T

3/1/2018

11.67%

6.11%

3.77%

8

INTEL CORP

INTC

Technology

AT, T, R

2/1/2018

10.09%

3.04%

3.76%

9

TARGET CORP

TGT

Consumer Staples

AT, T, R

6/13/2018

3.23%

4.04%

3.50%

10

CUMMINS INC

CMI

Industrial

T

7/11/2018

5.56%

3.86%

3.29%

11

KR

KR

Consumer Staples

AT, T, R

6/28/2018

12.00%

2.27%

3.26%

12

GILEAD SCIENCES INC

GILD

Healthcare

T

3/15/2018

9.62%

3.25%

3.15%

13

ROSS STORES INC

ROST

Consumer Discretionary

A, R

3/15/2018

40.63%

1.10%

3.02%

14

FedEx Corp.

FDX

Industrial

A, R

6/12/2018

30.00%

1.15%

2.97%

15

AFLAC INC

AFL

Financial

T, R

3/29/2018

15.56%

2.48%

2.93%

16

Walgreens Boots Alliance

WBA

Consumer Staples

AT, T, R

7/1/2018

10.00%

2.77%

2.92%

17

AT&T

T

Telecom

T

1/9/2018

2.04%

6.30%

2.80%

18

Bank of America

BAC

Financial

T

7/2/2018

25.00%

1.89%

2.71%

19

Southern Company

SO

Utilities

T

4/15/2018

3.45%

4.23%

2.39%

20

CISCO SYSTEMS INC

CSCO

Technology

A, R

2/20/2018

13.79%

2.34%

2.12%

21

WILLIAMS SONOMA INC

WSM

Consumer Discretionary

AT, T

4/25/2018

10.26%

2.03%

2.08%

22

ABBVIE INC

ABBV

Healthcare

AT

1/1/2018

10.94%

3.05%

2.02%

23

EBIX INC COM NEW

EBIX

Technology

AT

2/5/2014

0.00%

0.24%

1.90%

24

Johnson & Johnson

JNJ

Healthcare

AT

6/15/2018

7.14%

1.87%

1.87%

25

UNITED TECHNOLOGIES CORP

UTX

Industrial

T, R

6/14/2017

6.06%

1.37%

1.82%

26

QUALCOMM INC

QCOM

Technology

A, R

3/21/2018

8.77%

2.67%

1.80%

27

EXXON MOBIL CORP

XOM

Oil/Energy

T, R

4/25/2018

6.49%

2.40%

1.70%

28

Ameriprise Financial

AMP

Financial

T

4/18/2018

10.84%

1.31%

1.42%

29

Boeing Company (THE)

BA

Industrial

R

12/15/2017

20.42%

0.85%

1.26%

30

Realty Income

O

REIT

R

6/27/2018

4.03%

2.08%

1.25%

31

Omega Healthcare Investors Inc.

OHI

REIT

R

11/1/2018

6.72%

3.76%

1.24%

32

INTERNATIONAL BUSINESS MACHS

IBM

Technology

T, R

5/6/2018

4.67%

1.71%

1.14%

33

Chatham Lodging Trust (REIT) of Beneficial Interest

CLDT

REIT

R

3/29/2016

0.00%

2.29%

1.09%

34

Tanger Factory Outlets

SKT

REIT

R

4/12/2018

2.92%

2.21%

1.06%

35

J.M. Smucker Company (THE)

SJM

Consumer Staples

R

7/16/2018

8.97%

1.04%

0.96%

36

Celgene

CELG

Healthcare

T

1/0/1900

0.00%

0.00%

0.77%

37

SCHLUMBERGER LTD

SLB

Oil/Energy

T

12/1/2014

0.00%

0.79%

0.74%

38

CONOCOPHILLIPS

COP

Oil/Energy

T

2/12/2018

7.55%

0.42%

0.74%

39

NORFOLK SOUTHERN CORPORATION

NSC

Industrial

AT

2/1/2018

18.03%

0.45%

0.73%

40

Digital Realty Trust Inc.

DLR

REIT

R

3/1/2018

8.60%

0.75%

0.67%

41

Stag Industrial Inc.

STAG

REIT

R

1/30/2018

0.85%

1.13%

0.61%

42

Wells Fargo & Company

WFC

Financial

R

7/1/2018

10.26%

0.61%

0.57%

43

Ventas Inc.

VTR

REIT

R

12/15/2017

2.00%

0.98%

0.51%

44

TEVA PHARMACEUTICAL LTD - ADR

TEVA

Healthcare

AT

11/24/2017

-100.00%

0.00%

0.37%

In addition to the stocks in the list, RetirementRx includes a ~$1,200 investment in SCHD as a performance comparator and growing investments in index funds within an employer-sponsored 401K - the Fidelity US index fund FXSIX and Fidelity International fund FSPNX – split 70% to 30%, respectively.

Below is the sector break-down of RetirementRx. I would like to avoid new investments in the consumer discretionary sector for the time being as much of the names are overvalued and this sector is most sensitive to consumer spending. It also happens to be the sector with the strongest performance in recent years. It is no surprise seeing that the 20% capital weighting accounts for only ~11% of the portfolio income. Assuming I can find good value, I would like to direct new funds into Consumer Staples, Utilities, Industrials, Telecom, and Oil/Energy sectors. Value will always trump sector weighting.

Portfolio Performance

The current portfolio has an average dividend yield of 2.9% and an organic dividend growth rate of 8.8%. The dividend income for the first half of 2018 is $3,186 which compares to the 2017’s first half dividend income of $1,392; an increase of 122% YoY. This increase is a consequence of a large 401K rollover into the Traditional IRA at the end of 2017. I expect these yearly beats to continue, but more on the order of 10-20% once the 401K funds have been fully reflected.

The following chart shows the growth in RetirementRx based on its cumulative contributions, dividends, and capital appreciation. The sum of the cumulative contributions (red), cumulative dividends (green), and capital appreciation (BLUE) yields the current value of the portfolio which is approximately $250K.

RetirementRx 2018 Goals

RetirementRx has both long term and shorter-term goals. The long-term goals are more rigid and reflect my overall investment objectives. Short-term goals are generally yearly milestones that allow for small triumphs along the way. Both sets of goals must be measurable and challenging. In my 2017 review, I provided a list of short-term goals for 2018. Let’s check-in to see how I am doing so far in 2018.

  1. Surpass $7,000 in dividend income, which exceeds the $6,330 target for 2018

Dividend income as of end of 2Q18 is $3186 with an average dividend per month of about $500. I was a bit optimistic on this one and my ability to surpass $7000 is not looking likely. I am on track to achieve my original goal for 2018, but it is more likely that I will cross a projected annual income of $7000 in 2018 or early 2019.

2.Contribute approximately equal amounts to Roth 401K as pre-tax 401K

As of June 30th, I have contributed $8K to my Roth 401K and ~$10K in combined funds to my employer-sponsored pre-tax 401K. Based on my employer’s matching policy and the max 401K contribution of $18.5K for 2018, my current plan is as balanced as it can be without contributions exceeding the maximum. Just to remind readers, my intent is to achieve a better balance between Roth and pre-tax retirement funds so that I can have added flexibility around taxation of RMDs and other income sources in retirement. In my view, Roth dollars are worth more than pre-tax 401K dollars as Roth dollars are not subject to RMDs and can be easily transferred to heirs upon death while retaining their tax-free status

3. Keep transaction costs to <3% of dividend cash flow produced by the portfolio (<$190)

So far in 2018 I have made transactions costing $85.35 in commissions. Comparing this to the halfway dividend cash flow of $3186, the costs are below the 3% cap at 2.7%. I do not anticipate many more trades for the remainder of the year. I have reviewed the transaction costs at eTrade (my new broker at some point later this year) and see no reason to be concerned

4. Target a net reduction in portfolio beta

RetirementRx’s beta at the end of 2017 was 1.07 using Google Finance numbers. RetirementRx’s current weighted beta is 1.04 per Yahoo Finance estimates. The change from Google to Yahoo makes the comparison moot, but I am confident that the true beta of RetirementRx has been reduced so far in 2018 based on the transactions made. I would like to achieve a beta <0.8 which will take several years to achieve, but I think it would be achievable to have a portfolio beta of <1 in 2019. I have begun tracking the overall portfolio beta to measure my progress.

Future Investments

In the next month, I am looking to deploy ~$4-5K into an existing position or two. My current prospects include CMI, SJM, WBA, XOM, and T. All have raised dividends for over 10 years with CMI having the youngest streak of 12 years straight and all stocks have betas <1. Below I summarize some relevant metrics of these five stocks. I use bold to indicate the outperforming metrics and italics for the lower performing. While these companies are in different industries, I consider these valuation metrics comparable across the board.

Stock

Current Price

Annual Shareholder Yield in % (Div + buybacks +new Debt)

Ratio of Current GAP PE to Min 15-yr GAP PE

Chowder Number

Forecasted Annual Earnings Growth (next 3 yrs)

Fair Value for 1Q2020 (Fast Graphs est.)

Projected return in % EOY 2019

CMI

143.58

-0.98

0.98

21.7

14

213

48.5

SJM

112.81

-12.63

0.64

11.9

-14.2

119

5.5

WBA

68.64

-2.74

0.83

9.1

16.6

102

48.6

XOM

81.27

6.44

1.26

11

5.1

72

-11.4

T

32.40

-6.57

0.64

8.4

-6.6

42

29.6

Data in table is pooled from Seeking Alpha and Fast Graphs. All stocks are from CCC list and are existing positions in RetirementRx.

The primary growth vectors and risks for each company are also worth reviewing. While this is not an exhaustive review, I like to consider the ones that standout after reviewing recent earnings and investor presentations. My investment thesis should reflect these intangibles as they are what underlie the numbers the business generates.

Stock

Growth Vectors

Risks

CMI

Increasing demand for fuel efficiency, emerging markets, electric motorization, severe weather

Cyclical construction, car sharing, wind/solar power, high oil/ nat. gas prices

SJM

Focus on Pet food, coffee, and snacking

Private labeling across consumer staples, saturation of coffee market

WBA

Operational efficiencies (locations and product mix), expanding health services and conveniences at stores

Amazon pharmacy, drug price regulation, and growing market for generics

XOM

Increasing oil prices, growing population and demand, biofuel research

Increasing preference for electric motors and green energy, liabilities related to oil extraction/processing

T

Time Warner Cable, 5G, cable-wireless-content synergies

Faster DIRECT TV decay, rising interest rates on debt load

I like CMI and SJM the best based on their growth vectors. CMI is also a clear winner from the dividend and capital return perspective and I like their move into the electric motor market with the purchase of Efficient Drivetrains. Car sharing will have little impact on utility vehicles, construction vehicles, and mass transit vehicles.

SJM’s earnings are expected to go down over the next several years due to a large tax benefit in 2017. Also, it has been increasing its dept burden significantly over the past 5 years to acquire new brands. SJM's focus on pet food, coffee, and healthier snacking and their move away from baked goods seem to be a good strategy for future growth. Despite SJM’s low return expectations (which I need to understand better), I think it is positioning itself well for a strong future, though not necessarily a sexy, fast growing one. Being valued at only 64% of its lowest PE ratio over the past 15 years makes the company look very attractive should it be able to surprise and deliver on its growth strategy.

The challenges for WBA are greater than its current growth strategy appear able to offset. I do not believe the 16.6% earnings growth is likely to occur or be sustained once Rite Aid stores are fully integrated. XOM is a toss-up as it is the best returner of capital to shareholders of the group, yet it is in a very difficult industry to predict. I consider it a good income stock with a bumpy road ahead.

T is likely a great buy right now trading significantly below its nominal PE after its recent acquisition of TWC which is very likely to generate strong earnings growth in the coming years. 5G will also bring plenty of opportunity for this wireless and media company and with a large dividend, the primary risk will be on capital investment while paying off its large debt balance. Since T already produces 6.5% of RetirementRx's income stream, I will not be adding significantly to this position in the near term. CMI and SJM fall within the wheelhouse of my investing style with 3% yields and 5-10% DGR. I am favoring them as adds in August. XOM places a distant third.

What are your thoughts on the above stocks? Any clear favorites based on value and growth outlooks?

Summary

Dividend growth investing is a sound strategy for retirement planning as it shifts the focus away from stock price towards long-term wealth generation. In today’s market, dividend growth investing will help investors stick to their plan and goals. RetirementRx is producing good income growth and should be able to achieve 2018 targets. I hope others find my plan and performance useful in their quest for generating income for their eventual or current retirement. As always, I encourage comments and discussions and value constructive feedback.

Disclosure: I am/we are long all stocks mentioned. 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.