Is Your Dividend Growth Strategy Aggressive Enough?

by: Adam Aloisi

Why, all things considered, dividend growth is a fairly conservative approach to equity investment.

How "aggressive" a portfolio is or isn't is "eye of the beholder" type stuff.

Portfolio tweaking, if necessary, should be done in a calculated, deliberative and not wholesale manner.

Strategy session with some thoughts on the current market and continued bifurcation of equity valuations.

Within the universe of equity investing strategies, dividend growth is generally viewed as one of the more conservative methodologies. Indeed, to start, companies that pay a dividend are typically of mature ilk and model themselves toward reliable revenue replication. There's typically comparatively depressed risk here in terms of the investor being blindsided by disruptive or vertical business decisions or strategies.

From a capital-allocative perspective, dividend growth companies seem to sit in a practical sweet spot where cash flow resources can be flexibly and responsibly appropriated on an annual basis between current operating needs, growth initiatives, and direct shareholder value enhancement practices (dividends/buybacks).

Furthermore, companies that pay out growing income portions to their investor bases typically possess an unstated business directive. The annual (or more frequent) rite of the dividend increase is a sacrosanct common share expectation to be messed with only in dire circumstances.

Dividend advocates argue that the dividend itself brings about a more responsible level of managerial stewardship. On the flip side, it might be contended that dividend reputation or concentricity sometimes strongarms management into allocative decisions not always in the best interest of the organization.

Whatever one's philosophical dividend view, the more important consideration is how an income-generating portfolio is constructed.

For some investors, particularly those in retirement, these big-picture portfolio determinations may be easy to make. Indeed, it's easy to execute DG in conservative or indifferent fashion when one possesses sufficient investment capital to generate a high level of passive income. Still, for those whose lifespans may prospectively surpass current averages by large margin, longer-term risks may remain even if today seems secure.

Things get a bit tougher for older investors, strategically speaking, when there is insufficient current income being thrown off by the portfolio to handle living expenses. Younger investors who practice some sort of conservative DG program may be plagued by uncertainty as to whether present investment practice will ultimately meet retirement need. Those less sophisticated may unwittingly see dividend growth as some sort of certain holy grail only to find in time that it is not.

50 Shades Of Aggressive Gray And Making Things More Black & White

Whether one is being aggressive enough with an equity strategy is rarely an easily answered question. While it might be easy to tell a retiree without a lot of investment capital that they need to do more than invest in CDs, it's a little tougher to tell someone fully invested in large-cap blue chips that they should be doing something more, or different.

Aggression to a DG'er may be defined as the search for additional current income through perceived riskier high-yield securities that may or may not generate growth. Or aggression may take the form in the other direction -- lower (or no) yield with the prospect for greater capital growth and total return.

For the more seasoned DG'er or purist, going either direction may be akin to some sort of sacrilege. Still, if there is portfolio pressure being exerted from whatever direction, I'd opine that aggression of some sort should (and in some cases must) be a consideration.

This is not a suggestion to radically churn a portfolio, although, arguably, some investors may be more in need of change than others. The suggestion is merely to recognize that aggressive alternatives exist and challenge yourself to accept or reject their possible implementation as an adjunct to a largely "garden variety" dividend growth portfolio.

At the end of the day, a dividend investor needs to be in a place where they are adequately convinced that the portfolio is working hard enough without shouldering of undue risk. For some, as we've already alluded to, this may prove a larger challenge for some compared to others. A few may struggle with portfolio construction and positioning infinitum.

Strategy Session

Despite a rocky beginning to 2018 and seemingly omnipresent social/political controversy/negativity, the market is once again headed towards a double digit return.

Leading the way, as it has for the past decade now, has been the technology sector. As I suggested in an article this Spring, dividend investors need to seriously be evaluating their exposure to technology. The sector's influence and overall piece of the economic pie continues to deepen. While valuations aren't exactly awe-inspiring for the value conscious, you should have a shopping list ready and be prepared to pick your spots. The growing influence of disruptive technologies is an ongoing theme you'd be wise not to ignore.

As I noted recently about Microsoft (NASDAQ:MSFT), though not cheap, the stock seems to have secular wind at its back. Thus, I'd be reluctant to advise selling totally out, although some trimming may be warranted for oversized positions. The same could be said for a very large chunk of technology stocks these days.

On the not-so-positive side of the equity performance meter continues to be the consumer space, which has historically been a sector that dividend growth investors have had affinity for. Converse to technology, the valuations here are generally palatable, but growth rates are slowing to a crawl. While these kinds of stocks still have their place in a diversified portfolio, it's hard to fathom some sort of grandiose re-acceleration in fortunes. I'd be reluctant to overweight the space, even with the valuation trough.

In terms of individual stocks, one consumer name that I've taken a hard look at myself is Kraft Heinz (KHC). The stock trades at about 15X earnings, but sales growth is expected to be about flat this year and next, while the bottom line ticks upwards at about 4 percent. Despite the 4.3% yield, there's not a whole lot to be excited about here, and thus I've yet to pull the trigger. That kind of theme persists across the space.

REITs have had a nice run, collectively, since the Spring as well, although I certainly would not recommend chasing now. Performance has been highly erratic across operating spaces, as investors continue to mull the future demand and usage of a variety of building types. While I was bullish on data center Digital Realty (DLR) at the beginning of the year when it was trading sub $100/sh., I would take the foot off the buy pedal now.

Retail REITs continue to be an interesting study. Dividend growth investors will probably do fine owning A-mall names [Simon (SPG), Macerich (MAC), and Taubman (TCO)], as well as NNN names like Realty Income (O) and STORE (STOR). Despite what might be read elsewhere, I'd opine that the long-term survivability of both Washington Prime (WPG) and CBL is anything but certain. I'd also opine that the recent rise in Tanger (SKT) may ultimately be viewed as a dead cat bounce. While I wouldn't see some aggression in this space as foolhardy, I certainly wouldn't go overboard.

To conclude, each dividend investor needs to judge for themselves whether liberal risk tolerance or need (or both), or even just greed, provides solid rationale for a more aggressive portfolio posture. However, given today's somewhat valuation-bifurcated market with what I would consider elevated economic disruption risks, investors should approach incremental aggression with an extremely judicious and cautious approach.

Disclosure: I am/we are long DLR. 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.