A SWAN (Sleep Well At Night) Amid The Swoon?

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Includes: ABT, ADP, AET, AFL, APD, CL, CLX, CSCO, CVS, CVX, DEA, DWX, EMR, HCP, INTC, JNJ, LMT, MCD, MDT, MMM, MO, MON, MSFT, NSRGY, O, OHI, PEP, PFE, PG, QCOM, QCP, T, TEVA, UTX, VLO, VTR, WBA, WM, WMT, XOM
by: Financially Free Investor
Summary

A good DGI strategy should provide almost everything that most retirees need: decent income, relative safety, and reasonable growth.

Our Passive DGI Portfolio has completed its four years anniversary. We will provide the periodic review.

Is this DGI portfolio a SWAN (Sleep Well At Night) amid the market chaos and swoon? You be the judge.

Updates on changes, additional investments, dividends collected and overall YTD performance.

DGI (Dividend Growth Investing) generally means that you invest in a set of dividend-paying stocks that grow their dividend payout year after year. If you are still in the accumulation phase, reinvest (drip) the dividends, which results in more shares and higher future income. With each passing year, this growth of dividend-income becomes bigger and bigger. If implemented with some prudent planning and over an extended period of time, the DGI strategy can provide almost everything that a retiree needs: decent income, relative safety, and reasonable growth.

There are possibly a couple of drawbacks with this strategy. First, it cannot provide a very high level of income, probably no more than 4% based on the market value, so one would need a sizable amount of savings to generate the required amount of dividend income that one could live off comfortably. It can sure be overcome by starting saving early in life and investing regularly. Secondly, a DGI portfolio is not immune to drawdowns during big corrections or recessionary times. However, we feel a selection of solid blue-chip stocks will provide safety as well as the continuous flow of income that will help ride any storm. Further, the drawdowns will be much smaller compared to broader market indexes. If we could draw upon the experience of 2008-2009 crisis, an average DGI portfolio was down only about 35% compared to 50% for S&P500.

The popularity of DGI goes up and down in different cycles. Obviously, it wasn't very popular in the late 1990s. However, in the last decade, DGI has been very popular. One of the primary reasons was the low-interest rate regime of the last several years, which forced investors to chase income securities of all stripes, including DGI stocks. This resulted in steep valuations for many of the dividend-paying companies. However, interest rates are rising now, and this has impacted the valuations of most DGI stocks as well as high-yield securities. We consider this good for our portfolio since we will be able to buy at better valuations and higher yields. After all, this is a long-term portfolio, with a focus on income and not so much on total return.

A SWAN Amid The Swoon? You be the judge:

Can a conservative DGI portfolio prove to be a SWAN (Sleep Well At Night) amid market chaos and swoon like the one we experienced this month? It all depends on how you look at it based on your individual perspective and goals. The primary goal of a DGI portfolio is sustainable and growing income that would beat inflation and then some.

Some investors like to measure the performance only by the total returns. However, that can only be a partial goal for a DGI portfolio given the overriding importance of the primary goal of sustainable income. DGI may underperform the market at times especially during strong bull markets, but should also protect the capital during the crisis times, while providing ever-increasing income. Remember 2008-2009, when DGI stocks lost only 30-35% while S&P500 lost more than 50%. Now, 30-35% drawdown is not easy to stomach but still a lot better than 50% and especially knowing that the income stream is not in jeopardy.

Let’s see how our DGI portfolio performed during the recent market swoon starting Oct. 3rd until Oct 12th, 2018 as well as since Feb. 1st, 2018. Sure, this would not prove anything, because a 7-10 days period or even a one year period is too short, but just for the sake of academic interest, we are providing the comparison. Also, shown is the comparison from Feb. 1st until Oct. 12th, 2018.

Portfolio

Value as of Oct. 3rd, 2018

Value as of Oct. 12th, 2018

Difference

Passive DGI

$246,429

$236,278

-4.11%

S&P500 Index

$2,925.51

2,767.13

-5.90%

Portfolio

Value as of Feb. 1st, 2018**

Value as of Oct. 12th, 2018

Difference

Passive DGI

$233,441

$236,278

+1.22%

S&P500 Index

S&P 500 (after incl. dividends)

$2,821.98

$2,821.98

$2,767.13

$2803.73

-1.94%

-0.64%

**We are showing since Feb. 1st because we added $30,000 on Feb 1st to the portfolio as part of our annual routine. Going back prior to that date would have complicated the calculations somewhat.

The Passive DGI Core Portfolio:

We launched this DGI portfolio nearly 4 years ago in August/September 2014. Since then we have reviewed the portfolio regularly on the SA platform to provide the readers and our followers an overview of the progress and relative performance of the portfolio. We wanted to create a well-diversified portfolio with mostly blue-chip companies with a history of raising dividends year after year and hold them for years. We also wanted to invest over an extended period of time so as to take advantage of Dollar-Cost-Averaging and create a decent enough income stream without the need to ever withdraw the capital by selling shares.

We named this portfolio "Passive" because we thought it would require minimal management. True to its name, many times there is no action in this portfolio for months.

A Brief Background of the Basic Portfolio Structure:

The underlying principles of the portfolio were:

Select 30 plus solid dividend-paying, dividend-growing companies and invest the initial capital divided equally. Invest additional money on fixed intervals according to a pre-determined schedule. Use dollar cost averaging and buy in a spread-out manner on a set timetable. Stay consistent, and rarely sell or replace a company, unless there is a compelling reason. Reinvest the dividends for the first 5-10 years or more, to grow the yield on cost (YOC). Thereafter, reap the benefits!

This is what we have done so far until October 12th:

  • $1,000 invested on August 1, 2014, in each of 30 original stocks.$1,000 invested on November 3, 2014, the first trading day of November 2014, in each of 30 stocks.
  • Starting February 2015, every year on the first day of trading in February, we invested $1,000 in each of the 30 stocks. This was completed for the years 2015, 2016, 2017 and 2018. These annual investments will continue until the year 2024.
  • In 2017, we stopped reinvesting dividends automatically. Instead, we now let the cash accumulate and invest when we feel the price is right.

The original article that launched the portfolio can be accessed here and here.

Below is the current list of 37 stocks with the industry/sector information for easy reference.

Industry

Company Name

Aerospace & Defense

Lockheed Martin Corp. (NYSE: LMT)

United Technologies Corp. (NYSE: UTX)

Beverages - Non-Alcoholic

PepsiCo Inc. (NYSE: PEP)

Business Services

Automatic Data Processing (NASDAQ: ADP)

Consumer Goods (Packaged, Food, and Cleaning products)

Colgate-Palmolive Co. (NYSE: CL)

Nestle SA ADR ( OTCPK: NSRGY)

Procter & Gamble Co. (NYSE: PG)

Clorox Co. (NYSE: CLX)

Drug Manufacturers

Johnson & Johnson (NYSE: JNJ)

Teva Pharmaceutical ADR (NYSE: TEVA)

Pfizer Inc. (NYSE: PFE)

ETF - International Dividend (Foreign Large Value)

SPDR S&P International Dividend (NYSEARCA: DWX)

Industrial Products and Chemicals

Emerson Electric Co. (NYSE: EMR)

Air Products and Chemicals (NYSE: APD)\

3M Co. (MMM)

Insurance - Life

Aflac Inc. (NYSE: AFL)

Medical Devices

Abbott Laboratories (NYSE: ABT)

Medtronic Inc. (NYSE: MDT)

Oil & Gas

Chevron Corp. (NYSE: CVX)

Exxon Mobil Corp (NYSE: XOM)

Valero Energy Corporation ( VLO)

REITs

Realty Income Corp. (NYSE: O)

HCP, Inc. (NYSE: HCP)

Omega Healthcare Investors, Inc. (NYSE: OHI)

Ventas, Inc. (NYSE: VTR)

Easterly Government Properties, Inc. ( DEA)

Restaurants

McDonald's Corp. (NYSE: MCD)

Retail - Defensive, Drugstores

Walmart Inc. (NYSE: WMT)

Walgreens Boots Alliance (NASDAQ: WBA)

CVS Health Corp. ( CVS)

Technology

Microsoft Corp. (NASDAQ: MSFT)

Qualcomm Inc. (NASDAQ: QCOM)

Intel Corp. (NASDAQ: INTC)

Cisco Systems, Inc. (NASDAQ: CSCO)

Tobacco Products

Altria Group Inc. (NYSE: MO)

Telecommunications Services

AT&T Inc. ( T)

Waste Management

Waste Management, Inc. (NYSE: WM)

Brief Highlights from Annual Investments (February 2018):

  • As per our annual schedule of contribution in the first week of February, we added $30,000 of new money to this portfolio. We invested $1,000 into 29 out of current 37 securities.
  • We did not add new money to DWX, HCP, QCOM, T, TEVA, WMT, MMM and XOM at that time. MMM was added to the portfolio later in July 2018.

Additional Buy/Sell after Annual Buys in February 2018:

Company

Date

Buy/Sell

Shares

Share price

Amount

Easterly Govt. Properties ( DEA)

6/25/2018

Buy

51

19.40

$989.40

**Monsanto ( MON)

6/7/2018

Sell

55.71

127.99

$7,130.87

AT&T ( T)

4/30/2018

Buy

31

32.70

$1,013.70

AT&T (T)

7/20/2018

Buy

64

31.20

$1996.80

3M Co. (MMM)

7/25/2018

Buy

9

200.63

$1805.67

**In 2018, we had to sell our stake in Monsanto, since it got bought out by Bayer AG in June 2018.

Dividends:

Starting April 2017, we made a change with regards to the dividend reinvestment policy. We stopped reinvesting (dripping) the dividends automatically. This was to allow us to build some cash position and make some opportunistic buys from time to time.

Dividends in 2014

$560

Dividends in 2015

$2,830

Dividends in 2016

$4,025

Dividends in 2017

$5,207

Dividends in 2018 (until 10/12/2018)

$5,024

Total dividends since inception

$17,646

Current Yield: (6,847/236,278)

2.90%

Yield On Cost [YOC] (6,847/180,000)

3.80%

Dividend Cuts or Freezes in 2016/2017/2018

  • In 2017, CVS (CVS Health) froze its dividend at $0.50 per share due to its pending acquisition of Aetna Inc. (NYSE: AET).
  • HCP had to cut its dividend by 35% in 2017, following ManorCare assets spin-off in 2016. Since then, it has been paying a constant amount of $0.37 per share.
  • TEVA eliminated the dividends entirely in fourth quarter 2017.

Dividend Increase Restored

  • CVX (Chevron) had paid the same $1.08 quarterly dividend for five quarters, until February 2018. It got finally raised to $1.12 per share, an increase of 3.70%.

Dividend Increases Declared In 2018

2018 summary (until 10/12/2018):

  • One company ( TEVA) pays no dividend currently. Two companies (HCP, CVS) have their dividends frozen currently.
  • Out of remaining 34 companies, 31 have announced dividend increases. The average increase has been 7.94%.

Note: In the above table, the greyed-out rows show the companies that have frozen the dividend. The rows highlighted in "red," have yet to announce a dividend hike in 2018.

Total Return and Relative Performance:

Here is a snapshot of relative performance as of October 12, 2018, created using the Morningstar Portfolio Tool. The DGI portfolio and Morningstar Market-Index are represented by green and blue lines, respectively:

The total performance is more or less in line with the market indexes. This is in spite of the fact that we added $30,000 on the first day of February 2018, as part of our annual buys. We know the market was at the top at that time. But this was not market timing but as part of our regular routine and any negative impact would be temporary. At the same time, we must keep in mind that this is a long-term DGI portfolio and goal is not to beat S&P500 or any other index.

Portfolio Positions as of 10/12/2018:

In case, the above image (Google-sheet) is too small to read, here is the image of the portfolio from excel:

Note: In the above table, Profit/Loss columns do not account for the dividends that were not reinvested.

The Good, the Bad and the Ugly:

As of 10/12/2018, the portfolio has 37 positions, and when we include all of the dividends (the amounts that were dripped or not dripped), this is how they performed, sorted in order of performance, from top to bottom. You would see that in spite of the recent turbulence, as of 10/12/2018, only 6 stocks were in the negative territory, 4 of them just marginally. In fact, since Oct 12, markets have recovered and stabilized as of this writing.

Stocks In Negative Territory:

HCP:

HCP has underperformed since its trouble with one of its large tenants HCR ManorCare and subsequent spin-off of all skilled-nursing business to Quality Care Properties ( QCP). This led to a dividend cut that was the first in its history of raising dividends for 40+ years. We sold out of QCP shares that were received due to spin-off and stopped adding new money to HCP.

But we have kept our existing position intact. A healthy dividend of $1.48 per share, well-covered by its AFFO, will keep the income coming, while the company improves its business over time. After including all dividends and the sale proceeds from QCP, our position is down about -20%.

The worst performer: TEVA

TEVA is still our worst performer, down by nearly -59% from buying cost. The story about TEVA has not changed since our last update. However, please keep in mind that it has recovered nearly 100% from its lows of $10.85 in 2017. So, our decision to hold on to our small position, even though it pays no dividends, was not entirely a bad one.

Just to provide some perspective to new readers, the company had first cut its dividend by 75% and then cut it entirely in 2017, so it pays no dividend anymore. We stopped adding fresh money to this position as far back as Feb. 2017. However, we have retained our small position, less than 0.75% of the portfolio.

In fact, TEVA demonstrates that one or two bad choices in a highly diversified portfolio are not going to have any meaningful long-term impact on the overall portfolio.

Concluding Remarks

We personally follow a multi-basket strategy, of which DGI is an important part and plays the foundational role. We believe the DGI portfolio strategy described as above is the simplest way to accumulate wealth over a long period of time. This portfolio is simple, easy to implement and hassle-free.

In our own allocation model, we recommend about 35-45% of our investment assets into DGI. The rest is allocated to other compelling strategies that provide us the strategic diversification. A multi-basket approach certainly requires more effort and is not for everyone. For more passive type investors, a DGI strategy is ideally suited as it requires very little effort, mostly just a few times a year.

We feel in the long term this portfolio will offer better returns, lower volatility and drawdowns, and consistent and growing income. In addition, it requires minimal management. The current yield based on 2018 projected dividend income is roughly 2.90%. However, the yield-on-cost is very decent at 3.80%, compared to less than 2% yield from S&P 500.

Our regular readers know that in addition to a DGI Core portfolio, we invest in alternate portfolio strategies, mainly to enhance the current income and to hedge the risks by using Rotation strategies. Below is our investment allocation model, and as you can see the DGI portfolio forms the foundation of the overall strategy. These allocations are just for broad guidance, and it does not mean they are suited for everyone. Each individual should decide what is right for them based on his/her goals and risk tolerance.

Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. The stock portfolio presented here is a model portfolio for demonstration purposes; however, the author holds many of the same stocks in his personal portfolio.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, WMT, WBA, CVS, LOW, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, HCP, HTA, O, OHI, VTR, NNN, STAG, WPC, MAIN, NLY, ARCC, DNP, GOF, PCI, PDI, PFF, RFI, RNP, STK, UTF, EVT, FFC, HQH, KYN, NMZ, NBB, JPS, JPC, TLT. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.