This Is A Great Time To Build A Dividend Portfolio

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Includes: AAPL, ABBV, ADP, BIP, BLK, BNS, CDUAF, CMI, ENB, ETN, IBM, ITW, MAIN, MFC, MMM, MSFT, PEP, PG, QCOM, RDS.A, RDS.B, RY, TD, TM, TXN, UPS, VTR, WMT, XOM
by: Dividend Sleuth

Summary

Pressing on through some downward volatility.

Taking what the market gives.

Tilting toward dividends.

A note about IBM's purchase of Red Hat.

Re-thinking the watchlist.

A year ago, I expected to begin taking distributions from my IRA in early 2018 to coincide with leaving my "day job." Due to a 6-month delay in this transition (and partly due to a simple lifestyle), distributions from my IRA have been postponed until sometime in 2019, perhaps beginning in January. That decision could be made in the next 6 weeks.

Pressing on through some downward volatility

If you're a new reader, or would like to see the context for recent portfolio action, please refer to my non-paywalled Q3 Portfolio Review, which included the addition of several new companies in the wake of some "fresh money" from a pension rollover to my IRA. The Standard & Poor's 500 index stood at 2,913.98 on September 30, 2018. As of October 26, the index had dropped 8.76% to 2,658.69. My retirement income portfolio dropped 6.15% during this period. Year-to-date, the S&P 500 index is down 0.56% and the portfolio is down 0.77%.

As an investor with a long-term horizon, I see the present market as a great opportunity time to build a dividend portfolio. Not since the bear market that accompanied the Great Recession have we seen this many excellent dividend companies on sale. In an October 27 article, The Heisenberg makes the case that the October selloff isn't "the big one." In an October 28 article, Jeff Miller counsels making adjustments as needed but staying in the market:

"Many investors have been out of the market, planning to find a good opportunity to get back in. This is a poor approach. Making 'all-in' decisions is much more difficult than choosing a reasonable adjustment to your allocations."

Since September 30, I've used the rollover funds to buy additional shares of 24 positions in the portfolio. Here are the positions that were enlarged and the prices paid. These purchases were made during the market's downward trajectory. Most have fallen in price since I made the purchases. 10/26 is the October 26 closing price for each of these holdings. %Diff is the percentage difference between the price paid and the price on 10/26/18. SSD is the Dividend Safety score by Simply Safe Dividends.

Company Paid 10/26 % Diff SSD
Ventas (VTR) 52.31 56.77 +8.26% 70
PepsiCo (PEP) 106.62 110.49 +3.30% 96
Main Street Capital (MAIN) 38.26 36.14 -5.54% 67
Manulife Financial (MFC) 16.94 15.39 -9.15% 66
Illinois Tool Works (ITW) 133.69 124.06 -7.20% 89
Texas Instruments (TXN) 97.83 90.52 -7.47% 95
BlackRock (BLK) 411.96 386.69 -6.13% 97
Canadian Utilities (OTCPK:CDUAF) 22.93 23.66 +3.18% NR
3M (MMM) 196.96 184.86 -6.14% 86
Eaton Corp. (ETN) 77.81 72.02 -7.48% 89
International Business Machines (IBM) 133.61 124.78 -6.61% 92
Procter & Gamble (PG) 79.90 87.86 +9.96% 98
Enbridge Inc. (ENB) 32.57 31.27 -3.99% 55
Cummins (CMI) 139.06 128.72 -7.44% 98
United Parcel Service (UPS) 114.94 105.29 -8.40% 78
Bank of Nova Scotia (BNS) 54.25 53.47 -1.44% 80
Royal Bank of Canada (RY) 75.09 72.17 -3.89% 84
Toronto-Dominion Bank (TD) 56.42 55.22 -2.13% 87
Brookfield Infrastructure Partners (BIP) 39.06 37.60 -3.74% 65
Exxon Mobil (XOM) 78.49 77.53 -1.22% 80
Toyota Motor Corp. (TM) 117.52 117.38 -0.12% 61
AbbVie (ABBV) 85.49 80.79 -5.50% 65
Royal Dutch Shell (RDS.B) (NYSE:RDS.A) 64.80 63.99 -1.15% 70
Qualcomm (QCOM) 61.96 62.38 +0.68% 60

With the exception of VTR, PEP, CDUAF, PG and QCOM, hindsight indicates that I would have been wise to have waited until (at least) October 26 to make these additional purchases. It's not my nature to dwell on such things, but I want to learn from prior decisions.

IBM's purchase of Red Hat

Over the weekend, we learned that IBM will buy Red Hat (RHT) for $34 billion. The company seems to be "betting the ranch" on this one. On the one hand, this could be a good strategic move (particularly if Red Hat Chief Executive Officer Jim Whitehurst becomes IBM's next CEO). On the other hand, today Standard & Poor's lowered IBM's credit rating from A+ to A, with a negative outlook:

"We are lowering our issuer credit and issue-level ratings on IBM to 'A' from 'A+'. ..."

"We are affirming our short-term ratings on IBM and IBM Credit LLC's commercial paper at 'A-1', with no change to IBM's strong liquidity profile."

"The ratings outlook is negative, as we expect the company's leverage will rise to about 2.4x at transaction close from 1x at present. We expect IBM to experience overall revenue growth in the low single digit percentage area and adjusted EBITDA, at above 25% currently, to improve slightly, leading to leverage declining to about 2x by 2021 as the company suspends its share repurchases in the two years post-transaction close and pursues a balanced debt repayment and acquisition strategy."

We have experienced both a gradual downward slide in some stocks - particularly in the industrials and financials sectors as well as some significant volatility last week. I've added to some positions on weakness. Most of them continued to go lower, and they may go lower still.

I see these as long-term holdings. I now have a full complement of industrial companies in the portfolio. My focus is to assemble a relatively safe portfolio of growing dividends. In order to take advantage of what I saw as some disparity in valuation, I closed four positions earlier in the quarter to help fund the above buys:

  • Helmerich & Payne (HP) at $66.99 (cost $62.19);
  • Merck (MRK) at $72.08 (cost $51.51);
  • Northwest Natural Gas (NWN) at $71.02 (cost $54.08); and
  • Clorox (CLX) at $149.50 (cost $119.10).

Corrections and bear markets will occur. Peter Lynch famously said a bear market is not an unusual event, but (like winter) a recurring event.

Given the market's gains over the past decade, it's not surprising to see the recent drop in the market price of many stocks. The rapidity of some drops may have caught investors off guard. I believe sharp drops are partly caused by algorithmic trading. Individual traders are up against not only institutional traders and hedge fund managers. We now compete with computers, and they are faster than we are. The one advantage we have is a long-term perspective. We can use short-term gyrations to help us accomplish our long-term goals.

Taking what the market gives

I'll provide a full portfolio review at the end of the fourth quarter. This report highlights some significant changes thus far in Q4. The additional purchases noted above reduced the cash position of the portfolio from 6.18% on September 30, 2018 to 0.52% on October 23, 2018. As a result of some sales described below, the cash position as of October 26 is 5.57%.

The S&P 500 index price action on October 22-26 reflected the market's see-saw pattern, reflected in the table below:

S&P 500 Index Open High Low Close
Monday, Oct. 22 2773.94 2778.94 2749.22 2755.88
Tuesday, Oct. 23 2721.03 2753.59 2691.43 2740.69
Wednesday, Oct. 24 2737.87 2742.59 2651.89 2656.10
Thursday, Oct. 25 2674.88 2722.70 2667.84 2705.57
Friday, Oct. 26 2667.86 2692.38 2628.16 2658.69

Monday's S&P 500 index traded in a relatively narrow range of 29.72. The market opened sharply lower on Tuesday, down 34.85. It recovered much of the early loss, rising 32.56 but failing to close above Monday's close. Wednesday opened slightly down and proceeded to steadily decline, down 85.98 just before the close. The market tried to rally into the close. Thursday opened up 18.78 and continued to climb throughout much of the day, gaining 47.82 to the high before a reversal just before the close that saw the index lose 17.13. Friday opened down 37.71, dropping quickly another 39.70 to the weekly low of 2,628.16. The market attempted a mid-day rally but faltered, closing down 9.17 for the day and 115.25 for the week.

Last week's graph of the SPDR S&P 500 Trust ETF (SPY) tracks the daily ups and downs:

Graph of SPY (Graph from Seeking Alpha)

The above commentary and graph describe the action of the broad market during the week of October 22-26, but the graph below shows more explicitly the sharp ups and downs of Apple (AAPL). On Monday (October 22), I began to seriously consider trimming or selling one or more of my low-yielding stocks, one of which was Apple. It appeared to me that the broader market was demonstrating weakness but some market leaders, such as Apple and Microsoft (MSFT) were fighting the trend. The down-and-up action on Tuesday convinced me to look for an opportunity to trim or sell some or all of my four low-yielding stocks: AAPL, MSFT, Automatic Data Processing (ADP) and Walmart (WMT).

Last week's graph of Apple reflects the market's rapid up and down movements:

Graph of AAPL (Graph from Seeking Alpha)

On Wednesday, I used my spreadsheet to create several possible scenarios, and as the market turned down sharply toward the end of trading on Wednesday, I decided that there may be more good buying opportunities ahead for dividend stocks. Thus, I decided to generate cash by selling all of my four low-yielding stocks at an opportune time.

An opportunity presented itself much sooner than I expected - the next day. The four stocks returned to where they had begun the week, which was significantly stronger than the broader market's action. Notice the graph shows AAPL's high on Thursday is roughly equal to where it opened the week, but SPY's Thursday high failed to reverse the week's downward trajectory for the broader market. About an hour before the close on Thursday, I went to a coffee shop to check the market via the Internet and closed all four of my lowest-yielding positions. It was not an easy decision. Here's my history with these four holdings:

  • Microsoft was bought in September 2015 at $43.66. At the time, the yield was 3.30%. I sold MSFT during the market's last hour of trading on Thursday at $108.73. The yield was 1.69%.
  • Walmart was bought in October 2015 at $57.80. The yield was 3.39%. I sold WMT on Thursday at $99.01. The yield was 2.10%.
  • Automatic Data Processing was bought in September 2016 at $89.76. The yield was 2.36%. I sold ADP on Thursday at $140.93. The yield was 1.96%.
  • Apple was bought in September 2016 at $104.78. The yield was 2.18%. I sold AAPL on Thursday at $220.48. The yield was 1.32%.

These are great companies. I'm not suggesting anyone should sell these stocks. However, I will soon be 68. Even though growth is still important to me, my focus has gravitated toward current income.

Tilting toward dividends

I believe this is an unusual opportunity to secure some attractive yields from classic dividend-paying stocks. Stocks in the industrials sector have been particularly punished. As of October 26, 2018:

  • At $128.72, Cummins yields 3.54% and is 34% off its 52-week high of $194.18;
  • At $124.06, Illinois Tool Works yields 3.22% and is 31% off its 52-week high of $179.07;
  • At $184.86, 3M yields 2.94% and is 29% off its 52-week high of $259.77;
  • At $105.29, United Parcel Service yields 3.46% and is 22% off its 52-week high of $135.53; and
  • At $72.02, Eaton yields 3.67% and is 20% off its 52-week high of $89.85.

For many months, MMM was my only industrial company. I've used recent weakness to include a full complement of industrial stocks in the portfolio.

There are some other unusual opportunities that seem to be worthy of study. The following portfolio companies are at least 20% off their 52-week highs:

  • At $80.79, AbbVie yields 4.75% and is 36% off its 52-week high of $125.86;
  • At $386.69, BlackRock yields 3.24% and is 35% off its 52-week high of $594.52;
  • At $15.39, Manulife Financial yields 4.36% and is 31% off its 52-week high of $22.16;
  • At $124.78, International Business Machines yields 5.03% and is 27% off its 52-week high of $171.13;
  • At $29.09, AT&T (T) yields 6.88% and is 26% off its 52-week high of $39.33;
  • At $90.52, Texas Instruments yields 3.40% and is 25% off its 52-week high of $120.75;
  • At $31.27, Enbridge Inc. yields 6.54% and is 24% off its 52-week high of $41.21;
  • At $23.86, Canadian Utilities yields 5.07% and is 23% off its 52-week high of $30.82;
  • At $29.97, PPL Corp. (NYSE:PPL) yields 5.47% and is 22% off its 52-week high of $38.17;
  • At $37.60, Brookfield Infrastructure Partners yields 5.00% and is 20% off its 52-week high of $46.88;
  • At $39.41, BCE Inc. (BCE) yields 5.85% and is 20% off its 52-week high of $49.06;
  • At $53.47, Bank of Nova Scotia yields 4.85% and is 20% off its 52-week high of $66.78; and
  • At $16.22, Apple Hospitality REIT (APLE) yields 7.40% and is 20% off its 52-week high of $20.19.

Shifting toward a "buy only" strategy

In the past, I identified a target price for adding some shares and a target price for trimming some shares. There have been times that I bought some lower-yielding growth stocks thinking that if the yields moved significantly lower I might sell them before I began making withdrawals from the portfolio.

After closing the four positions described above, I realized there were no other positions in the portfolio that I saw as candidates to trim or close.

So, I deleted the "Trim" column on my spreadsheet. I'm not saying that I will never again trim or close a position, but my mindset has shifted and the spreadsheet now reflects this change. Now the spreadsheet contains only an "Add" column and no "Trim" column.

I use Custom Stock Alerts to receive notifications when a stock's price is near the target price.

Re-thinking the watchlist

As I prepare for the distribution phase, I approach my watchlist from a different perspective. When I closed the AAPL, MSFT, ADP and WMT positions, I put each of them on the watchlist, hoping that at some point in the future their yield would compete again with the stocks that are currently in the portfolio. I believe sector rotations will continue. There will be selloffs, corrections and bear markets. I would be happy to own shares of these great companies in the future.

I now approach the watchlist as a "farm-team" model. Just as a major league baseball team calls up players from its farm system as needed, I will maintain a list of stocks to watch for possible inclusion in the portfolio. I'll update the watchlist with the Q4 portfolio review.

Conclusion

As of October 26, 2018, the portfolio yield is 4.55% and the cash position is 5.57%. Here's the sector breakdown:

Sector % Market Value % Income Yield
Information Technology 8.96% 7.66% 3.91%
Financials 12.49% 11.77% 4.32%
Real Estate 15.96% 19.14% 5.49%
Health Care 6.54% 5.00% 3.50%
Consumer Discretionary 2.26% 1.68% 3.40%
Consumer Staples 7.41% 5.61% 3.31%
Industrials 11.78% 8.63% 4.18%
Energy 9.23% 11.50% 5.25%
Utilities 10.86% 12.62% 5.32%
Communication Services 4.64% 6.40% 6.32%
Materials None None None
Closed End Funds 4.32% 8.78% 9.31%
Cash 5.57% 1.21% 0.99%

In January, I'll provide a complete quarterly and year-end portfolio review.

I'm not advocating the purchase or sale of any security. My articles generally offer ideas for stocks to study. These articles form a journal of my effort to design and maintain a retirement income portfolio with a relatively safe stream of growing dividends. I seek companies with histories of rising dividends, strong financials and solid future prospects. Your goals and risk tolerance may differ, so please do your own due diligence.

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Disclosure: I am/we are long JNJ, XOM, PFE, PG, MMM, BLK, CSCO, RY, TD, TM, PEP, ITW, IBM, TXN, CMI, UPS, BNS, RDS.B, KMB, QCOM, SPG, MFC, CDUAF, FTS, PPL, WEC, ETN, ABBV, NNN, O, SKT, ENB, EPD, BIP, BEP, VTR, BCE, T, WPC, MAIN, APLE, ADX, ECF, IFN, RMT, RVT.

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.