The Passive DGI Core Portfolio: The Year-End Review

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

A DGI strategy provides almost everything that most retirees would need: Decent income, relative safety, and reasonable growth.

The Passive DGI Portfolio is over four years old. We will provide the year-end review.

Our DGI portfolio actually ended positive for 2018, while the S&P 500 was down -4.57% for the year.

We will provide updates on changes, additional investments, dividends collected and overall 2018 performance.

Obviously, the year 2018 was pretty bad for stocks, especially in the last quarter. The broader market as represented by the S&P 500 ended the year down by -4.57%, dividends included. Eight out of the total 11 sectors of the economy ended negative for the year. However, here's a cause for little celebration. Our Passive DGI portfolio not only beat the S&P 500 in 2018 by about 5 percentage points but ended slightly positive for the year. Sure, one year is too short to make any conclusions (portfolio itself is four-years-old), but it does demonstrate that in turbulent times this portfolio will not only continue to provide nice dividends but also will provide some element of capital preservation.

Portfolio value on 12/30/2017:

$198,470

Contribution in Feb. 2018:

$30,000

Total effective value:

$228,470

Portfolio value as on 12/31/2018:

$230,428

Portfolio gain/loss % in 2018:

+0.86%

Gain/loss % for S&P500 (SPY) in 2018:

(Returns are inclusive of dividends)

-4.57%

Here is the month-wise performance of the Passive DGI portfolio during 2018:

A DGI Portfolio: What is it?

DGI 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, you could re-invest (drip) the dividends, which would result in more shares and higher future income. With each passing year, this growth of dividend-income becomes bigger and bigger. We should mix high-yielding, slower-growth companies with low-yielding fast growing ones. We also should diversify among various sectors and industries. 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.

Sure, there's a drawback with this strategy that it cannot provide a very high level of income, so one would need a sizable amount of savings to generate the required amount of dividend income that one could live off comfortably.

It may be worth reiterating why we believe in the DGI strategy and consider it as the “core” portfolio. A well thought-out DGI strategy would outperform the broader market over the long term. It also will offer less volatility and smaller drawdowns during recessions and bear markets. It was proven during the 2008-2009 recession as well when the drawdowns of most DGI portfolios were one-third less than that of the S&P 500. Also, a significant stream of dividend income would make it little easier to wait out any downturn. Another big advantage of a DGI portfolio is that it requires little work after the initial set up. The best part is that it's a far superior strategy to draw 4% inflation-adjusted income (on the invested capital) compared to index investing since it lets you do this without ever selling the shares.

For several years, the valuations of most DGI stocks were stretched. Only recently (in 2018), the valuations started coming down, and many good stocks are trading 20% (or more) below their 52-week highs. Especially, the market downturn in December 2018 offered an excellent window to add to DGI stocks.

The Passive DGI Core Portfolio: Background

We launched this DGI portfolio slightly over four years ago in August 2014. We wanted to create a well-diversified portfolio with mostly blue-chip companies which had 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. Many times there's no action in this portfolio for months.

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. Reinvest the dividends for the first 5-10 years or more (depends on personal situation) to grow the yield on cost (YOC). Thereafter, reap the benefits!

This is what we have done so far:

  • $1,000 invested on August 1, 2014, in each of 30 original stocks, total $30,000.
  • $1,000 invested on November 3, 2014, the first trading day of November 2014, in each of 30 stocks, total $30,000.
  • Starting February 2015, every year on the first day of trading in February, we invested $1,000 in each of the 30 stocks (total $30,000 each year). 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.

Over the years, we added a few additional stocks. Below is the current list of 38 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 Company (MMM)

Illinois Tool Works Inc. (ITW)

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 36 securities at that time. We did not add new money to DWX, HCP, QCOM, T, TEVA, WMT, and XOM.

Additional Buy/Sell during the Year 2018:

Company

Date

Buy/Sell

Shares

Share price

Amount

T

4/30/2018

Buy

31

32.70

$1,013.70

DEA

6/25/2018

Buy

51

19.40

$989.40

**MON

6/7/2018

**Sell

55.71

127.99

$7,130.87

T

7/20/2018

Buy

64

31.2

$1,996.80

MMM

7/25/2018

Buy

9

200.63

$1,805.67

DEA

10/29/2018

Buy

110

18.2

$2,002.00

VLO

11/19/2018

Buy

24

80.69

$1,936.56

T

11/20/2018

Buy

67

29.42

$1,971.14

DEA

12/26/2018

Buy

66

15.2

$1,003.20

VLO

12/26/2018

Buy

15

68.9

$1,033.50

XOM

12/26/2018

Buy

15

64.9

$973.50

ITW

12/26/2018

Buy

9

118.1

$1,062.90

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

Dividends:

Note: Starting April 2017, we made a change with regard to the dividend reinvestment policy. We stopped reinvesting 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

$6,622

Total dividends since inception

$19,244

Current Yield: (6,622/230,428)

2.87%

Yield On Cost [YOC] (6,622/180,000)

3.68%

Dividend Cuts or Freezes in 2016/2017/2018

In 2017, CVS froze its dividend at $0.50 per share due to its pending acquisition of Aetna Inc. (NYSE: AET). The acquisition was completed in 2018. 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

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

Dividend Increases Declared In 2018

2017 summary:

Out of 35 individual stocks in 2017, dividends were increased by 30 companies, kept the same by 4 companies, and cut by one.

2018 summary:

One company Teva pays no dividend currently. Two companies (CVS, HCP) have their dividends frozen currently. Another position DWX is an ETF that pays a variable dividend.

Out of remaining 34 companies, 33 have announced dividend increases in 2018. The average increase has been roughly 8.8%, which is nothing to complain about. Even when we count all of the 38 positions, the average comes to roughly 7.6%.

The rows highlighted in "red," have yet to announce a dividend hike in 2018. The rows highlighted in “gray” have frozen the dividend payments.

Portfolio Positions, Total Return and Relative Performance:

Here's a snapshot of relative performance as of 31 December 2018 created using the Morningstar Portfolio Tool. The DGI portfolio and Morningstar Market Index are represented by green and blue lines, respectively:

Note: Morningstar describes "Personal Return" as follows: The calculation of Personal Return illustrates how your allocation of capital has affected the performance of your portfolio.

Obviously, the year 2018 has been a bad year for the stock market, and as a result, most portfolios suffered. But when we compare our portfolio to the broader market, we don’t have much to complain about. The portfolio had an edge of about 5 percentage points in outperformance over the S&P 500. Also, we must keep in mind that this is a DGI portfolio and as such the goal is not to beat the S&P 500. The primary goal is sustainable and growing income that would beat inflation and then some. In fact, our average dividend raise in 2018 was nearly 8%, which handily beats inflation. DGI may underperform the market slightly during a bull market environment, but also will protect the capital during the times of crisis, while providing nearly 4% income.

Portfolio positions as of 12/31/2018:

The above image (Google-sheet) may be too small to read. Here's the image of the portfolio from excel:

In the above table, P/L columns do not account for the dividends that were not reinvested. Also, the total cost in row-41 represents the sum-total that was invested in the portfolio.

The Good, the Bad and the Ugly:

As of 12/31/2018, the portfolio has 38 positions, and when we include all of the dividends (the amounts that were not dripped), this is how they performed:

Gain/Loss %

Number of positions

Tickers

Positions > 100% gain

1

MSFT

Positions > 50% gain but <= 100%

6

MCD, WM, ABT, ADP, AFL, CSCO

Positions > 30% gain but <= 50%

7

CLX, INTC, O, WMT, LMT, MDT, PFE

Positions > 10% gain but <= 30%

9

JNJ, OHI, APD, PEP, PG, NSRGY, VTR, CVX, EMR

Positions > 0% gain but <= 10%

5

ITW, UTX, VLO, MO, DWX

Positions < 0% but >= -10% loss

7

XOM, WBA, CL, MMM, T, QCOM, DEA

Positions < -10% but >= -20% loss

2

CVS, HCP

Positions > - 20% loss

1

TEVA

Stocks That Are In Serious Negative Territory:

CVS:

Both CVS and Walgreens were hit hard first in early 2018 on the fears of Amazon's (NASDAQ:AMZN) entry into the pharmaceutical business. However, Amazon's threat was overhyped. These companies are giants in the retail pharmaceutical business, and they have plenty of time to be ready for the competition, assuming it arrives in a couple of years. CVS and WBA have huge advantages in terms of their expertise in the pharmaceutical business and having their retail pharmacy stores within five miles of 75% of the US population.

Moreover, CVS recently completed its acquisition of the health insurer Aetna. This will result in a vertically-integrated giant healthcare provider that insures people through Aetna, manages pharmaceuticals procurement through its Pharmacy Benefit Management business, sells drugs at its 9,500-plus drugstores and provides treatments at MinuteClinics.

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 (NYSE:QCP). This led to a dividend cut that was the first in its history of raising dividends for 40 years-plus. We sold out of QCP shares that were received due to the 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 -12%.

Teva

We still maintain a small position in TEVA, though it no longer provides any dividends. The position weight is almost insignificant and less than 0.50%. We have written enough about or reasoning why we still have this stock. Please see our past review here.

We know that there are always going to be a couple of stocks in your portfolio that are not going to pan out according to your expectations. That's why diversification is so important. But more importantly, this demonstrates that one or two bad choices are not going to have any meaningful impact on the overall portfolio.

Concluding Remarks

We personally follow a multi-basket strategy of which DGI is an important part and plays a 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 allocation model, we suggest investing 30%-50% of the investment assets into DGI. The rest can be allocated to other compelling strategies that provide us the strategic diversification. A multi-basket approach certainly requires more effort and may not be suitable 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.

It's a well-accepted notion that over a long period of time the dividend-paying companies provide a higher total-return compared to non-dividend-paying companies. 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.

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 - everyone should decide what is right for them based on his/her goals and risk tolerance. The other two portfolios are focused on high income and risk management and are suited for active investors.

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, BAC, UPS, WBA, CVS, LOW, AAPL, CSCO, IBM, 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.