A Real Dividend Growth Machine: 2018 Portfolio Review

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Includes: BLK, FDX, GD, GILD, GNTX, MO, TROW
by: Dividend Growth Machine
Summary

Annual review of results from a real dividend growth stock portfolio.

Discussion of portfolio changes in the fourth quarter of 2018.

Example of how a dividend growth investor manages his portfolio.

Bonus feature: Projected versus actual dividend income.

Introduction

The purpose of this article is to review my investing progress in 2018, which was my seventh full year as a dividend growth investor. I follow a value-oriented dividend growth investing strategy that involves buying attractively valued stocks of companies that consistently pay and grow their dividends. My investing strategy is guided by two overarching goals:

  1. Build a sustainable and rising dividend income stream that beats inflation. I seek to achieve this goal by maintaining a diversified portfolio of dividend growth stocks (my dividend growth machine).
  2. Preserve and grow my capital by attaining a satisfactory total return on my investments. I seek to achieve this goal by purchasing the stocks of high-quality companies at attractive valuations for my dividend growth machine.

I pursue these goals in order to be financially secure when I eventually retire. I am a 37-year-old professor at an early stage of my career (I am currently going up for tenure). I plan to work for several more years, in part because I think there are additional contributions that I can make to science and education. However, I also want to position myself for the possibility of early retirement, and that is why I am a long-term dividend growth investor.

In this article, I will provide an update on my progress toward achieving my goals since my last review, highlighting events that occurred in the fourth quarter of 2018. As always, I will be presenting real results from a real portfolio involving real money.

Input To The Machine

New capital represents the input to my dividend growth machine and allows me to buy stocks. The figure below shows quarterly contributions of new capital to my investment accounts since 2012:

New capital

I contributed $9,000 in new capital in Q4, resulting in a year-end total of $31,000. The total exceeds my goal of $25,000 and represents a sizable increase over the totals in 2017 ($25,000) and 2016 ($18,500). I was able to contribute a substantial amount of new capital to my portfolio because of a high savings rate (over 50% of the after-tax income from my job), made possible by a relatively frugal lifestyle and no major unexpected expenses in 2018. To stay conservative, my goal is to contribute at least $25,000 in new capital in 2019.

Parts Of The Machine

Dividend growth stocks represent the parts of my dividend growth machine. The table below shows the composition of my portfolio at the start and the end of Q4 2018, with various changes highlighted.

Portfolio table

A breakdown of all transactions in 2018 is provided in the following table:

Transaction table

Here is an overview of the transactions that occurred in Q4:

  • I aggressively increased my position in Altria (MO), a tobacco company that does business in the United States. The decline in its stock price below $60 in Q4 made it an increasingly attractive candidate for additional investment. Considering that its core business is in systemic decline, I like the fact that management is willing to take reasonable risks to establish a foundation for future growth, as reflected by recent investments in cannabinoid company Cronos Group (OTC:CRON) and e-vapor product company JUUL Labs. The additional debt on the balance sheet is something to keep an eye on. I made four purchases (95 shares in total) of MO in Q4. With the stock now trading below $50, it remains a candidate for new money.
  • I increased my position in BlackRock (BLK), a financial company that provides investment management and advisory services for retail and institutional clients. It is a well-run company with a wide economic moat that will benefit from a trend toward passive investing products, such as its iShares exchange-traded funds. BlackRock just announced a 5.4% dividend increase on January 16, 2019, making it a Dividend Contender with a 10-year dividend growth streak. I think the stock is attractively valued at recent prices, which is why I made three purchases (10 shares in total) of BLK in Q4.
  • I added to my position in T. Rowe Price (TROW), which is similar to BlackRock in that it provides investment management and advisory services. It is a Dividend Champion with a 32-year dividend growth streak. The recent downturn in its stock price, despite decent operating results, provided an opportunity to make two purchases (25 shares in total) of TROW at an attractive valuation.
  • I increased my position in Gentex (GNTX), a midcap company in the automotive industry that is known for its auto-dimming rearview mirrors. It is a Dividend Challenger with an 8-year dividend growth streak. The last time I purchased GNTX was back in Q2 2016, when I started my position. The company continues to do well, which is why I took advantage of the drop in its stock price below $20 in Q4 and made a single purchase (55 shares) of GNTX.
  • I added to my position in FedEx (FDX), a transportation company that provides domestic and international shipping services for packages and freight. It is a Dividend Contender with a 17-year dividend growth streak. The stock appeared to be fairly valued at the time of my purchase in October, but the December earnings report and guidance cut suggest that it might have been overvalued. Mr. Market reappraised the stock sharply downward, to the extent that I now think the stock is undervalued and a more attractive candidate for new money. I made a single purchase (10 shares) of FDX in Q4.
  • For my final purchase of 2018, I increased my position in General Dynamics (GD), an aerospace and defense company that I have owned since 2012. It is a Dividend Contender with a 21-year dividend growth streak. General Dynamics continues to be a well-run company with good long-term prospects. I had been waiting for an opportunity to add to my position at a reasonable valuation and I got my chance during the sell-off in Q4 that dragged down all defense stocks. I made a single purchase (10 shares) of GD.

As longtime readers know, I am a buy-and-hold investor who rarely sells stocks. For example, I did not sell anything in 2017. I did make one sale in 2018:

  • I sold about 1/4 of my position in Gilead Sciences (GILD), a biotech company known for its HIV and HCV treatments. A few years ago, I built up a relatively large position in GILD because the stock seemed undervalued and it was evolving into a dividend growth stock (it now has a 4-year dividend growth streak). I anticipated that there might be continued pressure on the stock because of declining HCV revenues (a consequence of curing a disease), and I was okay with patiently waiting for stabilization of operating results and improved prospects for future growth. That is still the case – which is why I am still a GILD shareholder – but I decided to sell part of my position (60 shares) in GILD for a combination of four reasons:
  1. Recent management changes (notably, CEO and Chief Scientific Officer) created new uncertainty about the direction of the company going forward. Note that my sale occurred before GILD hired its new CEO, Daniel O'Day, who is currently the CEO of Roche Pharmaceuticals, a division of Roche (OTCQX:RHHBY). He starts his new position in March 2019 and it will be interesting to see whether he makes any major changes to the company.
  2. Near-term (2-3 year) prospects for future growth outside of the HIV business remain cloudy. There are some promising treatments in development for liver diseases and cancer, but many potential products in the pipeline still have years to go before they could reach the market (if they do at all). I prefer to see more clarity in a biotech company’s pipeline.
  3. My large position in GILD (prior to the sale) made it the largest dividend payer in my portfolio. Considering its higher risk profile compared with most of my other stocks, it seemed unwise to maintain that status. Following the sale, GILD became my 9th largest dividend payer at the end of 2018.
  4. Because my oldest shares of GILD also had the highest cost basis, the sale (using FIFO accounting) resulted in a modest capital loss in my taxable account that I can declare when I file my 2018 tax return. I have done a bit of tax-loss harvesting in the past – for example, when I sold out of Kinder Morgan (KMI) a few years ago – but it is not something that I do on a regular basis.

In summary, I made 12 purchases (6 different stocks) and one sale during Q4, keeping with my desire to have low portfolio turnover. Transaction fees averaged just 0.09% of my total costs in 2018, a result of planning my transaction sizes and having some commission-free transactions. Note that this number is not equivalent to an expense ratio of a mutual fund or exchange-traded fund because it ignores my existing investments that have no recurring or maintenance costs. An approximate “expense ratio” for my portfolio can be calculated by dividing my transaction fees by my portfolio value (analogous to “assets under management”), which gives 0.012%.

Besides adding or removing parts from my machine, I want to make sure all the parts are running smoothly. I monitor the operating results of my companies and stay on the lookout for dividend increases (or decreases). The figure below summarizes the dividend changes that took effect in 2018:

Dividend changes in 2018

Dividends increased for 44 of the 46 stocks in my portfolio. The mean and median increases were 11.7% and 8.8%, respectively, both well above inflation. These summary statistics were helped by several very generous dividend increases (over 20%), including a 50% increase by AbbVie (ABBV) and a 41% increase by Ross Stores (ROST). There were two companies in my portfolio, CVS Health (CVS) and General Mills (GIS), that held their dividends constant in 2018, but these freezes were signaled by management and seem prudent while each company digests recent acquisitions and reduces debt. I do not have a rule about selling a stock with a frozen dividend, which is why I continue to hold both stocks. Overall, I am satisfied with the dividend growth that occurred among the stocks in my portfolio. I anticipate that dividend growth will be good in 2019, but not as high as it was in 2018.

Output Of The Machine

Dividends and capital gains represent the output of my dividend growth machine, all of which is selectively reinvested when sufficient funds are available. The figure below shows the dividends I have received.

Dividends received

I received $2,318 in dividends in Q4, which resulted in a total of $9,483 in 2018. This represents a 26.5% increase over the total of $7,496 in 2017. The increase is due to a combination of organic dividend growth, selective dividend reinvestment, and new capital investment. At the end of Q4 2018, my forward 12-month dividend total was $10,476, moving me past the symbolic milestone of $10,000.

The figure below shows end-of-month portfolio values and the cumulative amount of new capital added since the start of 2012.

Portfolio value and cumulative new capital

My portfolio held up fairly well amid the volatility in the stock market in 2018 (especially in Q4), reaching $373,373 at the end of the year. This represents a 6.5% increase over my portfolio’s value at the start of 2018, but that number is misleading because it reflects new capital investment offsetting declines in stock prices. My annualized total return in 2018 (not counting new capital as investment gains) was -2.2%. It is not a preferred outcome – recall that my secondary investment goal is to preserve and grow my capital – but occasional losing years are to be expected over a multi-year time period of investing. By comparison, the S&P 500 index had a total return of -4.4% in 2018.

For completeness, I will also summarize the investments outside of my dividend growth machine. I participate in retirement plans with my employer, for which I have allocated 100% of contributions to the Vanguard Institutional Index Fund (VINIX). The fund tracks the S&P 500 index and has an expense ratio of 0.04%. The combined value of the plans was $82,081 at the end of 2018. I also have a Health Savings Account to which I contribute each year and it ended 2018 with a value of $16,983. Thus, if you add up the values of all my investment accounts, the year-end total was $472,437.

Outlook For 2019

I am beginning my eighth year as a dividend growth investor in 2019. It will be “investing as usual” and I do not expect any major changes to my strategy or portfolio. If there is market volatility similar to what transpired in Q4 2018, then I will be on the lookout for dips in the stock prices of high-quality companies that pay growing dividends. More generally, I will continue monitoring the operating results of my companies, researching new candidates for my portfolio, and making occasional stock purchases throughout the year.

Bonus Feature: Projected Versus Actual Dividend Income

At the start of 2014 – my third year of dividend growth investing – I was still settling into a new job that I started in August 2013. I was making considerably more money as an assistant professor than when I was a postdoctoral researcher (or a graduate student before that), which meant I had more new capital available to fuel my dividend growth machine. This change in my financial situation motivated me to explore some calculations for projecting my future dividend income over a multi-year period. In other words, how much dividend income could I expect to receive in 5 years? 10 years? 25 years? This is important because my primary investing goal is to build a sustainable and rising dividend income stream.

My projection was based on the following set of parameters and assumptions:

  • Initial portfolio value of $133,333 and initial dividend yield of 3.0%; both numbers were very close to my portfolio’s actual value and dividend yield at the end of 2013.
  • New capital investment of $20,400 per year ($1,700 per month). This seemed reasonable and somewhat conservative, considering that I averaged $18,633 annually in 2012 and 2013, but I would be earning a higher salary going forward.
  • Reinvestment of all dividends after subtracting 15% for taxes. Even though a sizable chunk of my dividend income is received in my Roth IRA, where it is not subject to taxation, I chose to tax all dividends to have a more conservative projection.
  • Dividend yield of 3.0% (on average) for new purchases, which seemed doable.
  • Annual capital appreciation and dividend growth rates of 7.2%, which seemed reasonable based on long-term historical trends and would lead to a doubling of portfolio value and dividends every 10 years. I assumed that earnings growth would drive both capital appreciation and dividend growth, and would do so at about the same rate.

(Side note: I have seen dividend income projections in some articles and books on dividend growth investing that neglected to address the last two points, making the projections unrealistic. For example, an author would assume steady dividend growth for 20 years but no capital appreciation, resulting in stocks being purchased at ridiculously high yields in later years, grossly inflating the projected dividend income.)

I calculated the projection for 25+ years and the results in the figures below reflect the parameters and assumptions described above. Note that I neither altered nor updated the projection based on anything that happened during the past 5 years – what you see is what I calculated back in January 2014.

The first figure below shows the projection (orange line) for my first 10 years of dividend growth investing. The dividends I actually received from 2012 to 2018 (green line) are shown for comparison. Overall, my actual results matched or exceeded the projection, suggesting that my parameters and assumptions were indeed reasonable and somewhat conservative. According to the projection, I will reach an annual dividend total of $10,000 in 2019. As noted earlier, my forward 12-month dividend total at the end of 2018 was $10,476, indicating I am on track to hit that projected milestone.

10-year dividend projection

One of the things you might have noticed about the preceding figure is that the projection seems almost linear. This seems incongruent with demonstrations of the compound growth that arises from long-term dividend growth and reinvestment, as I illustrated in an article on the topic back in 2012. However, “long term” is very important in this context, and 10 years is not a lot of time for compound growth to become readily apparent.

The second figure below “zooms out” and shows the projection for my first 25 years of dividend growth investing. The first 10 years of the projection are identical to what was displayed in the first figure, except on a different scale (compare the y-axes of the figures). Nonlinear growth is now more apparent when looking at a 25-year time period.

25-year dividend projection

The projection suggests I will exceed annual dividend totals of $20,000 in 2025, $30,000 in 2028, $40,000 in 2031, and $50,000 in 2033. That looks pretty encouraging!

However, it is important to bear in mind that it is just a projection. I calculated it out of curiosity, to give me some sense of where my dividend growth investing journey might take me in the distant future. Even though my actual results match or exceed the projection for the early part of the curve, there could be substantial deviations later on – a lot can happen in 25 years! Moreover, the assumptions I made back in 2014 could be updated. For example, I assumed new capital investment of $20,400 per year, but I have easily exceeded that in the past two years and I will likely continue to do so. That said, I think the projection represents a neat little exercise and provides points of comparison for tracking the long-term progress of my dividend growth investing efforts. For that reason, I might include it (or some variation of it) in subsequent annual reviews.

Until my next review, thank you for reading and good luck with your investing!

Disclosure: I am/we are long ALL STOCKS IN PORTFOLIO TABLE. 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.