DGI For The DIY: 2018 Portfolio Review

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Includes: AAPL, ABBV, ABT, AMGN, AVGO, BDX, CBRL, D, DLR, EOG, FLO, GIS, HD, HRL, IBM, LOW, MA, MKC, MO, NKE, O, OHI, OXY, PAYX, ROST, SKT, T, TGT, THO, TXN, UNH, UPS, V, WEC, WSO, XOM
by: Eric Landis
Summary

The market had a disappointing finish to 2018, as a bad fourth quarter brought the indices into negative territory for the year.

My portfolio value also fell during the year, but dividend income increased by 14.3%, above my targeted goal.

Despite an uncertain market, I remain well on track to meet my income growth goals once again in 2019.

Sun Dog

Project Background

The DGI For The DIY portfolio was created in 2013 when I liquidated the mutual funds in my retirement account and used the proceeds to create a new portfolio of dividend growth stocks. I've been writing quarterly updates to the portfolio ever since, documenting the portfolio's progress and my lessons learned as a Do-It-Yourself investor.

I am a forty-year-old engineer, married, with three young children. I share my personal story in an attempt to inspire others to take control of their finances and plan for their future. I've also found that writing these updates keeps me focused on the goal ahead, which is securing a growing income stream to help fund my future retirement. Knowing that I'll be documenting everything for others to see helps me to stay on the right path and keeps me disciplined in the process.

Portfolio Guidelines

As my investing approach has evolved, I've established guidelines that help meet my goal of building a portfolio that produces a consistent and reliably increasing stream of dividend income.

  1. Buy companies that consistently show positive growth in earnings and translate those earnings into increasing dividend payouts to shareholders.
  2. Focus on companies that are investment grade, with S&P credit ratings of BBB or higher.
  3. Maintain a diversified portfolio spread across multiple industries.
  4. Reinvest all dividends back into the companies that pay them.
  5. Consider for sale any company that cuts or freezes its dividend.

As mentioned, the purpose of this portfolio is to fund a portion of my future retirement. Being forty years old, I have another roughly twenty-five years to reach that milestone.

Before I switched to dividend growth investing, the question was: How big of a nest egg do I need for retirement? Now my focus has instead shifted to: How much income do I need at retirement?

Changing the perspective from portfolio size to portfolio income has been helpful because it gives me an easier way to benchmark my goals. Rather than focusing on the daily swings in portfolio value, I can instead concentrate on the steadily increasing dividend income that it provides. Not only is income easier to plan for, but it is also less volatile, making the recent market volatility much easier to stomach.

I switched to dividend growth investing back in 2013, but it was in the end of 2017 that I also established a goal of 10% annual income growth for the portfolio. I finished that year with $2,005 in dividend income, and figured that with a 10% annual income growth rate, this portfolio would produce over $26,000 in dividend income in 2044, the year I turn sixty-six years old.

DGI For The DIY - Dividend Scorecard

With 2018 now complete, I'm able to fill in the actual income column to show $2,299 for the year. This is $99 above my targeted goal, and a 14.6% increase over 2017's income of $2,005. This income growth came from organic dividend growth and reinvestment of dividends, as there are no longer any cash contributions being made into this account.

It's great seeing progress being made, and that I'm beating the pace set for the portfolio. It's especially reassuring to see this when considering the market's performance in recent months, as a big correction has caused the overall value of the portfolio to fall.

Market Overview

The markets were awful during Q4, as the promising gains seen up to the end of September were all wiped out and all major indices finished the year in the red. The fall of the Nasdaq Composite was most impressive, as the once 16%+ gains were turned into a 3.88% loss for the year.

Chart ^IXIC data by YCharts

My portfolio also finished the year in the red, as the total portfolio value dropped from $72,038 to $69,009, a loss of 4.2%. This slightly lagged the Nasdaq, but did manage to finish ahead of the Dow and S&P.

DGI For The DIY - Portfolio Progress

Income also dipped slightly in the fourth quarter, just as it's done the last few years. This is due to variable payments from two companies: Digital Realty Trust (DLR) and Cracker Barrel (CBRL). Digital Realty makes its Q4 dividend payment in January rather than in December, while Cracker Barrel pays out a special dividend in Q3 that isn't repeated in Q4. While this creates a bit of lumpiness in my income, it isn't anything that I need to worry about as long as the trend of growing annual income stays intact.

Dividend Income Progress

Dividend income dipped slightly from Q3 to Q4, but I'm not concerned about short-term fluctuations - my focus is on the long term. For the year, dividend income increased by 14.63%, which far outpaces the 10% goal set for the portfolio.

DGI For The DIY - Dividend Progress

However, there was a slowing of YOY growth over the course of the year as the impact of the ending of cash contributions to the portfolio started to take effect. Q4 2017 was the last one that saw new cash come into the portfolio to buy new positions, so the last of those purchases have now worked their way through and will no longer impact the YOY numbers.

Going forward, income growth in the portfolio will come mostly though organic dividend increases from the companies I own and through dividend reinvestment purchasing additional shares. With a current portfolio yield of over 3%, I'll need an average 7% of organic dividend growth to meet my income growth goals.

The fourth quarter was another good one for dividend increases, as there were fifteen announcements made during the period.

Announce Date Company Ticker Previous Payout Rate New Payout Rate Sequential Increase Year Ago Payout Rate YoY Increase Dividend Yield Link
10/11/2018 Thor Industries, Inc. (THO) $0.3700 $0.3900 5.41% $0.3700 5.41% 2.41% LINK
10/17/2018 Visa Inc. Class A (V) $0.2100 $0.2500 19.05% $0.2100 19.05% 0.73% LINK
10/25/2018 Watsco Inc. (WSO) $1.4500 $1.6000 10.34% $1.4500 10.34% 4.42% LINK
11/2/2018 AbbVie Inc. (ABBV) $0.9600 $1.0700 11.46% $0.7100 50.70% 4.98% LINK
11/15/2018 Nike Inc. (NKE) $0.2000 $0.2200 10.00% $0.2000 10.00% 1.09% LINK
11/18/2018 Becton, Dickinson and Co. (BDX) $0.7500 $0.7700 2.67% $0.7500 2.67% 1.28% LINK
11/19/2018 Hormel Foods Corp. (HRL) $0.1875 $0.2100 12.00% $0.1875 12.00% 2.02% LINK
11/27/2018 MCCORMICK & CO. /SH NV (MKC) $0.5200 $0.5700 9.62% $0.5200 9.62% 1.83% LINK
12/4/2018 Mastercard Inc. (MA) $0.2500 $0.3300 32.00% $0.2500 32.00% 0.66% LINK
12/7/2018 WEC Energy Group Inc. (WEC) $0.5525 $0.5900 6.79% $0.5525 6.79% 3.27% LINK
12/7/2018 Amgen, Inc. (AMGN) $1.3200 $1.4500 9.85% $1.3200 9.85% 2.89% LINK
12/7/2018 Realty Income Corp. (O) $0.2205 $0.2210 0.23% $0.2125 4.00% 4.13% LINK
12/14/2018 AT&T Inc. (T) $0.5000 $0.5100 2.00% $0.5000 2.00% 6.67% LINK
12/14/2018 Dominion Energy Inc. (D) $0.8350 $0.9175 9.88% $0.8350 9.88% 5.31% LINK
12/14/2018 Abbott Laboratories (ABT) $0.2800 $0.3200 14.29% $0.2800 14.29% 1.81% LINK
Average: 10.37% 13.24% 2.90%

The average incremental increase with those announcements was 10.37% and the YOY increase was 13.24%. I'm quite happy with those numbers, especially when considering how the small increases from Becton, Dickinson & Co., Realty Income, and AT&T brought down the average. AbbVie and Mastercard were the All-Stars, as they produced YOY increases of 50.7% and 32.0%, respectively.

2018 was a very good year for dividend increase announcements, as companies generally used the lowered corporate tax rates as a way to increase payouts to shareholders. I'm not quite as optimistic about increases in 2019, but still think the portfolio is in line to reach my income growth goal.

Portfolio Holdings

This is how the portfolio looked as of the end of 2018:

DGI For The DIY - Portfolio1 DGI For The DIY - Portfolio2

The portfolio value of $69,009 is an 11% decrease from Q3. The decrease was driven by big drops from some of my larger positions, including Apple Inc. (AAPL), Altria Group (MO), EOG Resources (EOG), Exxon Mobil Corp. (XOM), IBM Corp. (IBM), Occidental Petroleum (OXY), and Target (TGT).

Chart AAPL data by YCharts

I'm actually a bit surprised the portfolio held up as well as it did considering those large drops. A big reason was the performance of Realty Income and Omega Healthcare Investors (OHI), which both saw decent gains and are now the third- and fourth-largest positions in the portfolio as a result.

Chart O data by YCharts

I think this a good example of the virtues of having a diversified portfolio. When some of your horses are having a rough go of it, it's nice having others in the stable that can pull the weight.

Portfolio Weightings

Here is a snapshot of the portfolio's sector weightings at year end:

Portfolio Weighting

The portfolio is overweight real estate and consumer staples, as they account for ~36% of the portfolio's income and ~28% of the portfolio's value. The real estate stocks actually increased in weighting since last quarter, mostly due to the gains from Omega Health and Realty income.

I do wonder if it's time to take some profits on Omega Health, as it is now hitting 52-week highs. However, it still appears to be trading near fair value, and the company seems to be doing a good job of managing the tough operating environment for its business.

I'm generally one to let my winners run, but I do struggle a bit with the fact that REITs are three of my top four positions. My only concern with selling is the income I'd be giving up in doing so, as it would set me back on meeting the 10% income growth target.

I've considered cutting Tanger Factory Outlet Centers (SKT) loose and putting those funds into other sectors. While I think Tanger is a decent operator, it hasn't shown much in FFO growth in recent years, and with exposure to retail through Target Inc., Ross Stores (ROST), and other discretionary stocks, I may seek other opportunities for that capital.

My consumer staples weighting is a bit heavy, but that is distorted a bit, as CVS Health and Walgreens are classified as staples, yet have significant exposure to the health care sector. If I were to cut back my exposure to staples, it would probably be from either Flowers Foods (FLO) or General Mills (GIS). Both have lagging growth and are in industries (packaged and baked goods) that don't present much for growth opportunities. They've both seen growth slow considerably over the last 10- and 5-year periods, and have seen payout ratios expand, meaning slower dividend growth ahead.

On The Radar

Last quarter, I mentioned Broadcom (AVGO), Texas Instruments (TXN) and United Parcel Service (UPS) as three stocks I was watching. I have not purchased any of them yet, but thus far it looks like it would have been a good idea to do so. All three stocks are now higher in price, and I think are still attractive long-term holds for the portfolio.

Three other names I've been watching for are UnitedHealth Group Inc. (UNH), Home Depot, Inc. (HD) and Paychex Inc. (PAYX). All of them are companies with long track records of consistent growth, and have been strong dividend growers as well.

UnitedHealth would give me some more diversification away from pharmaceutical companies and give exposure to the top managed healthcare company in the U.S. The company consistently puts out double-digit EPS growth, and has put up ~20% annual dividend growth for the last several years. With a low payout ratio of just 26% of expected 2019 earnings, there looks to be plenty of room for future dividend growth ahead.

UNH FAST Graph

I already own Lowe's Companies, Inc. (LOW) in the portfolio, and I've long considered adding Home Depot Inc. as a complement to it. The company has put up nearly 19% annualized EPS growth over the last decade, with dividend growth to match.

Shares are trading below fair value for the first time in several years, and with another likely 20%+ dividend increase coming soon, this seems like a good opportunity to add shares.

HD FAST Graph

Paychex Inc. is another consistent performer that pays a 3%+ yield and provides high-single digit growth. It is a bit pricey at a nearly 25 P/E, but this isn't too far out of line with its recent history. With interest rates rising and employment rates low, this payroll and human resources management company should continue to do well.

PAYX FAST Graph

Closing Thoughts

I'm finding out that not having any cash coming into the account anymore is making it a bit more difficult to just stand pat and not tinker with things. Especially with the recent correction, it's been awfully tempting at times to sell out of positions that are showing paper losses to move on to other ideas.

I'm trying to be as patient as possible with what I do own, and want to keep the number of transactions low to keep from paying too much in commissions. Also, what I've been doing is working, as I'm more than meeting my income growth goals and have also produced similar total return results to the indices over the last year.

While I do have some concerns about a few companies I own, I'm quite happy with how the portfolio is performing overall, and expect to beat my income growth targets again in 2019.

I hope this update finds you well, and wish you the best in the new year!

Disclosure: I am/we are long AAPL, ABBV, ABT, AMGN, AMP, AWK, BDX, CBRL, CHD, CLDT, CMI, CVS, CVX, D, DLR, EOG, FLO, GILD, GIS, IBM, JNJ, KMI, KO, LMT, LOW, MA, MCD, MMM, MO, MSFT, NEE, NKE, NSC, O, OHI, OXY, PII, PM, QCOM, ROST, SBUX, SKT, STAG, T, TGT, THO, UNP, V, WBA, WEC, WFC, WSO, XOM. 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.

Additional disclosure: I am an engineer by trade and am not a professional investment adviser or financial analyst. This article is not an endorsement for the stocks mentioned. Please perform your own due diligence before you decide to trade any securities or other products.