Recently, a few of my Seeking Alpha followers (OK – three) have asked me to update my portfolio holdings for them. I have been answering them individually, but it occurs to me that it would be much more efficient to communicate to my followers and other interested parties with this article.
By way of introduction, I am a retired commercial loan officer who spent a 40-year banking career in the Philadelphia area. My wife Georgia and I retired 10 years ago to Maine, where we live near the woods with our Jack Russell terrorists Elva and Sophie. We have three wonderful children and four grandchildren who will someday have to resolve how they can all become President of the United States.
After numerous disappointments using various investment advisors, I became a self-taught dividend growth investor starting in 2012. Over the past 7 years, I have developed a quantitative model that uses thirteen financial metrics to screen and select stocks. The metrics that I use, and the weights that I assign to each, are as follows:
Dividend Yield and Growth:
- Current Dividend yield: 200
- 5-Year Projected yield: 130
- Share Buyback yield: 50
- Total: 380
- S&P Rating: 75
- Debt/EBITDA: 50
- Debt/Total Capital: 25
- Dividend Payout ratio: 150
- Yrs Consec Div Increase: 60
- 5-year growth CFO/share: 60
- Volatility: Return on Assets: 40
- Total: 460
- 3-5-10 year Total Return: 80
- Volatility: Total Return: 40
- Stock Price Recession Recovery: 40
- Total: 160
Please note that I weigh dividend protection more strongly than dividend yield. This protects me against reaching for yield, which is often very easy and very tempting to do.
A perfect model score is therefore 1000. I rank stocks for selection as follows:
- 750 and higher: Very Strong
- 700-749: Strong
- 650-699: Neutral
- 600-649: Weak
- 599 and below: Very Weak
Please notice that I do not use the terms “Buy,” “Hold,” or “Sell.” This is because stocks must also pass a qualitative screen in addition to my quantitative screen. The qualitative screen reviews the following issues:
- Economic moat and competitive strengths
- Product diversification and life cycle
- Customer and supplier concentration
- Industry trends
- Macroeconomic trends
- Management experience and tenure
In addition to these quantitative metrics and qualitative considerations, I also impose the following constraints:
- Company or fund must be at least 7 years old.
- Company or fund must have paid continuous dividends for the past 5 years.
- No dividend/distribution cuts since 2010 (excluding special dividends)
- Minimum dividend yield of 2.00%
- Minimum 5-year projected yield of 4.00%
- S&P investment grade rating (BBB- or higher) (not required for Preferreds)
Also note that I do not include the question of valuation in my model. I think the decision as to when to buy is wholly distinct and separate from the decision as to what to buy. I address valuation/price only after I have evaluated a stock’s worthiness as a long-term investment. These are two separate questions.
Some equity analysts would no doubt criticize my model as being focused on the past rather than the future. They would argue - and would be correct in theory - that the current value (stock price) of a company is equal to the discounted present value of future earnings. So in order to screen stocks for portfolio selection, it is necessary to make detailed income, balance sheet, and cash flow projections out into the future.
As a commercial loan officer, I reviewed hundreds of financial projections submitted by my clients over a 40-year career. Some were prepared by sole proprietors with little or no financial sophistication. Some were prepared by CFOs and involved extensive spreadsheet analysis. A few were even prepared by large national accounting firms and included detailed footnotes for all assumptions and - of course - lengthy disclaimers.
I can say with strong recall that some - a minority, but some - of these projections were fairly accurate for the first year or two. A much smaller number might be reasonably accurate for perhaps three or even as long as 5 years. But I cannot remember any projection, no matter how sophisticated its construction, that came anywhere near actual results after five or 6 years. Not a single one.
The reason is simple: There is simply too much going on out there. The interplay of countless interrelated micro and macroeconomic variables is so complex that, in my opinion, such fluctuations negate the viability of long-term projections.
Let me put this in a way that any banker or credit officer would understand:
I will be interested to learn what you think you may do.
I will be much more interested to learn what you have done.
The future is unknown and unknowable.
That is how and why I screen stocks the way I do.
Let me turn now to the details and construction of my current portfolio.
Regarding preferred stocks, I initially bought them only in closed end funds. I began buying individual issues 2 years ago and I have not yet developed a model to evaluate them. I rely on GAAP income coverage and CFO coverage of all preferred dividends (minimum 4X) and require also that a common dividend be paid and the ratio of common dividends/preferred dividends exceed 4/1. I again require the company to be 7 years old, but due to the higher ranking of preferred stocks, I do not require an investment grade rating. I look for solid balance sheets with good debt service coverage. I look for a minimum yield of 6.5% and minimum yield to call of 6.0%. I also look for call protection of at least 2 years if the price is above par.
My portfolio now produces a yield-on-cost of 6.6%, which I project will grow at an annual rate of about 2.2%. This cash flow comprises 60% of our total annual family income and, when combined with social security, a small pension, and an annuity, covers all of our living expenses and should increase enough each year to cover inflation. So as long as we stay on budget and inflation remains relatively tame, we are in a perfect defensive financial position.
This is what I define as being “100% organic,” and to me this is the pinnacle of investing. We should never have to liquidate securities to pay the bills. We sell securities because we want to, not because we have to.
Now I will readily admit that this is a delicate balance that could be upset by another severe economic or financial crisis or by a health or family emergency. And of course, this is not a “buy and hold forever” situation either. I review the portfolio with a formal “from the ground up” protocol twice a year and monitor market developments on a daily basis. So I am constantly weeding, watering, and replanting my investment garden to make sure my organic dividends stay strong and healthy!
For those who may be interested, the derivation and application of my model are explained in detail in my book “The Organic Dividend Portfolio,” available on Amazon. I am very pleased to have heard from various readers that my book has inspired them to become active portfolio managers and to take control of their financial future.
At present, my portfolio consists of 95 positions, such that no common or preferred stock constitutes more than 1.5% of the portfolio and no fund constitutes more than 3.0%.
I realize that this is a very large number of securities and I am sure that most investment advisors would recommend against such a number. But I am not investing with a primary focus on capital gains, where I aim to “buy low and sell high” with a relatively small number of carefully selected “conviction” holdings. I am investing for income, and as far as I am concerned, the greater the diversification, the smaller the impact of any one potential dividend cut will be (I have experienced only 3 cuts in the past 2 years). If I have the time and the inclination to follow these holdings – which I do – then this is yet another defensive strength of my overall position.
To review my current portfolio, let me begin with my asset class diversification:
- Equities/C corporations: 32%
- Preferred Stocks: 22%
- Closed End Funds: 12%
- Business Development Cos: 12%
- REITs: 12%
- MLPs: 6%
- Cash: 4%
- Total: 100%
My top holdings in each category are listed below, along with the model score:
- Amgen Inc. (AMGN) / 813
- Broadcom Inc. (AVGO) / 834
- Boeing Co. (BA) / 892
- Blackrock Inc. (BLK) / 800
- Cummins Inc. (CMI) / 827
- Cisco Systems (CSCO) / 848
- Eaton Corp. (ETN) / 839
- First American Financial (FAF) / 814
- Home Depot (HD) / 811
- Illinois Tool Works (ITW) / 814
- KLA-Tencor (KLAC) / 819
- Lyondellbasell NV (LYB) / 881
- Microsoft (MSFT) / 908
- Texas Instruments (TXN) / 826
- VF Corp. (VFC) / 813
- Williams-Sonoma (WSM) / 843
- Watsco Inc. (WSO) / 829
- AGNC Investment Corp. (AGNCN)
- Apollo Global Management (NYSE:APO.PB)
- Apollo Commercial Real Estate (NYSE:ARI.PC)
- Chimera Investment Corp. (NYSE:CIM.PA)
- Energy Transfer Partners (NYSE:ETP.PC)
- Golar LNG Partners LP (GMLPP)
- KKR & Co. Inc. (NYSE:KKR.PA)
- Lexington Realty Trust (NYSE:LXP.PC)
- MFA Financial Inc. (NYSE:MFA.PB)
- Annaly Capital Management (NYSE:NLY.PF)
- Sunstone Hotel Investors (NYSE:SHO.PE)
Closed End Funds:
- Adams Diversified Equity (ADX) / 791
- Eaton Vance Tax Advantaged Dividends (EVT) / 831
- Barings Corp Investors (MCI) / 864
- JH Premium Dividend (PDT) / 753
- Nuveen Nasdaq 100 Dynamic (QQQX) / 783
- Columbia Seligman Premium (STK) / 851
Business Development Companies:
- Ares Capital Corp. (ARCC) / 777
- Golub Capital BDC (GBDC) / 770
- Main Street Capital (MAIN) / 899
- New Mountain Finance (NMFC) / 773
- TPG Specialty Lending (TSLX) / 841
- EPR Properties (EPR) / 770
- National Retail Propereties (NNN) / 797
- Realty Income (O) / 831
- Simon Property Group (SPG) / 754
- Store Capital Corp. (STOR) / 758
- W.P. Carey Inc. (WPC) / 811
- Brookfield Infrastucture Partners (BIP) / 784
- Enbridge Inc. (ENB) / 748 (Recently converted to a corporation)
- Enterprise Products Partners (EPD) / 801
- Magellan Midstream Partners (MMP) / 863
As mentioned above, this is not a "buy and hold forever" portfolio. I review all holdings at fiscal year end and fiscal 6 months. Any score that slips below 650 is put "on probation" and that security should score above 650 by the next review or, with very few exceptions, it will be sold. Any score below 600 is automatically sold. Any corporation dividend cut will be sold, and any fund distribution cut in excess of 15% will be sold.
Another reason to sell occurs when the market dividend yield of a stock I own falls below 2.0%. This is the lowest yield that I would consider when selecting a stock, so a market yield below this amount enables me to sell some (or all) of a higher priced security and reinvest the proceeds at a higher yield.
My cash position is now close to 10% as I expect this volatile market to continue and I think that opportunities for bargain prices will occur with increasing frequency.
I hope this has been helpful and I look forward to responding to your comments.
Good luck and happy investing!
Disclosure: I am/we are long ALL POSITIONS. 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.