Bunker Dividend Growth Portfolio: Our First New Dividend King

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Includes: ABBV, AMZN, AOS, CAH, CL, FRT, ITW, KO, LOW, MMM, WBA
by: Dividend Sensei
Summary

I'm tracking a new model portfolio called BDGP, designed to deliver safe and growing dividends no matter what the economy or stock market does.

It is 100% made up of dividend aristocrats and kings, which makes it a highly concentrated but ultra high-quality portfolio.

The performance so far is poor, due to our heavy concentration in beaten-down healthcare companies like WBA, CAH and ABBV.

Last week Lowe's became the third most undervalued dividend king and was added to the portfolio.

Today BDGP owns 11 companies, yields 3.0%, has a beta of 0.87, five-year dividend growth of 11.4% CAGR, and 11.9% CAGR forward earnings growth according to analysts.

(Source: imgflip)

Introduction To The Bunker Dividend Growth Portfolio

I'm a huge fan of dividend growth stocks and dream of eventually becoming financially independent as defined by being able to live on 50% of my post-tax annual dividends alone. Being able to live 100% off passive income from a quality dividend growth portfolio is a dream shared by many of my readers.

And it's not hard to see why. Historically, S&P 500 dividends have been 16 times more stable than stock prices, even during recessions and bear markets.

Thus a well-built dividend growth portfolio can be trusted to provide you safe and even growing passive income no matter what the stock market or economy is doing. That makes it perfect for achieving your dreams of a comfortable retirement.

But wait it gets better. Dividend growth portfolios aren't just a boring way to earn income at the expense of great total returns.

Historically, dividend growth stocks have outperformed the S&P 500 and non-dividend payers, and all while experiencing 13% less volatility to boot. But as great as dividend growth investing is, it's far from the only proven market-beating or alpha factor strategy.

(Source: Ploutos Research) - note data through February 2019

I like to personally like to stack alpha factor strategies (like dividend growth, value, and low beta) so as to essentially rig the game so much in my favor that getting rich becomes purely an issue of time, patience, and discipline (to stick to time tested strategies). After all, Warren Buffett, the greatest investor in history (53 years of 20+% CAGR total returns), famously summarized the two biggest reasons for his success thusly:

We don't have to be smarter than the rest. We have to be more disciplined than the rest." - Warren Buffett

The Stock Market is designed to transfer money from the active to the patient." - Warren Buffett

Thus, my model Deep Value Dividend Growth Portfolio or DVDGP (beating the market by 4.1% in the first 11 weeks) combines the power of dividend growth stocks and valuation, and the focus on mostly low-risk blue-chips is why we also tend to be less volatile during market downturns while keeping up with the market during rallies.

That's a commonality that portfolio shares with the legendary dividend aristocrats, S&P 500 companies that have raised their dividends for 25+ consecutive years.

(Source: Ploutos Research)

The aristocrats have managed to beat the market by 25% annually since 1990 not because they are necessarily super fast-growing companies that soar high and fast, but steadily growing blue-chips that merely keep up during bull markets and fall a lot less during bear markets.

I've had a lot of readers ask me two questions about that portfolio. First, why do I own so many companies (76), and second, why I don't just buy a dividend aristocrat ETF like NOBL.

The answer to the first question is that I'm testing out several investing strategies simultaneously and thus need a lot of data points (I need to know the system itself is market-beating and reproducible since I plan to use it for all future savings).

As to why I don't just buy an ETF and be done with it, the answer is mostly about valuation. ETFs buy stocks blindly and ignore valuation, which is something I can't personally stomach.

A Yale study found that starting valuation can affect your future returns out to 30 years. In other words, overpaying for a company, no matter how great, is not something that patience and time can necessarily overcome.

However, in order to help ultra conservative income investors, like retirees or those close to retirement, harness the proven power of the aristocrats and kings and value investing, I've decided to build a model ultra-low risk portfolio called the Bunker Dividend Growth Portfolio.

It's 100% composed of nothing but aristocrats and kings and built on two modified watchlists from my "best dividend stocks to buy this week" series. As for my valuation approach, I use dividend yield theory or DYT.

(Source: Investment Quality Trends)

That's because asset manager/newsletter publisher Investment Quality Trends has been using a pure valuation approach on nothing but blue-chip dividend stocks (based on six quality criteria) since 1966 and has managed to consistently beat the market by about 10% with 10% lower volatility.

1% annual outperformance for 30 years doesn't sound like much but just 7% of mutual fund managers can even match the S&P 500 over 15 years. Beating the market by 1% over 30 years puts IQT in the elite of professional money managers/analysts.

(Source: S&P Global)

DYT merely compares a stock's yield to its historical yield. If a company is mature and the business model relatively stable yield will mean revert and return to a long-term average that approximates fair value.

For example, if a dividend aristocrat normally yields 2% and grows cash flow and dividends 10% per year, then buying it at fair value (2%) can get you about 12% long-term total returns (2% yielding + 10% long-term cash flow growth).

That's because stock prices are, in the long term, always a function of cash flow (from which dividends are paid). If that same company is now yielding 3%, yet the fundamentals are intact, then it's 33% undervalued (3% -2%/3%) and has 50% upside back to fair value (3%/2%).

My valuation-adjusted total return model (based on the one Brookfield Asset Management has been using for decades) is based on a return to fair value over five to 10 years.

Our example, aristocrat returning to fair value over five years would deliver total returns of 3% yield + 10% cash flow (stock price) growth + 8.5% valuation boost (return to fair value yield over 5 years) = 21.5%.

Over 10 years, it would be 3% yield + 10% cash flow growth + 4.1% valuation boost = 17.1%.

Historically, the margin of error on this valuation model (the best I've ever come across so far) is 20%. The point is that using dividend yield theory you cannot just invest in ultra-low risk aristocrats and kings but you can also know which are the very best ones to buy at any given time.

So, now that you know the theory behind the Bunker Dividend Growth Portfolio (capable of surviving any economic or market storm), let's take a look at the rules of how I run it.

Rules For The Bunker Dividend Growth Portfolio

The BDGP is very different than my DVDGP. That portfolio is very diversified because it serves as a kind of master watchlist of low-risk dividend growth stocks I consider worth owning with long-term 13+% total return potential.

BDGP is going to be:

  • far more concentrated (with no sector caps)
  • higher quality (the bluest of blue-chips)
  • has no long-term total return target (though it should deliver double-digit returns over time)

Here are the rules for this portfolio:

  • I start out buying $1,000 of each (rounded up to the nearest share) of the 5 most undervalued aristocrats and kings.
  • Any week where a new one makes the list (companies roll on and off naturally over time), I make a $1,000 starter position buy.
  • Once per month, I make a $1,000 cost average buy into any active recommendations (that week's top 5 aristocrats and kings).
  • Only sell if the thesis breaks (dividend becomes unsafe, or a company loses its aristocrat or king status, a very rare occurrence).
  • OR if a company becomes 25%+ more overvalued (sell 50%) or 50+% overvalued (sell the other half) - also very rare outside of crazy bubbles like 2000.
  • Dividends are reinvested via DRIP.

As with DVDGP, should some opportunistic buying opportunity appear (like during earnings season or unexpected bad news), I will move up the next month's buy to that day, using the next month's DCA funds. That's what occurred on March 1st when I moved up the March dollar cost average buy from the end of the month due to Walgreens (WBA) more than 6% plunge on news that Amazon (AMZN) was planning on launching a chain of discount grocery stores (which will not have a big impact on its business model). This is why WBA is by far our biggest holding right now.

This recreates the limited capital constraints most investors have and also helps maintain a more balanced portfolio (avoids buying too many dips and becoming severely overweight in one company). I'll provide a portfolio update any week there is new buying (which means at least once per month).

So, now that you understand why this new model portfolio is so potentially useful and the rules behind it, here are the top 10 most undervalued aristocrats and kings you can buy today. These are the first 10 buys of the portfolio.

The Best Dividend Aristocrats And Kings To Buy Right Now

These are the most undervalued dividend aristocrats and kings you can buy right now. I've curated this list myself to exclude companies that I think have a high risk of the thesis breaking (thus, the exclusion of certain companies like BEN). The companies are sorted by most to lease undervalued according to DYT.

Top 5 Dividend Aristocrats To Buy Today

Company Ticker Sector Yield Fair Value Yield Historical Yield Range Discount To Fair Value Expected 5 Year Annualized Cash flow Growth

Valuation Adjusted Total Return Potential

Cardinal Health (CAH) Healthcare 4.0% 2.1% 0.9% to 3.9% 44% 4.8% 14.3%
Walgreens Boots Alliance (WBA) Consumer Staples 2.9% 1.9% 1.0% to 3.1% 37% 9.5% 16.5%
AbbVie (ABBV) Healthcare 5.5% 3.6% 0.9% to 5.5% 35% 10.0% 19.3%
A.O. Smith (AOS) Industrials 1.7% 1.1% 0.8% to 3.4% 35% 8.9% 15.1%
Illinois Tool Works (ITW) Industrials 2.8% 2.1% 1.6% to 4.5% 27% 4.9% 10.8%

(Sources: Management guidance, GuruFocus, F.A.S.T. Graphs, Simply Safe Dividends, Dividend Yield Theory, Gordon Dividend Growth Model) Note: Margin of error on total return potential is 20%.

Top 5 Dividend Kings To Buy Today

Company Ticker Sector Yield Fair Value Yield Historical Yield Range Discount To Fair Value Expected 5 Year Annualized Cash flow Growth

Valuation Adjusted Total Return Potential

Colgate-Palmolive (CL) Consumer Staples 2.6% 2.2% 1.8% to 2.9% 13% 5.9% 10.1%
3M (MMM) Industrials 2.9% 2.5% 1.8% to 4.8% 12% 10.0% 14.1%
Lowe's (LOW) Consumer Discretionary 1.9% 1.7% 1.2% to 2.5% 10% 15.0% 17.8%
Federal Realty Investment Trust (FRT) REIT 3.1% 2.8% 2.2% to 6.4% 10% 7.0% 11.4%
Coca-Cola (KO) Consumer Staples 3.6% 3.2% 2.3% to 4.0% 10% 7.2% 11.7%

(Sources: Management guidance, GuruFocus, F.A.S.T. Graphs, Simply Safe Dividends, Dividend Yield Theory, Gordon Dividend Growth Model) Note: Margin of error on total return potential is 20%.

Note that the dividend kings trade at such high (but well earned) premiums that even the most undervalued one in America is only 12% undervalued. Buying these elite dividend growers is an example of Buffett's famous rule that:

It's far better to buy a wonderful company at a fair price, than a fair company at a wonderful price."

New Buys Last Week

  • $1,000 of Lowe's - new addition

Lowe's became the 3rd most undervalued dividend king which allowed us to start diversifying the portfolio by both holdings and sector. Due to our portfolio rules, the initial additions will mostly come from turnover in the "top 5" watchlists. Because the dividend kings are more closely spaced together, in terms of undervaluation ranking, most of our upcoming new additions are going to be dividend kings.

However, given the weakening economic fundamentals (recession might be coming in 2020 or 2021), I consider that a good thing, since dividend kings are the quintessential SWAN stocks.

The Bunker Dividend Growth Portfolio Today - 11 Holdings

(Source: Morningstar) - data as of March 8th

Starting out the portfolio is going to be heavily concentrated and skewed towards any opportunistic buys like Walgreens, which I added to after it plunged over 6% on news that Amazon was planning on launching a discount grocery chain (which would have limited effects on its growth prospects).

Due to the small investing universe we're dealing with the BDGP will likely top out at 60 holdings after many years of steadily adding aristocrats.

Our Highest Yielding Positions

(Source: Morningstar)

Note that stewardship is Morningstar's rating of the quality of management. S = standard (fair to good) and E = exemplary (very good to great). P = poor, but our policy is to avoid such companies (thus why we're not buying AT&T anytime soon).

The portfolio isn't "high-yield" by most definitions but is paying 50% more than the S&P 500. And given the ultra-low risk nature of its income stream and double-digit dividend growth rate, I consider a yield roughly equal to the 30 year US Treasury to be very good.

(Source: Morningstar)

Due to only owning aristocrats and kings, the portfolio is 100% US stocks. But in reality, we have very strong exposure to foreign markets because almost all our holdings are multi-national blue-chips.

Of course, that is likely to hurt us at times, such as periods when a stronger dollar and trade conflicts hurt multi-national earnings. However, that just creates more buying opportunities that will eventually result in superior returns when those temporary headwinds subside.

(Source: Morningstar)

Due to the 100% focus on the safest blue-chips, we're mostly in slower growing companies.

Sector Concentration

(Source: Simply Safe Dividends)

Since we're starting out very concentrated into the most undervalued kings and aristocrats, there is going to naturally be a lot of sector concentration. Over time, this will smooth out, but given the rock-solid dividend safety of every company we own, I'm not worried about being overweight by sector (there are no sector caps). That's especially true since the highly defensive sector concentration makes this portfolio ideal for a future recession/bear market.

The addition of Lowe's has helped reduce our top sector concentration from a peak of 45% to 41%.

It may end up weighing on performance in the short term, but it won't hurt this portfolio's SWAN like nature, which is the entire point of owning something like this.

Income Concentration

(Source: Simply Safe Dividends)

As with any equal weighted and concentrated portfolio, the highest yielding stocks will dominate the income stream. This will balance out in the future as we diversify into more companies.

Annual Dividends

(Source: Simply Safe Dividends)

Any concentrated portfolio is going to have a lot of month to month variation in dividend payments. Eventually, this will spread out as we diversify into a few dozen companies.

(Source: Simply Safe Dividends)

I'm pleasantly surprised at how fast this portfolio would have grown its dividends in the past one to 10 years. The S&P 500's 20-year median dividend growth rate is 6.4% and these dividend legends have delivered close to double-digits this decade and even better in recent years.

If we could maintain the five-year average rate then in 20 years even this $10,000 portfolio would be generating impressive amounts of super safe income generating a yield on cost of nearly 30% (15% adjusted for 2% long-term inflation).

(Source: Simply Safe Dividends)

However, 11.3% dividend growth (and thus cash flow growth) for 20 years is a pretty big ask from mature companies. But according to Morningstar, the analyst consensus for the forward five-year earnings growth rate is an impressive 11.9%. While such forecasts are educated guesstimates (based on analyst consensus), the portfolio should be able to deliver close to double-digit payout growth over time.

(Source: Morningstar)

The quality of these stocks can be seen in the far-above-average returns on assets and equity of this portfolio (good proxies for quality long-term management and good corporate cultures). In addition, Morningstar rates many of our companies' management as "exemplary" in terms of long-term capital allocation decisions.

Fundamental Portfolio Stats: (Total Return Potentials Are From Current Levels)

  • Yield On Cost: 2.8%
  • Yield: 3.0%
  • Expected 5-Year Dividend Growth: 11.9%
  • Expected 5-Year Total Return (No Valuation Changes): 14.9%
  • Portfolio Valuation (Morningstar's DCF models): 11% undervalued
  • 5-Year Expected Valuation Boost: 2.3% CAGR (20% margin of error)
  • 10-Year Expected Valuation Boost: 1.1% CAGR (20% margin of error)
  • Valuation-Adjusted Total Return Potential: 16.0% to 17.2% (market's historical return 9.1%) - note margin of error 20%
  • Margin of error adjusted total returns expected: 12.8% to 20.6%
  • Portfolio Beta: 0.87 (13% less volatile than S&P 500)

Portfolio Performance

  • CAGR Total Return Since Inception (February 25th, 2018): -5.7%
  • CAGR Total Return S&P 500: -1.6%
  • Market Outperformance: -4.1%
  • Long-Term Outperformance goal: 1+%
  • YTD: 2.9% vs 10.1% for S&P 500

Due to the highly concentrated nature of the portfolio and the timing of when the portfolio is starting (deep into a strong rally), it's not surprising that the initial results after a week are not that impressive.

(Source: Morningstar)

Starting out our heavy concentration in healthcare is badly hurting short-term returns. However, monthly dollar cost averaging buys will reduce the cost bases of our biggest losers helping to boost returns over time when these blue-chip SWANs recover.

Bottom Line: No Worries About The Rough Start To This Portfolio

I'm not a market timer, but a long-term, value-focused dividend growth investor. The "bunker" like nature of this portfolio stems not from the ability to avoid declines during bear markets or corrections, but rather deliver generous, bank vault safe, and steadily rising income in all economic/industry/interest rate environments.

Due to the concentrated nature of the portfolio starting out, as well as our rules for adding opportunistically (but just once per month), early losers like Walgreens and Cardinal Health are going to weigh on performance.

However, the power of low volatility, blue-chip dividend growth investing lies not in the short term, but over the entire market/economic cycle. When the market invariably corrects or falls into an outright bear market (during recessions), a flight to safety in quality dividend blue-chips is likely going to allow BDGP to significantly outperform the S&P 500 by falling less.

And thanks to our steady dollar cost averaging and DRIP strategies, the longer our SWANs languish the lower our cost bases will decline, making for stronger long-term gains when they recover.

Disclosure: I am/we are long CAH, ABBV, AOS, WBA, ITW, CL, HRL, MMM, FRT, KO, LOW. 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.