Deep Value Dividend Growth Portfolio: 4 Great Buys Last Week

Mar. 14, 2019 7:00 PM ETENB, GD, LOW, THO, ENB:CA54 Comments41 Likes

Summary

  • The Deep Value Dividend Growth Portfolio is the culmination of 23 years of investing experience and five years as a professional dividend company analyst.
  • It's the strategy I plan to adopt for all my future savings in late 2019 when my margin is paid off.
  • DVDGP is focused on low-risk dividend growth stocks bought opportunistically at good to great prices.
  • Last week we made four opportunistic buys on existing positions: ENB, THO, GD, and LOW.
  • The Portfolio is beating the market by 4.1% after 11 weeks, down from 10% outperformance as some of our overweight sectors have pulled back.

(Source: imgflip)

Due to reader requests, I've decided to break up my weekly "Best Dividend Stocks To Buy This Week" series into two parts.

One will be the weekly watch list article (the best dividend stocks to buy in a slowing economy). The other will be the update on the Deep Value Dividend Growth Portfolio (which is beating the market by 4.1% after 11 weeks).

To also make those more digestible, I'm breaking out the intro for the weekly series into a revised introduction and reference article on the 3 rules for using margin safely and profitably (which will no longer be included in those future articles).

I'm also tracking updates to my new Bunker Dividend Growth Portfolio (100% undervalued dividend aristocrats and kings) anytime there is a change to that portfolio.

Introduction To The Deep Value Dividend Growth Portfolio

I've spent 23 years trying to find an investing strategy that can consistently achieve great returns that will enable me to achieve my dream of financial independence.

While there are many good investment strategies to choose from after five years as a professional analyst/investment writer, I've determined that for me (and many of my readers) three approaches work best.

First, I'm focusing on dividend growth stocks because historically these have tended to significantly outperform the market, both on an absolute and risk-adjusted basis (total returns/volatility).

Second, I'm adding a value focus ("be greedy when others are fearful") because like dividend growth, value is a proven alpha factor that generally beats the market over the long term.

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

Finally, I'm targeting low-risk dividend stocks, primarily sleep well at night or SWAN blue-chips (such as dividend aristocrats and kings) because they have shown a remarkable ability to generate safe and steadily rising income as well as market-beating total returns over the long term.

(Source: Ploutos Research)

That's thanks to usually keeping up with stocks during a bull market but falling less during bear markets. In other words, low-risk dividend growth stocks manage to outperform not by "hitting grand slams" but by "avoiding striking out".

What evidence do I have that such a value-focused low-risk dividend growth approach actually can beat the market over time?

(Source: Investment Quality Trends)

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.

I'm applying the same system to things like younger companies, as well as REITs, YieldCos, and MLPs, which due to the 25 years of uninterrupted dividends requirement IQT has, excludes these kinds of investments from their recommendations.

Basically, my investing strategy can be summarized like this:

  • Only buy deeply undervalued blue chips (off my watch lists) during a market decline.
  • Save 50% of weekly cash (invested in the form of T-bills or long-term Treasury bond ETFs) and wait for pullbacks/corrections/bear markets.
  • During a pullback (average one every six months since WWII), deploy 50% of cash (sell the bonds) in stages.
  • If the pullback becomes a correction, deploy 50% of remaining cash (in stages).
  • If the correction becomes a bear market, deploy the remaining 50%.

This approach ensures that I'll be able to avoid hoarding cash for years on end (because market declines are frequent) and will always be able to buy some quality undervalued dividend growth stocks at highly attractive valuations.

I'm also considering deploying 50% of my real savings into the best-undervalued dividend growth opportunities on a monthly basis with the other 50% building up liquidity for market pullbacks (more on this in a second).

I use the same valuation-adjusted total return model that Brookfield Asset Management (BAM) uses, and they have a great track record of delivering 12-15% CAGR total returns (in fact, it's their official goal as a company, and they usually exceed that target).

There are four carefully curated lists designed to focus on:

  • Quality companies
  • Safe dividends (they are all low-risk stocks)
  • Good long-term growth potential
  • Good margin of safety (attractive valuations)

The portfolio also uses size caps for risk management purposes (in case a thesis breaks)

  • sector cap: 25%
  • industry cap (like tobacco): 15%
  • individual holding cap: 5%

This is currently a paper portfolio I'm maintaining on Morningstar and Simply Safe Dividends to not just provide in-depth portfolio stats but also the total returns over time. The rules for the portfolio are:

  • Each month, I buy $500 worth (rounded up to the nearest whole share) of any existing portfolio positions that remain on the active buy list (fair value or better).
  • Each week, I buy $500 worth of any new stocks that make it onto the "top 5 high-yield blue-chips/fast growers, aristocrats/kings" watch lists (stocks rotate on and off). But that's only if the long-term total return potential is 13+%, which is the official portfolio hurdle rate.
  • If opportunistic buying opportunities appear (like a 5+% one day crash due to an earnings freakout), then I can move up the next month's buy to that day.
  • Dividends are reinvested.
  • Stocks are only sold if the thesis breaks or a stock becomes 25% overvalued (then sell half) or 50% overvalued (sell all of it), and the capital is reinvested into new active recommendations.

Again, this is purely a tracking (model) portfolio. I'm not yet putting real money into it until the late 2019 or early 2020, once I've eliminated all margin from my portfolio and started saving up cash (in the form of either ultra-short-term bonds or long-term bonds, depending on the state of the economy).

The reason I'm tracking this portfolio is to determine if the best use of my savings in the future is a combination of 50% dollar cost averaging and 50% opportunistic buying during downturns, or a 100% focus on downturns only.

Late 2018 (worst correction in 10 years) was an ideal time to buy quality dividend growth stocks at steep discounts. DVDGP's early returns have been sensational (small profit in December and 10% gain in January vs. S&P 500's 8% January rally) mainly due to starting the portfolio when valuations were at their lowest levels in years. But many investors want to also deploy cash on a consistent basis. The monthly DCA buys of all active buy recs is our way of simulating that and testing how much alpha this investing system generates in a rising market (beating S&P 500 by 0.7% in February so far).

Ultimately DVDGP represents the culmination of my 23 years of experience and is designed to be a safe income growth portfolio that almost anyone can use. Or to put another way, if I were managing a pension/endowment fund, this is what the equity portion of that portfolio would look like. Thus it's also safe for most readers, as most of its holdings are "widows and orphans" stocks including plenty of dividend aristocrats and kings.

How can you use DVDGP? Mainly for investing ideas, and not necessarily tracking it move for move (it owns 76 companies and most people prefer a more concentrated portfolio). Since I'm an analyst for Simply Safe Dividends (researching over 200 companies per year) I am basically building out a smart beta ETF with DVDGP. One that yields double the S&P 500, has faster dividend growth and that should be able to outperform it by a wide margin over time (or so my total return model says which is why I'm testing it).

If the strategy works as well as expected I may partner with Brad Thomas and Chuck Carnevale to turn it into a closed-end fund. That would allow investors to profit from the portfolio but avoid the problems money managers have with redemptions forcing them to sell during market declines when they should be buying instead.

Think of DVDGP as a quality screening tool and master watch list of dividend stocks I consider worth owning for most investors. Then use it to help build your own watch lists and then buy those companies when they hit fair value or better.

4 Opportunistic Buys Last Week

I added $500 to the following companies.

  • Enbridge (ENB) - existing position
  • Thor Industries (THO) - existing position
  • General Dynamics (GD) - existing position
  • Lowe's (LOW) - existing position

Enbridge was bought after it fell 6% after announcing a 1-year delay on the Line 3 replacement project, which represents about 50% of its growth backlog. However, given that the Minnesota Public Utility Commission has granted the certificate of need (and unanimously rejected environmentalist calls to reconsider it), AND the company has secured a 20 year easement with all relevant tribes over which the pipeline is scheduled to be built, this delay has a low risk of cancelling the project permanently.

Rather it's more of a "guaranteed approval coming a bit later than expected" situation that analysts (and I) don't expect to impact the company's 10% planned dividend hike in 2020 or 5% to 7% long-term payout growth guidance.

Thor Industries plunged as much as 11% the day it announced earnings that disappointed Wall Street and offered soft guidance because in the words of its CEO

As dealers continue to rationalize inventory levels following the unusually high seasonal order and wholesale delivery patterns in the first nine months of fiscal 2018, the company has taken steps to adjust its production levels accordingly. A number of Thor's production facilities have reduced their production unit rates, while others have shifted to four-day production weeks."

Thor is a naturally cyclical company, operating in a high ticket consumer discretionary industry that results in high volatility to its sales and cash flow. The valuation approach I use takes this into account and I'm not afraid to opportunistically pick up cheap shares when the market is worried about future falling sales.

Lowe's was added after it broke into the "top 5 dividend kings" watch list off which DVDGP is based (it hit #3). Anytime a stock breaks into its respective top 5 watch list we add more.

General Dynamics broke into the adjusted "top 5 dividend aristocrats" list after hiking its dividend 9.7% (27th consecutive annual raise) and the stock had a poor week.

The Deep Value Dividend Growth Portfolio - 77 Total Holdings

(Source: Morningstar) - data as of March 8th close, CWEN is no longer owned by the portfolio because I sold it before it cut its dividend by 40%.

Our High Yield Stocks (4+% Yield)

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

(Source: Morningstar)

We're mainly focused on large-cap US dividend stocks because the goal of this portfolio is to only own low-risk SWAN stocks. Low-risk is defined as low-risk of a dividend cut during a recession. Note that in reality many of our large cap blue-chips have significant overseas sales so we have plenty of exposure to global growth markets.

(Source: Morningstar)

Due to the preference for undervalued stocks we're overweight high-yield, hard asset, and cyclical companies.

Sector Concentration (25% Sector Caps, 15% Industry Caps, And 5% Company Caps In Place)

(Source: Simply Safe Dividends)

I'm imposing firm sector caps to ensure good risk management. No matter how good the bargains may be, it's never a smart idea to let your portfolio get too risky. Due to most of our energy stocks being midstream corporations or MLPs, I'll be capping that sector at 20% to limit exposure to that industry to 15%.

Income Concentration

(Source: Simply Safe Dividends)

The portfolio's income is likely to be concentrated into the highest-yielding names, at least until it becomes more diversified over time. A good rule of thumb is you want to limit income from any one position to 5% or less. We've now achieved that goal in DVDGP.

Annual Dividends

(Source: Simply Safe Dividends)

While we may never fully get to the dream of daily dividend payments, we're currently getting paid every week. And the monthly income flow will smooth out nicely over time.

(Source: Simply Safe Dividends)

Note that the 10-year dividend growth figures are artificially low because my tracking software doesn't average in anything that hasn't existed for those time periods. Some of these stocks have IPO-ed in the last five years, and so, the 1-year and 5-year growth rates are the most accurate. These figures are purely organic growth rates and assume no dividend reinvestment.

The dividend declines during the Financial Crisis were due to REITs (such as Kimco and Simon) which cut their dividend (as 78 REITs did during the Great Recession) as well as our large exposure to mega-banks. Fortunately, since then, the REIT sector has deleveraged and enjoys the strongest sector balance sheet in history.

(Source: Hoya Capital Real Estate)

This means that during the next recession, most REITs will not cut their payouts, especially Kimco, which has a BBB+ credit rating and will be getting an upgrade to A- in 2019 or 2020. Simon is one of just 2 REITs with an "A" credit rating.

Top REIT Credit Ratings (S&P)

(Source: F.A.S.T.Graphs)

Similarly, I am confident that every bank we own (C, JPM, BAC, GS, HOMB, ABCB) will maintain its dividends through future recessions (though they are likely to be frozen).

There is no official dividend growth target, though I'd like to at least maintain long-term dividend growth (either 1-year or 10-year) which is above the market's historical 6.4% payout growth rate. The huge jump in the 1-year dividend growth rate is courtesy of some of our semiconductor stocks, several which raised their dividends by over 100% in the past 12 months.

(Source: Simply Safe Dividends)

While maintaining 11.8% dividend growth for 20 years is likely beyond the portfolio's ability, according to Morningstar, the projected EPS (and thus likely dividend) growth rate is about 12% over the next five years.

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

  • Yield On Cost: 4.3%
  • Yield: 4.0%
  • Expected 5-Year Dividend Growth: 12.0%
  • Expected 5-Year Total Return (No Valuation Changes): 16.0%
  • Portfolio Valuation (Morningstar's DCF models): 12% undervalued
  • 5-Year Expected Valuation Boost: 2.7% CAGR (20% margin of error)
  • 10-Year Expected Valuation Boost: 1.3% CAGR (20% margin of error)
  • Valuation-Adjusted Total Return Potential: 17.3% to 18.7% (market's historical return 9.1%) - note margin of error 20%
  • Margin of error adjusted total returns expected: 13.8% to 22.4%
  • Portfolio Beta: 1.03 (3% more volatile than S&P 500)

(Source: Morningstar)

The quality of these companies 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) as well as faster projected earnings growth rates.

DVDGP is also far more undervalued, offers a much higher yield and should achieve far superior dividend growth compared to the broader market. That's due to corporate America's bigger focus on buybacks vs. dividend hikes for most non-dividend focused companies.

As an added benefit, the average market cap is smaller, providing yet another alpha factor (smaller stocks tend to outperform). Note that the overall focus is on blue chips, which means that the average market cap is likely to rise over time (but remain far below the market's $100 billion average).

Portfolio Performance

  • CAGR Total Return Since Inception (December 12, 2018): 10.3%
  • CAGR Total Return S&P 500: 6.2%
  • Market Outperformance: 4.1%
  • Long-Term Outperformance goal: 2+%
  • YTD: 8.5% vs. S&P 500 10.1%

(Source: American Enterprise Institute)

Beating one's target benchmark is extremely difficult, even for professional money managers. That's because "hot funds" see lots of new money flows which makes it harder to recreate that success the next year.

(Source: S&P)

In addition, during market declines retail investors pull money out causing professional money managers to be forced sellers instead of buying at fantastic valuations. Thus, just 0.45% of mutual funds remain in the top quartile of performers for five consecutive years.

This is why DVDGP is a margin-free portfolio, using steady cash inflows (simulating steady and high savings) to buy opportunistically. There is no guarantee that the strategy can beat the market over time, but avoiding the biggest pitfalls of active money managers means I believe we have a very good chance.

Worst Performers

(Source: Morningstar) data as of March 8th

The good news is that due to our monthly additions to all stocks that remain active buy recommendations, the more any stock falls in the short term, the lower our cost basis will become.

Best Performers

(Source: Morningstar) data as of March 8th

The downside of our dollar cost averaging approach is that we also raise our cost basis for early winners. This is why I'm testing the DCA approach to see if it can continue to generate alpha outside of steep market declines.

However, since we only buy great companies at good to great valuations, ultimately, we should be able to deliver very strong returns. That's because winners tend to keep on winning, and thus adding to winners even at a higher cost basis should help keep the portfolio well balanced and avoid getting too top-heavy with out of favor companies that could cause very long stretches of underperformance.

This is why the monthly DCA buys are mostly based on target yields from the DVDGP Bear Market Buy List.

Bottom Line: So Far The Highly Diversified Value Driven Approach Is Working Well

I'm not surprised that the portfolio has pulled back from its 10+% outperformance achieved before the market began drifting lower. That huge alpha was due to piling into economically sensitive and cyclical sectors like Energy, Finance, and Industrials right before they stormed higher faster than the market.

Now slowing economic fundamentals are causing those same sectors to pull back, resulting in the kind of alpha mean reversion I have been expecting. However, I'm still pleased with how the strategy is doing, including opportunistically adding on a monthly basis via an accelerated DCA approach.

When my margin is gone at the end of 2019 (down to $73.9K from a peak of $139K in late November) I'll be using DVDGP watch lists to put 50% of my monthly savings to work, while storing up the other half to deploy during corrections and bear markets.

I find this approach is a good balance between putting your money to work right away (time in the market is more important than timing the market) while also respecting the fact that during times of peak pessimism and fear, even the highest quality blue-chips trade at obscenely low valuations.

This article was written by

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Adam Galas is a co-founder of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 5,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.


The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha).


I'm a proud Army veteran and have seven years of experience as an analyst/investment writer for Dividend Kings, iREIT, The Intelligent Dividend Investor, The Motley Fool, Simply Safe Dividends, Seeking Alpha, and the Adam Mesh Trading Group. I'm proud to be one of the founders of The Dividend Kings, joining forces with Brad Thomas, Chuck Carnevale, and other leading income writers to offer the best premium service on Seeking Alpha's Market Place.


My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives.


With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and safe and dependable income streams in all economic and market conditions.


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Disclosure: I am/we are long ENB, KIM, BPY, BLK, ITW, TXN, AOS, AAPL, ABBV, BEP, MMM, LEG, WBA, EPD, MMP, ET, GS, XOM, MPLX, V, MA, BIP, TERP, IRM, HD, SWKS, PM, OKE, C, AMT, BAM, LRCX, JPM, BAC, AMGP, LYB, BTI, TU, SPG, AMTD, BA, CONE, LOW, BMY, AMP, QTS, AY, EQIX, SWK, EPRT, GD, D., LAZ, QCOM, CVS, VOD, APD, AMP, HOMB, SYF, OMP, NBLX, EQM, SU, ABCB, LUV, PEGI. 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.

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