Bunker Dividend Growth Portfolio: 4 New Aristocrats

Includes: AOS, GPC, LEG, MMM, PH, XOM
by: Dividend Sensei

Dividend aristocrats and kings have proven themselves the ultimate SWAN stocks, delivering safe and growing dividends, even in recessions, plus market-beating returns over time.

The BDGP buys the most undervalued aristocrats and kings each week (and once per month via dollar cost averaging).

That valuation is determined by dividend yield theory, which has proven highly effective for dividend blue-chips since 1966.

Over the past month, BDGP has added four new aristocrats and kings, Exxon, Leggett & Platt, Genuine Parts Company, and Parker-Hannifin.

Over time it will diversify into all sectors which should improve the returns which have suffered thus far due to high concentration in unpopular sectors (like healthcare and industrials) as well as lack of time for the stocks to recover.

(Source: imgflip)

Note that to avoid reader confusion I've shifted to a rotating portfolio update schedule. I'll now be providing just one update per week, alternating between:

Last week I was on a family vacation and thus this will be providing a monthly update for each portfolio over the coming weeks.

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 March 2019

I 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 5.8% after 12 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 the ProShares S&P 500 Dividend Aristocrats ETF (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. According to Hulbert Financial Digest IQT's risk-adjusted 30-year total returns are the best of any investing newsletter in the country.

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 5 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.

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.

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

A.O Smith (AOS) Industrials 1.8% 1.1% 0.8% to 3.4% 35% 7.5% 13.8%
AbbVie (ABBV) Healthcare 5.5% 3.6% 0.9% to 5.5% 34% 5.7% 14.8%
Walgreens Boots Alliance (WBA) Consumer Staples 3.3% 2.4% 1.0% to 3.1% 28% 7.0% 13.6%
Leggett & Platt (LEG) Consumer Discretionary 4.2% 3.0% 2.4% to 9.7% 28% 5.2% 12.2%
3M (MMM) Industrials 3.3% 2.5% 1.8% to 4.8% 22% 6.4% 11.9%

(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

3M (MMM) Industrials 3.3% 2.5% 1.8% to 4.8% 22% 6.4% 11.9%
Hormel Foods (HRL) Consumer Staples 2.1% 1.8% 1.2% to 2.8% 12% 8.5% 11.3%
Federal Realty Investment Trust (FRT) REIT 3.2% 2.8% 2.2% to 6.4% 11% 6.0% 10.6%
Genuine Parts Company (GPC) Industrials 3.1% 2.8% 2.1% to 6.1% 10% 8.5% 13.1%
Parker-Hannifin (PH) Industrials 2.0% 1.8% 1.1% to 3.4% 9% 7.0% 10.0%

(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%

4 New Dividend Aristocrats Added Over The Past Month

Over the past month (mostly in the past two weeks) we've managed to opportunistically add four new aristocrats/kings.

  • 26 shares of Leggett & Platt (LEG) @ $39.28
  • 10 Shares of Genuine Parts Company (GPC) @ $105.45
  • 6 shares of Parker-Hannifin (PH) @ $176.08
  • 13 shares of Exxon (XOM) @ $77.29

We also opportunistically added to industrials on trade war-related weakness.

  • 20 shares of A.O Smith (AOS) @ $52.57
  • 6 shares of 3M (MMM) @ $187.09

We've continued to take advantage of the least popular sectors, which most recently are industrials due to trade war escalation fears. Healthcare, the most hated sector when the portfolio was launched is beginning to stabilize and rise as the market's short-term hatred/love of sectors naturally rotates.

It's going to take a while before beaten down aristocrats like Walgreens and 3M rebound from their recent earnings crashes. However, as Seeking Alpha's strategy guru Ploutos recently pointed out, over the past decade 80% of the time an aristocrat that suffers a 10+% single-day decline (when we buy opportunistically) the stock is up 12 months later (average of 32% total return within year).

Dividend Aristocrat Total Returns 12 Months After 10+% Single Day Declines

(Source: Ploutos Research)

This is the essence of BDGP's strategy, which aims to use low-risk, high probability investments to secure a safe and growing source of income and superior long-term returns relative to S&P 500 (whose quality is below that of these blue-chips).

This is a contrarian portfolio built on the notion that most of the time "this time isn't different" and that quality companies are likely to bounce back from temporary pitfalls.

The Bunker Dividend Growth Portfolio Today - 16 Holdings

(Source: Morningstar) - data as of May 10th

Starting out the portfolio is going to be heavily concentrated because we're working off a watchlist of just 10 companies, with minimal weekly turnover.

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 and kings.

Our Highest Yielding Positions

(Source: Morningstar) -data as of May 10th

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 (NYSE:T) anytime soon).

The portfolio isn't "high-yield" by some definitions but is paying over 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 that a highly attractive yield.

(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. There are no distressed or speculative companies in this portfolio.

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).

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.

The small annual income is due to this portfolio being about $33K in size. Over time adding fresh savings and steady dividend growth will generate impressive and very safe income.

(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 6.5% 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 about 25% (about 13% adjusted for 2% long-term inflation).

(Source: Simply Safe Dividends)

It might not be easy to maintain such growth rates but currently, analysts are estimating earnings growth (and thus likely dividend growth) of 8.7% over the next five years.

(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.

The slower expected growth of the next few years is likely a combination of factors including concerns over tariffs, slower global growth, and possible margin compression due to rising labor costs.

Assuming the portfolio generates 8% to 9% long-term income growth here is how its income stream will look over time.

(Source: Simply Safe Dividends)

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

  • Yield On Cost: 2.9%
  • Yield: 3.1%
  • Expected 5-Year Dividend Growth: 8.7%
  • Expected 5-Year Total Return (No Valuation Changes): 11.8%
  • Portfolio Valuation (Morningstar's DCF models): 7% undervalued
  • 5-Year Expected Valuation Boost: 1.6% CAGR (20% margin of error)
  • 10-Year Expected Valuation Boost: 0.8% CAGR (20% margin of error)
  • Valuation-Adjusted Total Return Potential: 12.6% to 13.4% (market's historical return 9.1%) - note margin of error 20%
  • Margin of error adjusted total returns expected: 10.1% to 16.1%
  • Portfolio Beta: 0.88 (12% less volatile than S&P 500)

Portfolio Performance

  • CAGR Total Return Since Inception (February 25th, 2018): -6.4%
  • CAGR Total Return S&P 500: 3.5%
  • Market Outperformance: -9.9%
  • Long-Term Outperformance goal: 1+%

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 are poor thus far.

(Source: Morningstar)

However, given the monthly dollar cost averaging into all active recs (off the two watchlists) the longer companies remain weak the lower their cost bases will become and the larger the gains once shares recover.

Bottom Line: I Remain Confident In This Overall Strategy

The thing to remember about any stock, even SWANs like aristocrats and kings, is that they can (and inevitably do) fall off cliffs during periods of market pessimism.

(Source: Ploutos Research)

Over the past 10 years, no less than 18 aristocrats and kings have crashed 10+% in a single day, typically due to a major earnings miss. But all of them have suffered large declines of close to 5% at one time or another.

This highlights why no dividend stock, no matter the safety of its dividend, is a true bond alternative. It also creates opportunities for patient value investors to scoop up shares after such temporary freakouts, which usually result in sensational 12 month total returns (80% of the time over the past decade).

DVDGP is off to a slow start due to the concentrated value-focused nature, which has us heavily overweight in unpopular crashed aristocrats like 3M and Walgreens. However, I remain confident in the overall approach, since it's backed by decades of market data, common sense, and the historical experience of the greatest investors in history (like Buffett and Lynch).

As we diversify over time, and the most beaten down aristocrats recover over the next 12 to 24 months, I expect the returns of this portfolio to steadily improve.

In the meantime I'll continue to provide updates every few weeks, so you can see how a disciplined approach to low-risk SWAN investing does over time.

Disclosure: I am/we are long WBA, MMM, AOS, ITW. 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.