3 Great Dividend Blue-Chips I Just Bought For My Retirement Portfolio

Includes: ABBV, CAH, ET, LAZ, LOW
by: Dividend Sensei

The market sell-off triggered by a steadily worsening trade war (now on multiple fronts) has sent stocks plunging about 7% in the past month.

Rather than sell my blue-chip dividend stocks and cower in fear, I've been steadily buying each week, mostly high-yield stocks at March 2009 valuations.

While recession risk is at a 10-year high, I refuse to ignore "fat pitch" buying opportunities until I see the whites of the next recession's eyes.

Which is why, unless all four yield-curve inversion confirmations trigger, I'll continue buying every week, following a time-tested approach that's made Buffett, Lynch and Private Equity firms rich over the decades.

Even if a recession becomes imminent, I'll sit on what I own now, and merely stockpile savings in bonds to sell during a bear market. In the meantime, I'm not checking my portfolio at all (ignoring irrelevant short-term paper losses) and focusing 100% on safe long-term dividend growth.

(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 watchlist article (with the best ideas for new money at any given time). The other will be a portfolio update.

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).

To minimize reader confusion, I will be providing portfolio updates on a rotating bi-weekly schedule. This means an update every two weeks on:

3 Great Blue-Chip I Bought For My Retirement Portfolio Over The Last 2 Weeks

Now that I've finished recession-proofing my retirement portfolio (where I keep my entire net worth), I'm free to keep putting my high savings to work in the best "fat pitch" Buffett style investing opportunities I can find.

I use a 181-company watchlist (all level 8+ quality blue-chips on my 11-point quality score) to help me keep track of the steady stream of great long-term income growth opportunities the market provides at any given time.

In the last two weeks, I've bought

  • 58 shares of Lazard (LAZ) @ $34.57 ($0.42 commission with Interactive Brokers tiered pricing)
  • 62 shares of Lazard @ $33.15 ($0.42 commission)
  • 21 shares of Lowe's (LOW) @ $99.02 ($0.35 commission)
  • 150 units of Energy Transfer (ET) @ $13.77 ($0.71 commission)

Lowe's I purchased on the May 22nd 12% earnings crash, which was due to management lowering guidance for 2019, specifically in terms of how much the recently begun turnaround would improve operating margins this year (still over 3%) and thus reduced 2019 adjusted EPS guidance by 8%.

However, I and most analysts remain confident that Lowe's turnaround will succeed, and as Peter Benedict from Baird pointed out, about 25% of the gross margin compression was tariff-related (thus not a permanent blow to the business model).

Essentially, my "buy aristocrats on 10% single day crash" rule is based on my contrarian strategy of time arbitrage. That means buying what Wall Street hates today, due to fears of a rocky tomorrow, because I can see over the next hill to a brighter next week.

I bought Lowe's due to short-term concerns that might hurt earnings in 2019 and 2020, but since I only care about long-term growth 5+ years out, I consider buying crashed aristocrats a great high probability/low-risk strategy.

And, that's backed up by the data. Aristocrats, despite their blue-chip status, still suffer significant single-day crashes, mostly over earnings misses (thus, why I love earnings season so).

Dividend Aristocrats Worst Single Day Crashes Since 2009

(Source: Ploutos Research)

I don't buy every single aristocrat that plunges double digits in a day, but only those whose long-term growth potential I remain confident in. For example, Cardinal Health's (CAH) business model has now deteriorated due to permanent secular industry headwinds, and its long-term cash flow/dividend growth outlook is about 4%. At the right price, I'd still buy it, but that would likely require a yield of closer to 7%, not 5%.

But for a company like Lowe's, where analysts and I still expect roughly 15% to 16% long-term EPS/dividend growth? I'm more than happy to buy the dip.

12-Month Forward Aristocrat Returns After 10+% Single Day Crash

(Source: Ploutos Research)

That's because, over the past 10 years, most crashed aristocrats bounce back nicely within 12 months, an average of 32%, and a median gain of 33%. That includes Lowe's itself, which delivered the single best 12-month forward crash return of almost 70% between May 2012 and May 2013.

I'm not saying that this strategy is guaranteed to deliver Buffett-like 12-month returns every time, or for Lowe's specifically (should we get a recession in 2020 the stock is likely to fall some more). But remember that my goal with Lowe's is to lock in a historically attractive yield, and put my money to work in a low-risk dividend growth blue-chip that is likely to deliver double-digit total returns over decades. Lowe's, a 56 consecutive year payout hiking dividend king, is a great way for me to invest $2,000 of my discretionary savings (i.e., money I don't need for at least 5 years).

Lazard, I tripled down on because my greatest passion is buying high-yield blue-chips at fantastically discounted valuations. For example, I bought Lazard at a yield north of 5.5%, a forward PE of under 9, and a price to cash flow of about 7.

Energy Transfer I paid an even better price for, as I cashed in on recession/trade war fear to scoop up a fast-growing MLP at just 6.0 times forward DCF and 3.5 times operating cash flow (literally a depression era valuation for an LP with decades of strong growth ahead of it). Oh and then, there's that safe 8.9% yield that I've locked in, which means market historical matching returns from distributions alone.

And, ET's payout is rock-solid courtesy of a 2.07 coverage ratio and a leverage ratio that's steadily headed to 4.0 (5.0 or less is safe for MLPs according to credit rating agencies).

Basically, the last two weeks continued my trend of deep value investing since I switched to a 100% value-focused, blue-chip portfolio system (earlier this year).

(Source: Morningstar)

I've bought 77% value stocks since then, and highly undervalued ones at that.

Valuations On Investments In Recent Months

  • weighted average forward PE: 10.5 (March 2009 S&P 500 forward PE bottomed at 10.3)
  • average price/operating cash flow: 8.7 (Chuck Carnevale recommends 15.0 or less)
  • average yield: 4.3%
  • 5-year average dividend growth rate: 13.3% (roughly doubling organically every six years)
  • Morningstar star rating (based on valuation): 4.2 stars (strong buy)
  • Average discount to Morningstar fair value (based on conservative, long-term discounted cash flow method): 28%

Essentially what I've spent the last few months doing is buying $79,000 worth of high-yield dividend growth blue-chips at March 2009 level valuations. Which is why, despite recession risk now rising to the highest levels in 10 years, I'm confident that I'll enjoy great total returns over the next five to 10 years.

  • yield: 4.3%
  • Morningstar's 5-year forward dividend growth expected (even factoring in a recession): 6.1%
  • Total return expected (no valuation change): 10.4% (S&P 500's historical total return 9.1% CAGR)
  • Valuation boost (5-year CAGR return to Morningstar fair value): 6.8%
  • Valuation boost (10-year CAGR return to Morningstar fair value): 3.4%
  • Valuation-Adjusted Total Return Expected over next five to 10 years (including historical 20% margin of error): 11.0% to 20.6%

But just because I'm giddy to be buying great income producing assets at Financial Crisis valuations doesn't mean that I'm expecting quick profits. After all, we might now be facing a recession and bear market in 2020.

Plan Going Forward (Including During A Potential Future Recession/Bear Market)

Peter Lynch once famously said, "The key to making money in stocks is not to get scared out of them." Well, during corrections like what I believe we're now in (due to the escalating trade war with no deals in sight), short-term paper losses can be very scary indeed.

Which is why Michael Batnick, director of research at Ritholtz Wealth Management (where Ben Carlson, who runs "Wealth of Common Sense" also works) recommends checking your portfolio very infrequently. Asset manager Wealthfront agrees with this citing a study by SigFig (a maker of portfolio tracking software) that found its average user checked their portfolio eight times per month or about twice a week. The more frequently a client checked the worst their annual returns got

  • those who checked once per day saw 0.2% CAGR lower returns over time
  • those who checked twice a day saw 0.4% CAGR lower returns over time

Which is why I've decided to not check my portfolio returns at all until the correction (or possibly bear market) is over, and the market returns to a new all-time high. At that time (possibly not until 2021), I'll do a more detailed retirement portfolio review, highlighting the monthly and annual total returns of my portfolio during the correction/bear market.

After all, my strategy is purely long-term focused, with a specific goal of generating safe and exponentially rising dividends, including during recessions.

Dividend Growth Chart Of My Recent Blue-Chip Investments

(Source: Simply Safe Dividends)

Even the Great Recession didn't stop my new companies from raising their dividends every year (nothing I've been buying has ever cut its dividend).

And, as you'll see in my overall portfolio dividend stats, my entire portfolio is a source of generous, safe, and steadily rising income.

Which means that the best strategy for me to use is to stick my head in the sand about short-term paper losses (which I'm sure are grisly in the past few weeks) and just focus on buying smart things each week.

That means steadily accumulating deep value blue-chips each week until I see the whites of the next recession's eyes. That's based on four confirmations from the 10y-3m yield curve, the most accurate recession predictor in history, according to the San Francisco, Cleveland and Dallas Federal Reserves.

Major Yield Curve Recession Confirmations

Using those four confirmation signals (determined by far smarter people than I) here is my recession buying plan.

  • Regular Weekly Buy: $2,000
  • post 10-day confirmation (June 6th): $1,500 weekly buy
  • post-1-month confirmation (June 23rd): $1,000 weekly buy
  • post 10-week confirmation (August 15th): $500 weekly buy
  • post-3-month confirmation (August 23rd): $0 weekly buy (100% bonds)

Basically, I'm attempting to balance the need to keep buying great bargains we see today (like blue-chips trading at 3.5 times operating cash flow) with the fact that in a recessionary bear market, safe dividend stocks could be trading at even more absurd levels (two to four times cash flow, literally private equity multiples on liquid and safe blue-chips).

Is this "market timing" which I frequently rail against because decades of market data prove it doesn't work? I prefer to think of it as a reasonable capital allocation plan that keeps me putting new money to work in safe and recession-resistant income sources (in case a downturn does happen) but also leaves me with plenty of buying power should the market end up diving much lower.

Traditional market timing means "tell me when to sell 100% of my stocks and then get back in at the bottom." Once I buy a company, I won't sell it unless the thesis breaks. After all, I am using a "perpetual equity" style of investing, such as what Chenmark Capital (a Portland Maine based private equity fund) has used to great effect for several years.

Chenmark buys small businesses at fantastic valuations (usually three to five times cash flow) with plans to own them forever, with all returns generated purely from cash flow yield.

While publicly traded blue-chips seldom trade at four times cash flow (though some do today, like ET) the point is that buying quality companies, with steadily rising cash flow and dividends, for single digit cash flow multiples is a great long-term investing strategy.

It's a way to earn great total returns over time, but without relying on the fickle equity market to deliver capital gains. Or to put another way, should what I own now languish forever, despite steadily rising fundamentals (cash flow and dividends), then I won't be sad, I'll be overjoyed.

Because it means that I'd always have a steadily more undervalued place to invest my discretionary savings (about $10,000 per month) for many years and decades to come.

But while that isn't actually possible (the market can't ignore great fundamentals forever) a bear market, that sees blue-chips trading at low to mid-single-digit cash flow multiples, is inevitable, which is why I need to prepare not just to survive it but go on a major buying binge.

My Retirement Portfolio Today - 27 Holdings

(Source: Morningstar) Data as of May 31st. A sea of red, but I'm not bothered in the slightest.

I have a long way to go to hit my 5% max position size goal. It will likely take three years of investing before AbbVie (ABBV) falls to that 5% target. However, given the safety of that dividend, I'm happy to patiently wait and collect my exponentially rising income from that company.

Top 10 Income Sources

(Source: Simply Safe Dividends)

Similarly, my dividend concentration is extremely high and will take many years to bring down to reasonable levels. Fortunately, thanks to my de-risking, I have near total confidence in the safety of my income stream, even during a recession.

(Source: Morningstar)

The portfolio has become far more diversified by stock style, especially compared to the early days, when it was pretty much 100% small-cap value. I'm now mostly focused on large-cap blue chips, but have a nice amount of foreign exposure (mostly Canada where companies tend to follow the US style of steady dividend growth over time).

Due to my personal situation (very low monthly expenses and about $15,000 gross monthly income, $10,000 of that investable), I have a high-risk tolerance and 100% stock portfolio. Most investors need to diversify into cash/bonds in order to decrease portfolio volatility and avoid having to sell stocks during corrections/bear markets.

40% to 60% of your portfolio in cash equivalents (such as T-bills) and bonds is a good rule of thumb for most people. That balances the strong price appreciation of stocks but with far less volatility (making it easier to stay calm and avoid panic selling stocks during market declines).

(Source: UBS Bear Market Guidebook)

(Source: Morningstar) - note the lack of speculative growth or distressed assets. I'm focused on a low-risk strategy that tries to avoid such companies.

De-risking has put me in a more defensive portfolio focused on hard assets (with recession-resistant cash flow) and high-yield stocks (which will hold up relatively well in a bear market where interest rates fall significantly). Eventually, my exposure will become smoothed out as I collect more undervalued blue chips in various stock types and sectors.

Sector Concentration

I've managed to diversify down from 59% energy to just 25%, thanks to selling 80% of my small cap MLPs as part of my deleveraging effort.

(Source: Simply Safe Dividends)

25% is a high sector concentration that is at the extreme end of safe for most people, but a level I'm comfortable with.

(Source: Morningstar)

As you can see, my portfolio has a very low forward P/E of just 13.0. For context, the S&P 500's forward P/E bottomed on December 24, 2018, at 13.7, roughly the typical recessionary bear market bottom valuation.

My portfolio is trading at such levels and Morningstar estimates its weighted valuation (based on conservative DCF models) is 20% below fair value (25% upside to fair value). In the coming weeks, those valuations are going to get even lower based on what I'll be buying.

(Source: Simply Safe Dividends)

The S&P 500's 20-year median annual dividend growth rate is 6.6%. My goal is to have an overall portfolio yield about double that of the market, with long-term dividend growth of 7% (slightly faster than the S&P 500's). Based on the Gordon Dividend Growth Model (highly effective at forecasting dividend stock total returns since 1954), that would ensure market-beating returns.

The portfolio's growth rate over the past decade has indeed been impressive, even in 2018's tax reform-fueled payout boom. The S&P 500's dividend growth over the past year is 9.9%, while I achieved nearly double that.

(Source: Simply Safe Dividends)

If I could maintain a 14.1% dividend growth for decades, my portfolio would become a cash-minting machine and allow me to retire on a fraction of my dividends, even if I never invested another penny.

But even at 6.8% projected dividend growth (over the next five years), that still achieves great income growth. I consider 6% to 10% long-term dividend growth reasonable goals, depending on how you prioritize growth vs. yield and weight your portfolio.

(Source: Simply Safe Dividends)

Portfolio Statistics

  • Annual Net Dividends: $14,452
  • Monthly Average Dividends: $1,204
  • Daily Average Dividends (my business empire never sleeps): $39.59

(Source: Simply Safe Dividends)

  • Portfolio Beta (volatility relative to S&P 500): 1.0 (down from high of 1.29)
  • Dividend Yield: 5.5% (YOC 5.3%)
  • Projected Long-Term Dividend Growth (Morningstar's conservative estimate): 6.8%
  • Projected Annual Total Return (No Valuation Change): 12.3%
  • Morningstar's Estimated Weighted Portfolio Valuation: 20% undervalued
  • Projected Valuation-Adjusted Total Return Potential: 14.6% to 16.9%
  • Margin of Error Adjusted Long-Term Total Return Expected: 11.7% to 20.3%

Bottom Line: Darn The Tariff/Recession Torpedos! Full Speed Ahead!

Don't get me wrong, I'm not blind to the fact that recession risk is rising, according to numerous economists and investment banks.

Morgan Stanley has officially declared the US on "recession watch" based on its proprietary adjusted yield curve (factors out Fed's bond-buying through 2013) and leading economic indicator reports.

Those reports show that even in April before the trade war escalated, service and manufacturing growth was slowing to recessionary levels. In other words, the steadily rising tariffs are only making a weakening economy worse, and even trade deals in the next few months might not stop a recession (and bear market) from beginning in 2020 (or even this year).

Meanwhile, the Cleveland Fed's GDP growth/Recession risk model shows that in May, 12-month recession risk increased to 35%, the highest level in 10 years, and a level consistent with previous recessions. The yield curve averaged -1 basis point during that time and today the best recession forecaster ever discovered sits at -22 basis points right now. In other words, recession risk is now likely 40+% and the bond market is screaming that a recession is coming next year.

But as a long-term investor, who only cares about putting my savings to work in high-quality undervalued companies, I am not afraid. I've constructed a 100% blue-chip bunker portfolio packed with proven track records of safe and rising dividends in all economic conditions (including seven current or future (in 2020) dividend aristocrats and kings).

And, while I'm sure that my 100% stock portfolio is going to be highly volatile (my paper losses will be frighteningly high), I have a simple solution to avoid getting scared out of what I own. I plan to ignore my portfolio value and paper losses for as long as it takes for the correction/bear market to end.

Numerous asset managers (including Ritholtz, JPMorgan Asset Management, Vanguard, Wealthfront, and SigFig) backed by decades of market data say that sticking your head in the sand and trusting in a diversified portfolio of quality companies and proper asset allocation is the best approach to take.

While my asset allocation might be "high risk" for most investors (for the love of god don't mirror my portfolio), given my unique situation (a pension that covers 170% of monthly expenses and $15,000 per month in income from 32 sources), I'm able to sleep very well indeed even during market crashes.

In fact, during May's bloody decline for stocks, I've gotten steadily more excited about the fantastic bargains I am able to put my savings to work in. I'm literally buying blue-chips at Financial Crisis valuations and a bear market might let me pick up even better bargains (the best buying opportunity in a generation).

The historical evidence is clear that the approach I'm using now is a good one, and long-term success is just a matter of time. Because as Buffett famously said

The stock market is designed to transfer money from the active to the patient...We don't have to be smarter than the rest. We have to be more disciplined than the rest."

Disclosure: I am/we are long BPY, ABBV, ET, BIP, NEP, EPR, MPLX, IRM, AM, ENB, SPG, BLK, AOS, AAPL, UNH, MMM, ALB, LAZ, TXRH, BTI, LOW, WBA. 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.