Mid-Year Dividend Income-Growth Portfolio Rebalance: 4.6% Yield And Lower Beta

by: Jeff Paul


One year ago, I created a Dividend Growth (DG) model portfolio focused on Income Growth. It sought a 4%+ yield and lower beta by screening the DG universe using criteria including yield, dividend growth rate (DGR), earnings growth, and payout ratio. While income and income growth were the focus, my own goal was to also achieve higher total return than the overall stock market. The DG-IncomeGrowth model started with $300,000 on August 16, 2011, and has met its goals by outperforming the S&P (NYSEARCA:SPY) and S&P Dividend ETF (NYSEARCA:SDY) over the last year and having a beta of 0.65. The portfolio is generally passive, though I replace stocks that cut their dividend or that trigger a -20% stop-loss rule. The portfolio was rebalanced last in February 2012 and I intended to perform annual rebalances. However, after reading research that found rebalancing beneficial for value-oriented portfolio yields and returns, I decided to rebalance this portfolio and will shift to 6-month rebalances in the future.

Inception performance

Performance Review

Looking at the 30 stocks in this portfolio, there was just one with negative returns exceeding -5% since the February rebalance, Microchip Technology (NASDAQ:MCHP), which was down 8%. This stock mainly declined in May when it announced an acquisition. On the flip side, 9 of the 30 stocks gained over 10% each, particularly some popular large-caps, utilities, and telecom stocks.



%Gain since Feb 2, 2012







Abbott Lab






Magellan Midstream



UGI Corp



NextEra Energy



Several of these stocks are no longer in the portfolio after this rebalance, as they were replaced with higher-yielding stocks. This is one way that rebalancing is beneficial - it sells the stocks that have had large run-ups in price, and therefore have lower current yields, and replaces them with higher-yielding alternatives.

The Screening Process

This section outlines my screening process. I have tried to make it as objective as possible; readers should be able to replicate the results. The number in brackets indicates the number of stocks remaining after each filter step. The screening process for these models relies on David Fish's CCC list, so again, thank you to him for putting it together each month!

  • I began with the August 31 CCC list, combining the champions and contenders, which have 10 or more years of consistent dividend growth. I also included stocks with nine years of DG from the Challengers list. I wanted a slightly larger universe, as I plan to tighten some of the criteria to ensure more of a value-orientation than in the past. [324 stocks in total]
  • I sorted the list by Market Cap, and removed those with a market cap less than $500MM. This portfolio seeks mid- and larger-cap firms for more stability. [273 remain]
  • I sorted the remaining list by current yield, and proceeded to remove stocks with a yield less than 2.5%. [158] U.K. research found that higher-yielding stocks tend to outperform, and also, the purpose of this portfolio is to provide investors with a decent yield as well as growth. Individual readers could choose a higher cut-off, but ultimately, I reviewed survivors starting with higher yielders anyway.
  • I sorted the remaining list by 5-yr Dividend Growth Rate [ DGR ] and removed all stocks with a DGR < 4%, since this portfolio seeks equities that are growing their dividend at a decent rate. [127]
  • From this list, I removed Unilever NV (NYSE:UN) because it is the same as Unilever plc (NYSE:UL) and BHP Billiton Ltd (NYSE:BHP), which is the same as BHP Billiton plc (NYSE:BBL). BBL and UL are preferable because the UK does not withhold taxes on dividends to U.S. shareholders. [125]

Screened Group Characteristics

The 125 stocks that survived the screening process had an average yield of 3.89% (close to the 4% that many DG investors look for), and 1-, 3- and 5-year DGRs of 10.2%, 8.8% and 11.5%. For comparison, the original 324-stock universe had an average yield of 3.00%, with respective DGRs of 10.5%, 8.9% and 10.9%. So we have generally retained the dividend growth rates, but raised the yield by 89 basis points. I proceeded to add a sector tag for each stock, sort the stocks into sector groups and then by yield. The table below shows the group characteristics.

Group Statistics

I calculated the percentages for each sector based on market cap and by representation (count). Since there is a difference between the percentage by count and percentage by market cap, I averaged the two values to obtain a weighting for this portfolio. This average weighting was then used to determine how many of the 30 stocks would be allocated to each sector.

Relative to the September 3, 2012 S&P weightings, the portfolio is heavier on consumer staples, energy, telecom, materials and utilities. It is noticeably lighter on technology, consumer discretionary and financials. This allocation helps to explain the lower beta and lower standard deviation of weekly returns of this portfolio. It also contributes to the higher yield, as some of the higher-yielding DG stocks reside in the telecom, utilities and energy sectors.

Stock Selection

To decide which stocks to select from the screened list, I added columns for Yield, 5-yr DGR, 1-yr DGR, Payout and 2012 EPS Growth Rate, and assigned point values to help me compare the stocks. More points are better!

4 pts

3 pts

2 pts

1 pt

0 pts



3.8%<= x < 5%



n/a; already removed lowest yielders







NY Earnings Growth Rate


10% to <15%

5% to <10%

0% to <5%


DGR 1-yr


10% <= x < 14%

6% <= x <10%



DGR 5-yr


10% <= x < 14%

6% <= x <10%



The stocks in each sector were ranked based on Yield, followed by 5-yr DGR. The 1-yr DGR was used as a tie-breaker if two stocks had the same yield and 5-yr DGR rankings. Likewise, the EPS Growth metric was used as a tie-breaker. The payout metric served to verify value. Any non-MLP, non-REIT stock with a payout over 80% underwent two checks. First, I looked up the estimated earnings for the next year and required that the forward payout ratio be under 80%. For example, Leggett & Platt (NYSE:LEG) failed this test and was removed from consideration. Next, I checked operating cash flows and required that the dividend payout be covered by these cash flows for at least three of the last four quarters. This second test applied to MLPs and REITs as well.

With this information, I proceed to select stocks from each sector, starting with those that had the highest yield and 5-yr DGR combinations. If the payout ranking was a zero, I verified the cash flow and future payout ratio, and removed the stock if it did not pass these tests. Before final acceptance, I performed my -20% stop-loss test to see if the stock's performance was 20% below the S&P's for four consecutive weeks since its last dividend increase. If the stop-loss was triggered, the stock was removed from consideration. This process was repeated until the quota for that sector was reached. The final list of 30 stocks is presented in the chart below.

DG Income Growth Rebalanced portfolio

Portfolio Observations

The final portfolio has an average yield of 4.59%, an 11.4% increase over the pre-rebalance yield. Its 1-, 3- and 5-yr DGRs are 10.3%, 9.2% and 12.6% respectively, which are slightly higher than the screened universe's traits. Compared to the SPY, SDY and my other DG models, this portfolio has the highest yield and lowest beta.

Portfolio comparison

Of the 30 stocks, 13 are new to the portfolio. In general, stocks with higher yields replaced the stocks that were sold. The Utilities, Industrials and Materials sectors experienced the highest turnover, with just UniSource Energy remaining in the portfolio. The shift from RPM International (NYSE:RPM), a chemical company, to BHP Billiton and Nucor (NYSE:NUE) raised the portfolio beta a few notches, but also increased the income stream.

In the rebalance for the DG-HYLP (high yield, low payout) model, I included a Yield-Payout matrix that showed most stocks concentrating in the high-yield/low-to-medium payout region of the table. For comparison, the DG-IncomeGrowth stocks mostly occupy the high-yield/high-to-medium payout region, providing higher portfolio yield, but less protection in terms of dividend coverage by earnings.

High Payout (>60%)

Medium Payout
(45% to 60%)

Low Payout
(< 45%)

Medium Yield
(2.1% to 3.5%)

Northrop Grumman (NYSE:NOC)

High Yield (3.5%+)

Meredith Corp (NYSE:MDP)

Heinz (HNZ)

Kimberly-Clark (NYSE:KMB)


Altria (NYSE:MO)

Plains All American (NYSE:PAA)

Kinder Morgan Partners (NYSE:KMP)

Alliance Resource Partners (NASDAQ:ARLP)

TC Pipelines LP (NYSE:TCP)

National Health Inv (NYSE:NHI)

Omega Healthcare Inv (NYSE:OHI)

Johnson & Johnson (NYSE:JNJ)

Novartis (NYSE:NVS)

Waste Mgmt (NYSE:WM)

Microchip Tech



UNS Energy

Avista Corp (NYSE:AVA)


Sysco Corp (NYSE:SYY)

Conoco Phillips (NYSE:COP)

Community Bank System (NYSE:CBU)

Astrazeneca plc (NYSE:AZN)

Lockheed Martin (NYSE:LMT)

Shaw Comm (NYSE:SJR)



BHP Billiton

Tax Considerations and Substitutions

While I like the diversity that the foreign ADRs and MLPs add to the portfolio, they can also add some tax considerations. I'm not an accountant, so if others have more accurate information, please post it.

  • UL and BBL should be fine, as the U.K. does not withhold taxes on U.S. investors.
  • SJR should be fine for an IRA, as Canada does not withhold taxes on IRA dividends.
  • NVS is Swiss, and from what I've read, an investor can submit a claim for withholdings above 15%, plus you can claim a U.S. tax credit for the rest (non-IRA).
  • Investors can purchase Kinder Morgan's (NYSE:KMR) shares instead of KMP to avoid UBTI tax issues in an IRA.

Next Steps

I have updated my virtual IncomeGrowth portfolio with the new holdings as of the closing prices on September 3, 2012. The total account value was $378999.60, so approximately $12,630 was invested in each of the 30 stocks after commissions (~$358). I will continue to track this portfolio and report on its performance relative to the S&P , S&P Dividend ETF , and the other DG model portfolios. The next full rebalance will occur in February 2012, unless there are major market movements before then. If any stocks cut their dividend, get bought out, or exhibit the -20% gap rule, they will be removed and replaced with another stock from the same sector based on the screening process.

I welcome feedback on this screening and selection process, as I continue to refine it based on comments, observations and new learning. I hope SA members find the process and the recommended list useful for identifying potential candidates for their portfolios.

Disclosure: I am long KMB, COP, KMR, ARLP, CBU, NHI, INTC, BBL. 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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