Recently, I was approached by a friend who asked for help constructing a portfolio of dividend growth stocks. My friend has a Roth IRA that is invested in a S&P 500 index fund at the present time. He is planning to retire and wants to begin taking monthly withdrawals from the account. He is concerned about the potential for a stock market correction in the near future and is considering converting a portion of the S&P 500 Index Fund, which has a high percentage of its assets in mega cap tech stocks, to a less volatile DGI portfolio comprised of individual stocks that will provide a safe and steady source of monthly income.
I began by running a screen on Simply Safe Dividends for stocks with a dividend yield of 2.50% or higher that were rated VERY SAFE or SAFE (61 points or higher) by SSD. Then I ran a second screen on Morningstar for stocks rated 3 Star or higher. Morningstar considers 4 & 5 Star stocks undervalued and 3 Star stocks to be "Trading within a range we consider fairly valued." I compared the two screens and compiled a list of stocks that appeared on both.
The list of stocks was quite long. I narrowed it down considerably by eliminating stocks with a DVK Quality Snapshot score below 17. What remained were investment quality stocks that Morningstar considered reasonably valued.
When I look at stock valuations, I always consult multiple sources and then look for consensus. In addition to Morningstar, I checked Dividend Radar and Value Line. I removed any stock that was more than 10% above Dividend Radar's estimate of Fair Value or Value Line's 18 Month Target Price Midpoint. When I showed the results to my friend, he had two concerns. First, he was disappointed that there weren't more names from the list of Highest Quality Dividend Growth Stocks on the list. We discussed valuation and my friend decided that he was willing to accept a slightly lower dividend yield and also pay a little above fair value for the very best blue chip names. When I reduced the minimum dividend yield to 2.40% and relaxed the valuation requirements a little, Johnson & Johnson (JNJ) Pepsi (PEP) and Coca-Cola (KO) all qualified for inclusion.
My friend's second concern was that he didn't have exposure to all sectors of the market. There were no REITs or Materials stocks on the list. So we added the highest rated stock from those two sectors. Realty Income (O) and Air Products and Chemicals (APD) to address that issue. The final list of 33 stocks, sorted by DVK Quality Snapshot score, is posted in the table below. In addition to the DVK Quality Snapshot score, the table shows the current dividend yield, % above/below the average five year dividend yield, Simply Safe Dividends Safety Score and the Morningstar Valuation Rating for each stock.
Stock |
Ticker Symbol |
DVK Score |
Yield |
5 Yr Ave Yield |
SSD |
M* Rating |
Johnson & Johnson |
JNJ |
25 |
2.42% |
in line (9% off) |
99 |
3 star |
Intel |
INTC |
24 |
2.60% |
in line (3% off) |
96 |
4 star |
Lockheed Martin |
LMT |
24 |
2.92% |
12% above |
84 |
4 star |
Merck |
MRK |
24 |
3.37% |
12% above |
99 |
4 star |
Sanofi |
SNY |
24 |
2.62% |
in line (5% off) |
90 |
4 star |
PepsiCo |
PEP |
24 |
2.74% |
in line (6% off) |
93 |
3 star |
Bristol-Myers Squibb |
BMY |
23 |
2.99% |
in line (2% off) |
79 |
3 star |
3M Corp |
MMM |
23 |
3.05% |
in line (8% off) |
75 |
3 star |
Coca-Cola |
KO |
23 |
2.96% |
below (10%) |
80 |
3 star |
Air Products & Chem. |
APD |
23 |
2.24% |
in line (5% off) |
95 |
4 star |
Atmos Energy |
ATO |
22 |
2.56% |
15% above |
97 |
4 star |
Pinnacle West Capital |
PNW |
22 |
4.30% |
25% above |
92 |
4 star |
Toronto-Dominion |
TD |
22 |
3.78% |
in line (0% off) |
80 |
3 star |
Unilever plc |
UL |
22 |
3.62% |
16% above |
75 |
3 star |
Verizon |
VZ |
22 |
4.62% |
in line (4% off) |
87 |
3 star |
WEC Energy |
WEC |
22 |
2.82% |
in line (9% off) |
87 |
3 star |
Am. Electric Power |
AEP |
21 |
3.27% |
in line (4% off) |
81 |
3 star |
Clorox |
CLX |
21 |
2.74% |
in line (8% off) |
75 |
3 star |
Kellogg |
K |
21 |
3.66% |
in line (6% off) |
66 |
4 star |
Consolidated Edison |
ED |
20 |
4.06% |
11% above |
90 |
3 star |
Gilead Sciences |
GILD |
20 |
3.95% |
12% above |
70 |
4 star |
General Mills |
GIS |
20 |
3.53% |
in line (1% off) |
69 |
3 star |
Hasbro |
HAS |
20 |
2.74% |
in line (1% off) |
80 |
3 star |
M&T Bank |
MTB |
19 |
3.17% |
31% above |
99 |
4 star |
J.M. Smucker |
SJM |
19 |
3.28% |
10% above |
96 |
3 star |
Campbell Soup |
CPB |
18 |
3.44% |
14% above |
70 |
4 star |
Chevron |
CVX |
18 |
5.50% |
36% above |
65 |
4 star |
Sempra Energy |
SRE |
18 |
3.30% |
in line (7% off) |
79 |
3 star |
Abbvie |
ABBV |
17 |
4.66% |
in line (0% off) |
70 |
3 star |
Cardinal Health |
CAH |
17 |
3.66% |
in line (4% off) |
74 |
4 star |
ConocoPhillips |
COP |
17 |
3.06% |
34% above |
61 |
4 star |
Sun Life Financial |
SLF |
17 |
3.39% |
in line (6% off) |
89 |
3 star |
Realty Income |
O |
17 |
3.91% |
below (11%) |
70 |
3 star |
The stock valuation metrics are summarized in the table below. As I mentioned previously, in addition to Morningstar, I also looked at valuation estimates from Dividend Radar and Value Line. A Price to Fair Value Ratio was calculated using Morningstar's Fair Value Price and Value Line's 18 Month Target Price Midpoint along with Dividend Radar's estimate of Fair Value. Closing stock prices from Friday 9/3/21 were used for the calculations.
Stock |
Stock |
Fair Value |
Midpoint |
Price to FV |
Price to FV |
Price to FV |
Price |
Morningstar |
Value Line |
Morningstar |
Value Line |
Div Radar |
|
ABBV |
111.62 |
108.00 |
146.00 |
1.03 |
0.76 |
0.85 |
AEP |
90.41 |
89.00 |
100.00 |
1.02 |
0.90 |
1.01 |
APD |
268.28 |
316.00 |
360.00 |
0.85 |
0.75 |
1.24 |
ATO |
97.50 |
108.00 |
118.00 |
0.90 |
0.83 |
1.00 |
BMY |
65.61 |
68.00 |
76.00 |
0.96 |
0.86 |
0.63 |
CAH |
53.64 |
60.00 |
58.00 |
0.89 |
0.92 |
0.86 |
CLX |
169.51 |
161.00 |
226.00 |
1.05 |
0.75 |
1.00 |
COP |
56.24 |
69.00 |
52.00 |
0.82 |
1.08 |
1.00 |
CPB |
43.05 |
48.00 |
54.00 |
0.90 |
0.80 |
n/r |
CVX |
97.49 |
115.00 |
119.00 |
0.85 |
0.82 |
1.00 |
ED |
76.30 |
78.00 |
83.00 |
0.98 |
0.92 |
1.00 |
GILD |
71.96 |
81.00 |
74.00 |
0.89 |
0.97 |
1.00 |
GIS |
57.77 |
62.00 |
66.00 |
0.93 |
0.88 |
n/r |
HAS |
99.36 |
93.00 |
111.00 |
1.07 |
0.90 |
1.00 |
INTC |
53.51 |
65.00 |
51.00 |
0.82 |
1.05 |
1.00 |
JNJ |
175.04 |
167.00 |
190.00 |
1.05 |
0.92 |
1.01 |
K |
63.44 |
83.00 |
68.00 |
0.76 |
0.93 |
0.99 |
KO |
56.73 |
58.00 |
62.00 |
0.98 |
0.92 |
1.07 |
LMT |
356.00 |
425.00 |
428.00 |
0.84 |
0.83 |
0.94 |
MMM |
194.39 |
195.00 |
213.00 |
1.00 |
0.91 |
1.00 |
MRK |
77.23 |
94.00 |
92.00 |
0.82 |
0.84 |
1.00 |
MTB |
138.96 |
156.00 |
140.00 |
0.89 |
0.99 |
n/r |
O |
72.30 |
71.00 |
76.00 |
1.02 |
0.95 |
1.02 |
PEP |
157.09 |
153.00 |
175.00 |
1.03 |
0.90 |
1.08 |
PNW |
77.18 |
88.00 |
94.00 |
0.88 |
0.82 |
0.96 |
SJM |
120.61 |
125.00 |
121.00 |
0.96 |
1.00 |
0.99 |
SLF |
51.67 |
54.00 |
62.00 |
0.96 |
0.83 |
n/r |
SNY |
52.13 |
59.00 |
49.00 |
0.88 |
1.06 |
n/r |
SRE |
133.41 |
136.00 |
157.00 |
0.98 |
0.85 |
0.93 |
TD |
65.83 |
70.00 |
62.50 |
0.94 |
1.05 |
0.94 |
UL |
55.15 |
59.00 |
64.00 |
0.93 |
0.86 |
n/r |
VZ |
55.43 |
57.00 |
60.00 |
0.97 |
0.92 |
0.86 |
WEC |
96.08 |
92.00 |
110.00 |
1.04 |
0.87 |
1.06 |
I created a model portfolio on Simply Safe Dividends based upon an equal weighting of these 33 stocks. Since one of the screening criteria was the SSD dividend safety score, I wasn't surprised to learn that 100% of the dividends were considered safe by SSD. According to SSD, the dividend yield of the portfolio is 3.36% and the Beta is under 0.60. The average dividend growth for the portfolio over the last 5 years was 6.1% per year.
Overall, I am reasonably satisfied with the results of this exercise. From a quality standpoint, almost 40% of the stocks are on the list of Highest Quality Dividend Growth Stocks and every stock on the list is considered investment grade. From a valuation standpoint, there are a lot of blue chip dividend stocks that appear to be reasonably priced. A number of stocks including Bristol Myers (BMY) Kellogg (K) Sempra Energy (SRE) and Verizon (VZ) are considered undervalued by all three rating sources while Chevron (CVX) ConocoPhillips (COP) and M&T Bank (MTB) stand out as having current dividend yields well above their five year average. Merck (MRK) Con Ed (ED) Gilead (GILD) J.M. Smucker (SJM) and Atmos Energy (ATO) are rated at or below fair value by all three sources and have current dividend yields above their five year average while Lockheed Martin (LMT) Pinnacle West (PNW) Campbell Soup (CPB) and Unilever (UL) are considered undervalued by all valuation metrics and have yields above their five year average.