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Dividend growth investing, retirement
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Summary

  • My Dividend Growth Portfolio [DGP] is a real portfolio designed to demonstrate dividend growth investing.
  • The main goal of the portfolio is to generate growing dividends from excellent companies that raise their dividends regularly.
  • The portfolio is managed for income optimization over a very long term. Short-term market noise is generally ignored.
  • Now over 6 years old, the DGP is on track to meet its 10-year income goals.

Overview

The Dividend Growth Portfolio [DGP] is a public, real-money, real-time portfolio that I launched in June 2008. Its purpose is to demonstrate the dividend growth investing strategy. I do not hold it out as the best, or a model. It is simply an illustration of a particular investing strategy in action.

I like to think that it is an important illustration, because it is real. From its inception, it has been created and managed in real time. Thus, it stands as a live counterpoint to the theoretical studies, back-tests, and rear-view-mirror suggestions that are in plentiful supply. Decisions in this portfolio were actually made, and continue to be made, with my own money at risk and an eye toward the future. A monthly report on the portfolio can be found here.

The goal of the DGP is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies. The numerical target is to achieve 10 percent yield on cost within 10 years of inception. I am more interested in the ability of this portfolio to produce income than its sheer size.

The portfolio was created on June 1, 2008. Its initial stake was $46,783. No new money has been added since then. All capital gains and income have been generated as a result of the original amount invested.

Stating the goal in dollars instead of yield on cost, the 10-year goal is to have the portfolio generating income at the rate of $4678 per year by its 10th anniversary in 2018.

Semi-Annual Portfolio Reviews

One of my practices is to give the DGP a checkup twice per year.

The portfolio review is both strategic and tactical. The basic questions are: How is the portfolio doing? Is it heading toward its goal? Should changes be made to keep it on track?

The portfolio reviews are formalized; I capture them on a Word form. What follows are snapshots of that form for this October 2014 review.

Overall Summary

The first two sections describe the portfolio and list the transactions since the previous review in April. (That review was discussed here.)

(click to enlarge)

As you can see, in the last 6 months there have been just four transactions. Two of them were dividend reinvestments of about $1000 each. The other two involved a swap. When an acquisition offer for Lorillard (NYSE:LO) was announced, its price jumped. I sold LO and purchased HCP (NYSE:HCP). The swap kept the number of stocks in the portfolio level at 18.

Stock-by-Stock Examination

Section 3 in the form takes a detailed look at each stock.

(click to enlarge)

(click to enlarge)

I will speak in more detail about some of these stocks later in this article.

Portfolio Dividend Growth

The DGP's 10-year goal is to reach 10% yield on cost within 10 years of inception. In dollars, that is a $4678 per year run-rate on June 1, 2018.

The DGP is on track to achieve its goal. The following table shows how dividends received each year have risen since inception, with projections for 2014 and for the next 12 months.

A few notes about the table.

  • The dollars from 2008-2013 are the actual amounts received.
  • The dollars for 2014 and the next 12 months are projections from the Income Estimator at E-Trade (where the account resides). The estimates are based on information known now. No dividend increases are presumed unless they have already been announced.
  • The projected income increase for 2014 over 2013 is currently +14%. At the time of the last review in April, it was +7%. The projections rise during the year as companies announce dividend increases and dividends are reinvested (producing more dividends).

In the following chart, the red line is the portfolio's goal line, while the blue line shows the actual run rate as of each June 1 through 2014. I have not projected 2015's run rate yet. I will do so in January when I have more real information at hand.

The graph shows that the DGP is on track to meet the 10-year goal in 2018.

Assessments of Each Stock

I examine each stock's performance from the income-centric perspective of the portfolio's goal. The objective is to decide what, if anything, ought to be done with each position.

By far, the majority of actions are to continue to hold each stock. This is a low-transaction portfolio, reflecting that the dividend growth strategy is based on a long-term perspective. I try to own high-quality companies and then exercise patience.

Most of the 18 stocks in this portfolio are doing more or less what I want. Several stocks delivered excellent annual dividend increases this year. These include Alliant (NYSE:LNT) with 9% in January, Coca-Cola (NYSE:KO) 9% in March, Hasbro (NASDAQ:HAS) 8% in April, and PepsiCo (NYSE:PEP) 15% in June.

The weaker links right now are these:

  • BHP Billiton's (NYSE:BHP) 5% and 4% dividend increases the past two years have been disappointing, but I am sticking with it largely because of its healthy 4.4% yield. This is a high-beta stock. If I had it to do over, I might not buy it today. It's not boring enough.
  • McDonald's (NYSE:MCD) has come up with 5% increases two years in a row, which is also disappointing. They have had rough patches in their history before and come through OK, and I believe that will happen again. I don't think the company is facing a massive secular change that will destroy their business model. As they have always done, they will tinker with their food offerings and service model to align with changing customer tastes and competitive challenges.
  • Shaw Communications (NYSE:SJR) is displaying a declining DGR pattern that I don't like: 1-yr DGR < 3-yr DGR < 5-yr DGR < 10-yr DGR. Its 2013 increase was 3%. Its 2014 increase will be known in a month or two. I would like to see it break the declining pattern with a 4%+ increase.
  • AT&T (NYSE:T) keeps raising its dividend $0.04 per year, which means its DGR has fallen below 2% per year. But I like its 5.2% yield. That generates dollars to reinvest, so growth comes that way.

Kinder Morgan

The one stock that I have singled out for special attention is Kinder Morgan Energy Partners (NYSE:KMP). As you probably know, Kinder Morgan announced in August that KMP will be bought out by Kinder Morgan Inc. (NYSE:KMI) later in the year. This is a forced sale for me as a KMP unitholder. I had no intention of selling KMP on my own.

At the current time, my plan is simply to hold onto KMP until the acquisition is made, and then to accept the KMI shares plus cash that I will receive when the deal is done. The reorganization creates a taxable capital gain situation. There appears to be no tax advantage to selling early.

The terms of the plan are to issue 2.1931 KMI shares plus $10.77 per KMP unit. The announcement caused an immediate price run-up in KMP shares, which was nice, but my main interest is the impact on income. The table below compares my estimated final distribution from KMP in October to the probable first distribution from KMI in January. To make these calculations, I assumed:

  • KMP distribution in October at a penny more per unit than in July.
  • Replacement of KMP units with KMI shares at the 2.1931 exchange rate (probably in December).
  • KMI payout in January at a penny more per share than in July.
  • Using the cash kicker to purchase more shares of KMI. (There is no way of knowing what the price will be at that time, so I used today's intra-day price to make the estimate.)

KMP units

Estimated

Distribution

KMI shares

Estimated

Distribution

October 2014

55

$77.00

0

0

January 2015 (no additional purchase)

0

0

120

$52.80

January 2015 (with additional purchase)

0

0

136

$59.84

From this calculation, it appears that I will experience a 22% drop in income from my Kinder Morgan position after the reorganization. However, the company has made encouraging pro-forma projections for KMI's future dividends.

  • First, they have estimated that KMI's dividend will increase 16% in 2015 compared to 2014.
  • Second, they project that KMI's dividend will increase 10% per year for the following 5 years.

(click to enlarge)

[Source: Kinder Morgan Presentation]

KMI does not have a long dividend history, since it just came public in 2011. Because of its short life, KMI is not on the CCC list nor has it ever been a Top 40 dividend growth stock eligible for my own purchase. However, it is a near-contender on the CCC, as its dividend history shows uninterrupted annual dividend increases since 2011, and logically I expect that pattern to continue.

The bottom line is that I expect to suffer an approximate 20% drop in income from this position after the exchange, but with a significantly faster dividend growth rate in 2015 and subsequent years.

Reinvesting Dividends

I reinvest the dividends in this portfolio, but I don't drip them. I accumulate them to $1000 cash, then buy a stock I am interested in. (See this article for a discussion of why I accumulate incoming dividends and then make selective purchases. It comes down to valuation.)

A purchase with accumulated dividends could be more of a stock that I already own, or it could be a new position. Reinvesting dividends accelerates overall dividend growth in the portfolio each year beyond what you would get from dividend increases alone. The compounding effect of reinvestments is why the blue and red lines in the earlier graph curve upward.

Since the last review in April, I made two dividend reinvestments:

  • In May, I created a new position by purchasing Ventas (NYSE:VTR), a senior housing and healthcare REIT. You can read an article about the purchase here.
  • In September, I added to an existing position in Procter & Gamble (NYSE:PG). My reasoning is described in this article. PG has been a Top 40 Dividend Growth Stock every year since I began publishing the eBook in 2008.

I love to go shopping with accumulated dividends. As of now, I think I will fall just short of making another dividend reinvestment in 2014, so I expect the next one will take place in January 2015.

I am on a long-term mission to increase the DGP's diversification, so 2015's reinvestments will probably include one or two new positions to bring the total number to 20.

Total Performance

Total return is a secondary goal of the DGP. I want it to be competitive with the general market while meeting my primary income goals.

I compare the DGP to the S&P 500 for my own general interest, and because lots of readers seem to appreciate the comparison. Beating the S&P 500 -- what many call alpha -- is not a specific goal.

That said, the DGP has been ahead of SPY (representing the S&P 500) since inception. Both portfolios are depicted with dividends reinvested.

Postscript

Over the years writing about dividend growth investing, it has been interesting to hear from commenters and contributors who do not accept the validity or logic of investing for income optimization. Almost invariably, they switch the conversation to maximizing total return, which they believe is the only valid goal of investing.

That happens over on Morningstar, too. Christine Benz is their principal retirement writer. She does great work, but her attempts to model dividend investing fall short, in my opinion. A commenter (who is an RIA and goes by "Orygunduck") left this comment on one of Benz's recent articles.

Many advisors and commenters revert to measuring success exclusively by portfolio valuation. In the income-optimization approach, the changes in the price of the income securities held DOES NOT MATTER...only the ability of the company to pay the dividend matters. [In other words], you cannot measure the effectiveness of the true income approach through portfolio valuation metrics.

And none of the 3 methods you've described is a pure income approach. So let me offer you one...

"The Pure Income Method: A portfolio of at least 30 income producing securities pay interest and/or dividends that are collected each month. Over 12 months, the amount collected in interest and dividend by the original investment amount is the yield the portfolio provides. So if the retiree begins with $800,000 invested in 40 income securities, and these pay during the year $31,040, then the yield to the income investor is 3.88%. The next year, if the dividends paid for that have increased to $33,336, then the retired investor who requires this income will have a yield-on-cost of 4.08% and a dividend growth rate...for that first year....of (33,336 - 32,040) / 32,040 = 4.04%.

What has been the portfolio valuation change over this period? With few exceptions, it does not matter. Huh? Doesn't this approach violate every rule of investing? The price change doesn't matter?!? What!! Well ... [no] it doesn't, and here's why. If prices of the securities have gone up and I sell to 'take profits', what will I do with the proceeds, net of income tax due (for taxable accounts) and trading costs? I've decreased the income of the portfolio that I now must replace. If I go out into the marketplace, I can purchase another income security of equivalent income risk, but...hey...it went up in price too!! So to replace the lost income I'm now going to have to seek out higher yields which almost always means higher income risk (note: preferred stock and other very thinly traded income securities can be an exception to this). So the act of 'taking profits' just reduced my household income or increased the income risk of it...which violates my retirement investment goal. [In other words], I've gained nothing.

Now, this is not to say that a total return approach should not be used. What I am saying is the pure income approach is a method with more dissimilarities to a total return approach than similarities...and if a pure approach is used, it should be done using only measures of dividend sustainability...not price fluctuation.

I do not agree with all of this comment, but it largely reflects my own thoughts. Clearly the commenter is trying to convey the difference between total return from an approach focused on income. The latter is the method that I am focused on in this portfolio.

I would not use a term like "pure income approach," and I don't think the example of selling is well thought out. (One may sell an overvalued stock and replace it with an undervalued stock with a better yield, for example.)

But I hope that Orygunduck reads over here, too, and that he or she gets involved in the discussions here. There are not many investment advisors that understand or utilize dividend growth strategies, so I would like to add that person's voice to the discussions here.

Disclosure: The author is long BBL, CVX, HAS, HCP, JNJ, KMP, KO, LNT, MCD, MSF, O, OHI, PEP, PG, PM, SJR, T, VTR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Dividend Growth Portfolio Fall Checkup And Semi-Annual Review