This article first appeared on Dividends & Income
My public, real-life Dividend Growth Portfolio (DGP) is “mature.” It has been in existence for over 12 years, and it has reached its original dividend goals.
Based on almost $47,000 invested in 2008 (and no new capital since then), the DGP’s dividend cashflow is more than $4700 per year, or more than 10% yield on my original investment. The annual rate of cashflow growth the past few years has generally been over 10% per year.
While the basic portfolio has been built, I am not drawing off dividends as spending money yet. Rather, I’m still reinvesting dividends.
That means this portfolio is still in its accumulation stage.
With a dividend reinvestment coming up later this month, I decided that I should look for weak spots – or over-weighted spots – in terms of the DGP’s diversification and safety, so I can take those into account for future purchases.
Diversification and Safety Categories
I have often described the DGP as “well rounded.” I try to be diversified across yields, dividend growth rates, industries, and so on.
For this review, I identified three characteristics that contribute to the kind of diversification I want:
- Current yield
- Dividend growth rate (trailing 5 years)
- Sector
I also identified two other characteristics where I want a definite tilt toward safety and conservatism:
- Dividend safety (per Simply Safe Dividends)
- Defensiveness (per Morningstar and GICS classification)
So those are the factors that I will be focusing on in this article.
Evaluating the Factors
Yield and dividend growth rate
To “score” yield and dividend growth rate, I use a slight modification of the approach I use when evaluating stocks as shown in DGI Lesson 14. It’s a sliding scale that interprets yield and DGR in relation to each other.
The idea is that it’s OK for a high-yielding stock to have a slow growth rate, and so on.
Sector
In this article, I use the GICS classification system (a joint product of MSCI and S&P Global) to categorize stocks as to their economic sectors.
Defensiveness
Many dividend growth investors, trying to be conservative and avoid drama, focus on “defensiveness.” What does that mean?
Morningstar has its own industry classification scheme, with industries segmented into Sectors, which themselves are grouped into Super Sectors.
Their Defensive Super Sector includes industries that are relatively immune to economic cycles. These industries provide services that consumers require in both good and bad times. They state that in general, the stocks in these industries have betas of less than 1 (meaning that their prices are usually less volatile than the S&P 500).
Morningstar’s Defensive Super Sector consists of the following Sectors:
- Healthcare
- Utilities
- Consumer Defensive
The latter sector – Consumer Defensive – seems identical to what investors usually call Consumer Staples: Food, tobacco, toilet paper, and the like. The idea is that these are the last things that consumers will cut back when their financial lives get tough.
In this article, I use the GICS classification system to assign stocks to Sectors, and I use the three Morningstar Sectors (with Consumer Staples as a proxy for Consumer Defensive) to categorize stocks as Defensive or not.
Dividend Safety
I use Simply Safe Dividends’ classification of its Dividend Safety Scores.
Rating Grid
With those preliminaries out of the way, I put all 26 of the DGP’s companies into the following grid. I will explain the colors after the display.
GICS Sector
All of the Defensive holdings are a shade of green.
The other colors in this column are only to distinguish different sectors. I hold stocks from 9 of the 11 GICS sectors.
Beta
Green indicates stocks with betas less than 1.0. There are 12 such stocks of the total of 26 in the portfolio.
Yield and Dividend Growth Rate
Yield and dividend growth rate are colored per the sliding scale described earlier.
Two stocks (Hasbro and Lowe’s) have frozen dividends, so I colored their DGRs orange rather than based on their DGR.
SSD Dividend Safety
In the SSD Dividend Safety Score column, I used dark green to shade stocks in the Very Safe category and light green for Safe.
Percent of Annual Income
In the last column, I show what percentage of dividend income each position supplies. No colors.
The percentage of income from various positions runs from less than 1% to one stock that exceeds 10%
What I Learned
This exercise turned out to be very instructive. Here are the major things I learned about the DGP.
(1) With just 26 stocks, the portfolio is well-rounded in terms of economic sectors. Nine of the 11 sectors in the GICS system are represented.
(2) There is not a high concentration in Defensive stocks. There are 10 such stocks accounting for 45% of the portfolio’s income. I may want to focus on raising that percentage over time, but see point #4 below.
(3) All of the Defensive sectors have betas equal to or beneath the S&P 500’s beta. That means they tend to be no more volatile than the market, and sometimes less. That observation comports with Morningstar’s idea that Defensive stocks tend to be less volatile than the market.
(4) But if we look at SSD’s Dividend Safety Scores as another indicator of Defensiveness, we see that many stocks outside the three designated Defensive sectors have Safe or Very Safe dividends. Here are a few examples:
- Cisco in the Information Technology sector has a beta of 1.0 and a Very Safe dividend score of 91.
- Digital Realty Trust in the Real Estate sector (which specializes in info-tech real estate) has a beta of 0.9 and a safety score of 94.
- General Dynamics, a defense company in the Industrials sector, has a beta of 1.0 and a safety score of 97.
These examples make me think that the three-sector concept of what makes a stock “defensive” is too narrow.
I am especially wondering whether technology has become so embedded in our modern lives that some technology stocks fit the Defensive concept that they provide services that consumers require in both good and bad times.
I’m also thinking that if a stock has a beta less than 1.0, and/or a Dividend Safety Score in the Very Safe category, it can be considered “defensive” for my purposes.
(5) Only one position (AT&T) accounts for more than 10% of the portfolio’s income. I don’t plan to invest more in that stock. As I invest in other stocks, that proportion will come down naturally, especially as AT&T’s dividend, while large, is slow-growing.
(6) Eight of the positions are “high yield” as defined by me, meaning yields greater than 4%. They account for 44% of the DGP’s income. That strikes me as a little high proportion, because high-yield stocks are often accompanied by lower safety scores than in the rest of the portfolio.
Since I have already achieved the portfolio’s income objectives, I will probably be looking to lower yield categories – hopefully with higher safety scores, faster dividend growth rates, and acceptable amounts – for most of my future purchases.
Impact on Future Decisions
I have always looked for well-valued stocks to purchase, and I do not intend to ignore valuations to go after the “types” of stocks that I want.
Rather, I will try to obtain those types when they are well-priced. I may be willing to relax my valuation standards slightly to add shares of companies that fit my desired tilt towards quality, defensiveness, and safety.
As I said, I have a dividend reinvestment coming up shortly in August. We’ll see how the learnings from this review impact that decision.
Looking at stocks already in the portfolio, these stocks seem to fit the type that I will be looking for: Cisco (CSCO), Digital Realty Trust (DLR), General Dynamics (GD), Johnson & Johnson (JNJ), PepsiCo (PEP), Pinnacle West Capital (PNW), Procter & Gamble (PG), Smucker (SJM), and Verizon (VZ).
Of course, I may look outside the portfolio for a new candidate too. I’ll let you know as soon as I decide what to add to the DGP next.
— Dave Van Knapp
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Source: Dividends and Income