Damn Fed.

I was all set to buy more shares of Schwab’s U.S. Dividend Equity ETF (SCHD), because I was going to be able to get the shares at a price just within what I consider to be SCHD’s fair-value range. I was simply waiting an extra day for a couple more dividends to be credited to my account.

I had spent hours … days! … preparing this article so that I could quickly submit it for publication right after the purchase. I would just need to plug in final numbers and copyread it after I bought the shares.

But nooo. On Wednesday, December 15, the Fed announced both that it was leaving interest rates unchanged for now, but also that it would accelerate its tapering of support for the economy.

The market was still open, and it reacted instantly to this news. Stock prices shot up, and SCHD sailed right into over-valued territory.

I could have faked it, but my Dividend Growth Portfolio (DGP) is meant to be an educational demonstration of dividend-growth investing. I want to show how best practices can be applied in the real world.

One practice that I consider to be important is not to invest in over-valued stocks or ETFs, even by just a little.

So I switched my choice to a high-quality stock that is still undervalued even after the market flare-up.

My new choice is Merck (MRK), the pharmaceutical giant.

Why Merck?

Buying more shares of Merck allows me to expand an existing, small, high-quality position in my portfolio.

Here’s what Merck looked like before I made this reinvestment:

As you can see, I started the position in May this year, and I have added to it 3 times since then. All the purchases have been small, and I now have 28 shares that comprise 1.2% of the DGP.

Merck is a very high-quality company. Here is its Quality Snapshot:

Merck gets 24 points, just 1 short of the top score possible. Here is a quick look at the company itself:

Merck yields 3.7%, which is near the top of the mid-range category. The company recently declared a 6.2% dividend increase that will be paid starting in January. The increase puts its annual dividend-growth streak at 10 years.

Merck’s Very Safe dividend rating from Simply Safe Dividends (99/100 points) was just re-affirmed in November, and we’ve already seen that its Quality Snapshot is stellar.

That brings us to valuation. Merck’s price has been stagnant for several years, even though its profits per share have been growing, as shown by the yellow highlights across the bottom of the next chart from FASTGraphs.

I don’t understand why the market does this sometimes, but it creates one of my favorite scenarios for buying stocks: Growing profits + flat price.

I calculate valuation in 4 ways, then take the average. For Merck, after running the numbers, I conclude that the stock is 18% undervalued. There was agreement across my 4 methods that Merck is undervalued.

Let’s translate that to dollars and yields.

The Purchase

On Thursday, December 16, I was able to get my new shares at $76.23, well within discounted range and at a yield of 3.7%.

I could have gotten them a buck cheaper when the market opened, but I was out running errands. Like I said, this is a real-life portfolio.

The annual dividend added by the new shares (last column) is the annual dividend run-rate of the 7 shares computed forward from Merck’s new quarterly payout.

Here is Merck’s position in the portfolio with the new shares added:

Today’s purchase is highlighted near the bottom. At the top, also highlighted, the addition of 7 shares brings Merck up to 35 shares and a 1.5% position size in the portfolio.

Merck is still a small position, so my intent is to keep adding to it so long as I can get it at a fair or discounted price.

Portfolio Update

Here is the reinvestment’s impact on my portfolio’s annual rate of incoming dividends:

The additional $19 in annual income bumps the portfolio’s yield on cost to 11.6%. That is a new record high. It means that the portfolio is sending me cash dividends at the rate of 11.6% per year of the amount that I originally used to start the portfolio back in 2008. Isn’t that cool?

I do not add new capital to the portfolio ever, so I often emphasize that there are three remaining reasons that my Dividend Growth Portfolio’s income goes steadily up:

(1) Dividend increases: Companies raise their dividends. Four companies in the DGP have already announced increases that will take effect in 2022, including Merck.

(2) Dividend reinvestments: I reinvest accumulated dividends every month.

(3) Occasional adjustments: Every so often, I change the portfolio, as when I sold and replaced AT&T (T) earlier this year (see article).

Focusing on reason #2 – reinvesting dividends – the following table shows how those purchases create small regular increments to the portfolio’s dividend income.

They seem insignificant each time, but they add up. The latest purchase is highlighted in yellow in the table below, and it concludes my reinvestments for 2021.

As highlighted in green at the bottom, the dividend reinvestments in 2021 have added $210 – or 4.3% – to the DGP’s annual dividend run-rate in 2021.

Another way to think about that: If every stock in the portfolio froze its dividend, my income would still go up 4.3% simply from dividend reinvestments each month.  That is the very definition of compounding: Making money on money already earned.

Here is how much each of the three mechanisms has added to my income run-rate in 2021:

And here is the total impact of those 3 mechanisms when you add them together:

As always, if you want to see the complete portfolio, I update it each month at its home page here. Since this month’s reinvestment added to an existing position, the portfolio remains at 31 holdings.

This article is not a recommendation to buy, hold, sell, trim, or add to Merck. Any investment requires your own due diligence. Always be sure to match your stocks and funds to your personal financial goals.

— Dave Van Knapp

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Source: DividendsAndIncome.com