Why A DGI (Dividend Growth Investing) Portfolio?
There are generally two groups of investors. The first one believes in the power of compounding of dividends. The second group cares only about the total returns and couldn’t care less about the dividends. So, which group of investors have more powerful arguments? In fact, there are reasonable arguments that can be presented in favor of both belief systems. What will suit you more depends on your individual situation, income needs, risk tolerance, or psychological temperament.
We personally believe in DG Investing and think that should form the foundation of a portfolio. This is especially important for older investors or anyone who is getting close to 50 years old. When we say foundation or core portfolio, we mean the DGI portion should be the biggest part of the total portfolio, which may be close to 50% or more. One of the investment pyramids that we can recommend is presented below:
Image 1: Investment Pyramid
Also, in this article, our focus is on individual stocks rather than owning funds or ETFs (Exchange-Traded Funds). We will try to list both the advantages and disadvantages of owning a DGI stock portfolio.
Advantages:
- The process of selecting and forming a DGI portfolio is fairly easy and straightforward. Many folks think it is complicated, and you have to constantly research or read about stocks. Sure, it does not hurt to have as much knowledge as possible, but you do not have to spend a ton of time structuring a DGI portfolio either initially or to maintain it going forward.
- You do not need to own 30 or 40 stocks to make a diversified DGI portfolio. All you need is anything between 15-20 individual stocks.
- Once a portfolio is structured and initial positions have been acquired, there are no ongoing fees of any sort. Even to purchase the initial positions, there are no expenses or very minimal expenses. Most brokerage companies offer commission-free trades. It was not always like that, but this is the norm these days. This is not true with funds or ETFs; most of them charge upwards of 0.50% fees annually, but they can go much higher. It is also true that there are many low-cost ETFs or funds available, but most of them are either index funds or passive funds.
- With your individual stock portfolio, you only try to choose the best stocks. With funds, there is generally over-diversification, and that comes with the good and the bad. We know that over-diversification generally results in mediocre performance.
Disadvantages:
- Even if we try to downplay, there is no denying the fact that with owning and maintaining an individual stock portfolio, you need some level of interest and time to gain knowledge about the stocks that you want to own. You also need to spend some time on an ongoing basis (even if it is 3-4 hours a month) to read and research your current or prospective holdings.
- With some individual stocks, there can be more volatility compared to a fund that owns 200 positions. Though overall, a 15-stock DGI portfolio will generally be either less or as volatile as the S&P500. It will generally depend on the profile of your portfolio.
What Is the Simplest Way to Structure a DGI Portfolio:
In this article, we will follow one of the simplest methods of shortlisting the stocks. In this process, our initial list comes out to be of 50 different stocks, which is obviously way too many. Sure, to bring down our list from 40 to 15, we will apply a set of simple techniques that any investor can perform in an hour’s time using sites like Seeking Alpha.
While income is important and a must for retirees, one should not overlook the importance of growth. These days, more often than not, retirements can easily last 30-35 years. Your portfolio will outlast you only if it is oriented towards reasonable growth that easily beats the rate of inflation. The process outlined below makes sure that we at least have 1/3rd of the portfolio with high-growth stocks.
Step 1: First, we make a list of the top 10 holdings of some of the most popular DGI-oriented ETFs. These ETFs are:
- Schwab U.S. Dividend Equity ETF (SCHD)
- Vanguard High Dividend Yield Index ETF (VYM)
- Vanguard Dividend Appreciation Index ETF (VIG)
- SPDR S&P Dividend ETF (SDY)
- ProShares S&P500 Dividend Aristocrats ETF (NOBL).
Step 2: When we combine these 50 stocks (top 10 from the above 5 ETFs), there are some duplicates. We found eight duplicates, including one repeating three times. These duplicates were:
Air Products and Chemicals (APD), Broadcom (AVGO), Chevron (CVX), Johnson & Johnson (JNJ), JPMorgan Chase (JPM), NextEra (NEE), Procter & Gamble (PG), and Exxon Mobil (XOM).
CVX repeated three times, while others repeated two times. After removing the duplicates, we are left with 41 names.
Step 3: Now, we copy some data from the public financial website on the following metrics for each of the 41 stocks (from step-2). These data elements are:
- Dividend Yield %
- Average of 5-DGR and 10-DGR (5-year and 10-year div growth rate)
- Payment Ratio (Average, based on Cash-flow and EPS)
- Credit Rating (from S&P)
- We also copy the Number of Years of Dividend Growth
We sort on each of the above elements (first four), and from each one, we select the top 5 candidates. These are presented in the tables below.
Table-1A: Top 5, based on dividend yield
Table-1B: Top 5, based on average of 5-year and 10-year dividend growth
Table-1C: Top 5, based on lowest payout ratios
Table-1D: Top 5, based on Credit Rating
When we combine these four sets of 5 stocks each, we get 20 names. We find three duplicates among them (Apple, Chevron, and Microsoft), so after removing duplicates, we are left with 17 names. Then we sort the list by sector and remove two names:
- We find both Mastercard (MA) and Visa (V) on our list, so we remove Visa and kept MA. MA had a slight edge in terms of dividend growth.
- Also, we find Bank of America (BAC) and JPMorgan (JPM) on our final list. We want to keep just one big bank (not two), so we keep JPM and remove BAC.
- We also remove Walmart (WMT) as neither the yield is attractive (only at 1.24%) nor the past dividend growth. The dividend growth over the last 10 years has been anemic, at a little over 2%.
- However, now we are left with only 14 names, but since we did not have any utility stock in our final list, we added NextEra Energy (NEE) from our earlier list.
Now, we have 15 stocks on our list, which are presented below.
The Final DGI Portfolio:
Here is the final portfolio of 15 Stocks, in order of Sector:
These are Verizon (VZ), Chevron (CVX), JPMorgan Chase (JPM), Mastercard (MA), Johnson & Johnson (JNJ), Pfizer (PFE), UnitedHealth (UNH), Brown & Brown (BRO), Amcor PLC (AMCR), Realty Income (O), Home Depot (HD), Broadcom (AVGO), Apple Inc. (AAPL), Microsoft (MSFT), and NextEra Energy (NEE).
Table-2: The Final 15 DGI Stocks
Portfolio Highlights:
- The current dividend yield is mediocre at 2.96%. Even then, it is almost two and a half times better than that of the S&P500.
- The dividend growth is excellent at about 10.7%, with an average of 5-year and 10-year growth rates. If this group could maintain the same level of growth for the next five and ten years, the yield on the cost basis should grow to 5% and 8.2%, respectively, which sounds great. However, it is always good to remember that past performance is no guarantee of future results.
- The payout ratio is reasonably low at 45% (average), and that bodes well for future dividend increases.
- Out of 15 companies, 11 of them have an excellent credit rating of “A-“ or better. The other four also have investment-grade ratings. This shows the quality of the overall portfolio, and it is comforting to know that the debt levels of our companies are reasonable and well within their means of servicing those debts.
- Out of 15 companies, there are at least five companies (AAPL, MSFT, AVGO, MA, and UNH) that are high-growth stocks. In addition, there is another set of five companies (JPM, CVX, BRO, AMCR, and HD) that are likely to provide above-average growth. This set of 10 companies will ensure that this portfolio does not lag in total returns either.
Risk Considerations:
- Investments in any financial instrument or stock are inherently risky and subject to price fluctuations or losses.
- There is a general market risk. If the entire market takes a deep dive, most stocks in the above portfolio will take a dip along with the market.
- The general risks due to the worsening geopolitical situation.
- Many of our holdings are sensitive to the direction of interest rates. But this is not unique to this list. Also, as of now, all indications point out that the interest rates should start declining by the year’s end. That will help income-generating assets in very significant terms.
- There is no hedging mechanism in this portfolio, so in a deep market correction, the portfolio will lose value along with the broader market, and drawdowns cannot be predicted.
- Out of this group of 15, at least a couple of stocks, such as Johnson & Johnson and Pfizer, have been going through some difficult periods recently. In the case of JNJ, there are uncertainties over various litigations that the company has been facing over talcum powder products. In the case of Pfizer, there are concerns over the decline of Covid-related revenue and profitability, as well as its drugs pipeline. However, it appears that most of the bad news is already reflected in the price, and these two stocks can be considered turn-around candidates. However, investors should be aware of the risks in such situations.
Concluding Thoughts:
As stated in the introductory paragraph, we believe a DGI portfolio should form the core foundation of the overall portfolio. However, whether you choose to have individual dividend stocks or dividend funds should be guided by your personal preferences and temperament. Obviously, there are many paths to reach the same destination; however, the common requisites are regular saving and investing.
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