This Real-Money Portfolio is a Cash Machine

My Dividend Growth Portfolio (DGP) is a real-life demonstration of dividend growth investing.

The portfolio is displayed on Daily Trade Alert. Just click the tab “Dividend Growth Investing” at the top of any page, and you will find a direct link to the portfolio.

I created the DGP a little over six years ago. The idea was to illustrate dividend growth investing in real time with real money. The DGP resides at E-Trade.

Besides being a demonstration portfolio, the DGP is a component of my wife’s and my retirement investments.

When I started it, the DGP’s value was $46,783.

No new money has been added to or removed from the portfolio since it was created. Dividends are received into the portfolio and reinvested, as I will explain later.

I don’t hold this portfolio out as the best or only way to execute a dividend growth strategy.

It is simply an example that I hope has educational value.

Let’s take a look at the portfolio’s performance in the first six months of 2014.

Steadily Rising Dividends

 

 

The DGP’s goal of steadily rising dividends has been met splendidly so far. This table shows actual dividends 2008-2013 plus a projection for 2014.

Let’s look at that in graphical form.

The estimate for 2014 (full year) takes into account upcoming dividend increases that have been announced. Thus it understates dividends that will be increased during the rest of the year, and of course it does not know about dividends from shares that I will purchase with incoming dividends.

The DGP has a current yield of 3.8%. For comparison, the S&P 500’s current yield is 1.9%. So my portfolio is generating cash twice as fast as an equivalent investment in the S&P 500.

Good Governance: The DGP’s Business Plan

To manage the Dividend Growth Portfolio, I created a business plan that spells out its goals, strategies, and tactics. I wrote the first plan in 2008 and amend it annually.

The complete document can be found here. I call it the Constitution for the portfolio, since it is the highest-level document. Some of its highlights include:

Goal Statement. My goal is to generate a steadily increasing stream of dividends paid by excellent, low-risk companies. Specifically, I want the portfolio to deliver 10 percent yield on cost within 10 years: $4678 by 2018.

I manage the portfolio for income optimization. Total returns happen as a byproduct of that central focus.

Strategies. The constitution lays out my strategies. They include:

• Use the current Top 40 Dividend Growth Stocks for 2014 as my shopping list.

• Buy only stocks with “Fair” or better valuations.

• Reinvest dividends when the incoming cash accumulates to $1000.

• Shoot for an eventual total of 20 to 25 stocks (there are 18 stocks now).

• Seriously consider selling any stock if:

(1) It cuts, freezes, or suspends its dividend.

(2) It bubbles or becomes seriously overvalued.

(3) Significant fundamental changes impact the company.

(4) It is going to be acquired.

(5) It announces plans to split itself up or to spin off a separate company.

(6) Its current yield rises above 9 percent or drops below 2.7 percent.

(7) Its size increases beyond 15 percent of the portfolio.

Portfolio Holdings

Here is the portfolio as it exists today, with each stock’s date of entry into the portfolio and the percentage it comprises of the whole portfolio. Some stocks have been purchased more than once; the entry date is the year of first purchase. The right-hand column shows 2014’s actual or expected dividend increases.

Reinvesting Dividends

As stated earlier, I do not “drip” dividends. Rather I accumulate them and reinvest them when they reach $1000. That allows me to hand-pick each stock for reinvestment. I might select a new stock, or I might purchase more of a stock that is already in the portfolio.

The DGP currently has $464 cash (less than 1% of the portfolio). That has come from dividends since the most recent reinvestment in May. When the sum reaches $1000, I will reinvest it. I project that will happen once more this year.

I have already made two reinvestments in 2014:

  • In January, I purchased 27 shares of Microsoft (MSFT). The stock currently yields 2.7%, and its market value has appreciated 12% since I bought it.
  • In May, I bought 15 shares of Ventas (VTR). It currently yields 4.5%, and its shares have declined 7%.

When my cash gets back up to $1000, I will make another purchase following the guidelines in my business plan. In a nutshell, the purchase will be of a Top-40 stock that is well valued and that I believe will improve the portfolio in some respect. Factors to be considered will include yield, expected dividend growth, the quality of the company, and good valuation.

Turnover

 

 

The DGP has never been a buy-and-forget portfolio. A better term would be buy and manage.

Since the beginning of the year, besides the two dividend reinvestments just described, I have made 6 other transactions.

Sold Intel (INTC). Intel failed to raise its dividend last year and still hasn’t. That is grounds for considering a sale, and I sold the stock in January. I made a slight profit and used the proceeds to fund the following two purchases.

Bought Coca-Cola (KO). This was a new stock for the DGP. The purchase is discussed in this article.

Bought more Philip Morris (PM). This added to a position begun last year.

• Sold Darden (DRI). In March, I became concerned about DRI’s overall business results (see this article). One of my concerns about the company was that it would not raise its dividend on schedule in July. That has come to pass, as DRI recently announced an unchanged dividend payment (at least they did not cut it). I sold the stock at a profit and used it to fund the following two purchases.

• Bought more Coca-Cola.

• Bought Procter & Gamble (PG). This brought another new stock into the portfolio. (See this article).

Bought Ventas. In May, I made my second dividend reinvestment of the year. VTR is a new position, bringing the total number of holdings to 18. (See this article.)

Currently I have one stock under special watch. Reynolds American (RAI) has floated a proposal to purchase Lorillard. I have a 63% paper profit in LO (it is a small position). RAI has never been a Top 40 stock, so I may sell LO at some point, although I will investigate RAI with the idea of just keeping it if and when they acquire LO. There is plenty of time to make this decision.

Performance: Total Return

 

 

As stated earlier, total return is not the main goal of the DGP, and I do not manage it for total return.

Nevertheless, total return happens. Total return is the sum of dividends plus price changes. The following chart compares the DGP’s total return to the S&P 500’s total return (with dividends reinvested). The DGP has never trailed the index since the portfolio’s inception.

Starting from its initial value of $46,783, the portfolio has increased in total value by 66% to $77,777. For comparison, the S&P 500 (represented by the ETF SPY), with dividends reinvested, has increased 59% in total value over the same time frame.

Looking Ahead – The Power of Compounding

 

 

I see the Dividend Growth Portfolio as a cash machine. It started with capital that I acquired elsewhere. But since it began, it is an investment operation that generates more cash each year.

The central principle on which this machine operates is compounding. Perhaps the most powerful financial force, compounding means making money on money already made.

In this portfolio, compounding occurs in two ways.

Dividend increases. To be a member of this portfolio, a company must reliably increase its dividends. That’s why Intel and Darden were cut loose: One company froze its dividend, the other seemed like it might freeze its dividend (which it later did). Even if they aren’t reinvested, dividends compound upon themselves. A 10% increase this year is piled upon the dividend increase from last year. Next year’s increase will be stacked upon both of them.

Dividend reinvestments. I am not living off these dividends yet, so I reinvest them. That is literally making money on money already made. The money already made is this year’s dividends. Those go to purchase new shares, which will themselves generate more dividends next year.

Because of compounding, the annual increase in income from the portfolio actually exceeds the average dividend increase of the stocks in the portfolio. For example, the average stock may have an increase of 8% in a year, but the total increase in the portfolio’s income may be 12%. The difference comes from compounding.

I stated earlier that the numeric goal for the portfolio’s dividend stream is to reach $4678 by 2018. As shown by the following graph, I am on target to reach that goal.

The upward curvature in both lines indicates compounding taking place. Each year’s increase in income is larger than the year before.

Dave Van Knapp
Author of Top 40 Dividend Growth Stocks