A couple weeks ago, I embarked on a project to solidify my Quality Snapshot rating system. You have probably already seen the Quality Snapshots used in various of my articles, especially the ones in the Valuation Zone series.
That project made me realize that one of the holdings in my Dividend Growth Portfolio (DGP) has fallen into a low-quality category, and I decided it was no longer suitable to hold it in the DGP.
While I was working on that, the DGP’s kitty of accumulating dividends topped $1000, which is the trigger for reinvesting them.
So for this article, I decided to combine the two events. What follows is about portfolio management in two acts:
- Deciding to sell and replace a low-quality holding to improve long-term portfolio safety.
- Reinvesting dividends.
Act 1: Reviewing Portfolio Quality
I derive Quality Snapshots from the following sources, which I have come to trust and respect over the years:
- Safety and Financial Strength grades from Value Line
- S&P’s Credit rating
- Morningstar’s Moat rating, and
- Simply Safe Dividends’ Dividend Safety grade.
That gives me five factors to consider. I developed a straightforward points system for each factor. In the table, NA means “not applicable.”
As you can see, each factor can get 0-5 points. To create the Quality Snapshot for a company, I total up its quality points. The highest possible total is 25 points.
To interpret those totals. I use the following ranges.
The rankings are perhaps a bit more demanding than some investors would require, but I tend towards conservatism and safety. Obviously, anyone can adjust the system to suit themselves.
After I solidified the system as shown, I applied it to each stock in the DGP. The next table shows the results. The table is sorted from highest to lowest total quality points for each stock.
Of the 26 stocks in the portfolio, 16 are in the green ranges, with Excellent or Above Average quality scores. Another 9 holdings, in the yellow range, are solid, Investment Grade stocks.
Apart from its poor quality score, Ventas has been on my radar for another reason.
Its 2019 dividend increase was miniscule at 0.3%.
Then this January, when one would have expected its 2020 increase, they announced none, choosing to continue with the same dividend payout.
In other words, Ventas’ dividend is frozen.
Not good. I decided to sell Ventas – despite its 5.6% yield – and replace it.
Act 2: Dividend Reinvestment at the Same Time
Under the DGP’s business plan, I collect dividends and reinvest them when the cash tops $1000. That happened a few days ago.
So this article is about two aspects of portfolio management:
- Deciding when to let a stock go and replace it.
- Reinvesting dividends.
The next step in both examples of portfolio management is selecting a stock or stocks to buy. In one case, it’s to replace a stock being sold. In the second case, it’s to decide where to reinvest dividends.
Choosing What to Buy
I draw my purchase candidates from two prospect pools:
- Stocks that I have written favorably about in the past 12 months that are still undervalued.
- Stocks already in the portfolio that are undervalued, provided that they do not already occupy more than 6% of the portfolio.
To buy a new stock, I usually require that it yields at least 2.7% at time of purchase. That has nothing to do with dividend growth investing in general, it’s just a mental goal that I’ve established for this portfolio.
After winnowing down candidates from the two pools, here are the finalists:
I decided to select Enbridge and Texas Instruments, which will mean adding to the DGP’s two smallest positions.
- Enbridge is not in the “green” quality range, but it sports a high yield, good DGR, and attractive under-valuation.
- Texas Instruments is extremely high quality, which justifies paying much closer to fair value for it and accepting its middling yield. It also sports a very good DGR.
I decided to buy enough Enbridge to approximately match the income I was getting from Ventas. (That leaves a little money left over, which goes into the dividend kitty.) And I decided to buy the usual dividend-reinvestment amount of $1000 of Texas Instruments.
So on Wednesday, January 15, I made three changes to the portfolio.
- Sold Ventas out, eliminating it from the portfolio.
- Bought Enbridge to replace it, adding to an existing position.
- Bought Texas Instruments with reinvested dividends, also adding to an existing position.
Portfolio Before and After
The three transactions increased not only the portfolio’s quality, but also its income.
This graphic from Simply Safe Dividends shows the portfolio’s annual rate of dividend income before the changes.
And this shows the portfolio’s income after the transactions:
As you can see, the DGP’s income increased by $33 per year, or a little under 1%.
When combined with several dividend raises that have been announced for the new year, the DGP’s yield on cost has been pushed up to 9.8%. It is getting close to a mental target I have had since initiating the portfolio in 2008: Having it yield – meaning pay me – 10% of my original cost each year.
Since I eliminated one stock (Ventas) and added to two existing positions (Enbridge and Texas Instruments), the number of stocks in the DGP drops from 26 to 25.
I have always focused on quality in building the Dividend Growth Portfolio, but years of experience have led me not only to improve my methods for ascertaining quality, but also to become more conservative in wanting to hold only high-quality stocks.
A year ago, Ventas was a higher-quality stock than it is now. It had a better dividend safety score, and it had not frozen its dividend. But now, it has become a stock that required watching, both because of its frozen dividend and also on the basis of declining quality.
That’s not the direction I want the DGP to go. So I feel that I de-risked the portfolio a little by getting rid of Ventas. Its replacement (Enbridge) is a little better-quality company that brings a higher yield and better dividend growth record along with it.
The dividend reinvestment into Texas Instruments is nearly a no-brainer. Its yield is adequate, as is its dividend growth record. Texas Instruments is a very high-quality company that pulls up the quality – and reduces the risk – of the whole portfolio.
— Dave Van Knapp
Other Reading Resources
If you are interested in the topics raised in this article, here are a few places to learn more:
The Highest Quality Stock to Buy Today: Texas Instruments (Money Morning Staff, May 2019)
Dividend Growth Stock of the Month for October, 2019: Enbridge (Dave Van Knapp)
Undervalued Dividend Growth Stock of the Week: Enbridge, Inc. (Jason Fieber, August 2019)Buy This $5 Stock BEFORE This Apple Project Goes Live [sponsor]
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